Base Case & Quick Notes

• Charter Communications (“CHTR”) is the second-largest provider of broadband internet in the U.S., with ~26% market share by subscribers.

• CHTR controls vast swaths of critical infrastructure across the U.S. that would cost tens (perhaps hundreds) of billions to replicate.

• The consumer internet market is in turmoil post-COVID, as it experiences the largest secular shift in market dynamics since cable displaced DSL in the 1990s.

• Despite secular shifts, we believe cable infrastructure will remain the dominant form of internet as we reach a new equilibrium.

• At today’s price, CHTR’s phenomenal utility-like asset base is selling for <10x FCFF even before accounting for a pending merger, back-cycle earnings, and more.

Thesis Summary

Charter Communications (“CHTR”) is the second-largest high-speed internet provider in the U.S., serving c.26% of consumers nationwide. Historically, an attractive MSD% grower with monopolistic regional positioning, CHTR’s competitive edge has recently come under scrutiny due to a series of cyclical and secular issues, which have driven a protracted re-rate in the stock.

Charter’s current valuation implies a meaningful extension of recent (mostly subsidy-related) subscriber losses, which seems unreasonable when examining the competitive environment. Competition clearly points to moderation in growth going forward, but CHTR is priced well beyond moderation; the stock is priced as if it were a cigar butt.

At 9x Core FCFF and 6.5x P/E, we believe CHTR presents an extremely attractive r/r ratio against our base case of broadband stabilization. Moreover, we see a clear path to inflection over the next 12 – 24 months as broadband net additions stabilize, capex inflects lower, and CHTR returns to aggressive buybacks. Further, we believe that additional upside will be injected into our model through the recently announced Cox merger (pending regulatory approvals).

Recent Events

• December 2021. FCC introduces a broad subsidy program, the Affordable Connectivity Program (ACP), for broadband internet.

• June 2024. ACP subsidies officially end, setting up extended broadband churn in Charter’s subscriber base.

• November 2024. Charter ratifies an all-stock deal to acquire Liberty Broadband, aiming to simplify its capital structure.

• May 2025. Charter announces Cox Communications merger. Deal still pending approvals.

Why Does This Opportunity Exist?

• Competitive Uncertainty. For decades, Charter’s Hybrid Fiber Coaxial (HFC) infrastructure was the dominant form of broadband, operating as a regional monopoly wherever it was deployed. New competitors FWA and Fiber have challenged HFC, adding significant competitive pressure to previously monoplistic markets.

• Abysmal Sentiment. We’ve universally heard that investors have chosen to sideline themselves regardless of valuation until broadband subs begin to inflect and sentiment turns. Charter is among the most hated stocks in the S&P 500 after its precipitous multi-year downturn.

• Technical Dynamics. Charter has neatly come into the crosshairs of the increasingly important long/short equity pods1. Pods can cleanly trade quarterly net broadband additions and pair the stock against near-peer Comcast. This has created massive volatility around earnings revisions and quarterly prints.

Business Background

Charter serves 31 million+ consumers and businesses with cable TV, broadband internet, landline, and wireless services. Charter’s footprint spans 58 million passings across many major hubs, primarily in the Eastern and Midwestern United States. A high-speed internet behemoth, the firm is only outstripped by Comcast’s Xfinity (28% share). Below is a brief description of core business lines:

• Internet (43% Sales): High-speed internet services through a blended hybrid-fiber coaxial (HFC) and fiber to the home (FTTH) network. By far, Charter’s most important segment. Although the company doesn’t provide segmental profits, we estimate that Internet services account for the vast majority of earnings today.

• Video (25% Sales): Charter’s cable TV business still accounts for a substantial portion of sales, but is an immaterial profit center. Disclosed programming costs imply a stable 35% GPM, while our pro-forma OpEx allocation indicates ~0% EBIT margins. Video services are almost entirely variable cost, allowing for an orderly winddown of the service as it inevitably declines. Video services are maintained primarily to reduce churn.

• Wireless (6.5% Sales): In 2018, Charter launched Spectrum Mobile, a discount mobile service, through an MVNO relationship with Verizon. Today, Spectrum Mobile is the fastest-growing mobile network in the U.S. and the primary driver of growth for Charter. Historically a loss leader, mobile's EBITDA has turned positive in recent quarters and is expected to scale meaningfully from here.

Charter also generates revenue through landlines, advertisements, mobile device sales, and business customers (aggregate ~20% of revenues). Overall, these services are not significant profit or growth centers.

One of Charter’s main selling points is its “converged” offering, available through its Spectrum One package, which bundles entertainment, internet, and mobile services at a significant discount compared to purchasing each service separately. Bundling reduces churn, significantly improves CHTR’s customer LTV, and drives better total ARPU per relationship. Charter is the market leader in convergence and maintains that its converged offerings are a competitive advantage.

History of cable and evolving landscape

The cable industry has a complex and often misunderstood history. Cable infrastructure was initially laid in the 1960s and ‘70s to deliver TV to the home, but shortly after the internet emerged, the coaxial network was repurposed as a high-speed competitor to DSL. By the 2000s, cable had become the standard for consumer internet, as it was faster, more scalable, and more convenient than any other form of transmission. Fast forward to today, and, while many of us still think of cable companies as declining Pay TV media firms, CHTR and peers now primarily focus on internet delivery, earning only minimal profit from their legacy operations.

Unlike the now-dying cable TV business (which receives disproportionate press fanfare), CHTR’s broadband business has long enjoyed secular growth as data consumption has grown exponentially. Moreover, the business is enviably moaty, as Cable operates as a regional monopoly with excellent incremental margins, robust pricing power, and (until recently) ample opportunities to add new marginal subscribers through network buildout and increased penetration. Cable internet growth has been so strong, in fact, that Charter has delivered decades of consistent MSD% growth at accretive incrementals, even as its cable TV business shrank.

Unfortunately for Charter, post-COVID, broadband dynamics began to shift dramatically. In 2021, Verizon and T-Mobile launched and scaled value-oriented competitor networks via “Fixed Wireless Access (FWA)” by leveraging unused spectrum to deliver 5G internet to homes. Contemporaneously, “fiber overbuilders” (legacy DSL companies replacing copper networks with modern fiber) became increasingly aggressive in building “the network of the future” (seemingly without regard to their own economics). The introduction of FWA and fiber converted many historically monopolistic markets into triopolies, adding competition to an industry that previously faced none.

FWA and Fiber have compellingly attacked Charter’s subscriber base from opposite ends of the value spectrum. FWA is slower and less reliable, but it provides an excellent value proposition for price-conscious consumers ($30/month). By contrast, Fiber is a faster network offering speeds of up to 5/5 symmetric (and beyond), and is marketed as a premium internet connection. Both FWA and Fiber have attracted significant market share at the cost of HFC growth.

Market competition in numbers

We can clearly see the competitive story play out in the chart above. Pre-COVID, broadband adoption progressed predictably, adding incremental subscribers as more consumers required broadband and rural buildouts gradually replaced residual DSL customers. In COVID, this trend markedly changed.

• FY2020: We witnessed a dramatic pull-forward in broadband subscriptions, driven by WFH mandates and a massive broadband access subsidy, known as the Affordable Connectivity Program (ACP).

• FY2021: ACP-related pull-forward and beginning ramp of FWA created a modestly weak year for net additions.

• FY2022: Net additions plummeted in 2H22. The broadband market finally reached saturation. Net additions in broadband disproportionately moved to FWA as consumers felt the pinch of inflation. Meanwhile, fiber became a more significant competitor, aggressively leveraging cheap debt to expand its infrastructure.

• FY2023: Broadband struggled to add subscribers in the face of increased competition. Growth had obviously slowed, and FWA continued to win the rural war for incremental additions.

• FY2024: For the first time in cable’s history, net additions turned sustained negative. Increased competition stifled growth, but the expiry of the ACP drove losses. Previously subsidized consumers flocked to FWA.

In 2025, we’ve seen a continuation in net losses from the ACP expiry. While many subs churned early, others remained on CHTR’s network as non-paying customers. As we fully lapped ACP expiry in 2H25, we’ve seen an increase in forced churn.

Fundamentally broken or myopic sell-off?

Against the current competitive backdrop and declining subscribers, investors are now questioning whether CHTR and its peers are fundamentally broken companies. We believe the answer is a resounding “no,” with the conviction that forward sentiment and multiples are far too low. We will address why we think FWA and Fiber are not going to “kill” HFC individually.

1. Will Fiber kill HFC over the long term?

One concern investors raise is that Fiber is a cable killer. Fiber offers faster symmetric speeds than HFC and has greater ability to scale in the future. The tech has captured significant (c.40%) market share wherever available. Consumers of all ages are aware that fiber is faster than legacy infrastructure, and fiber companies have actively marketed themselves as the premium/futuristic option to great effect.

What many consumers don’t realize is that Fiber’s enhanced speed is almost universally irrelevant. Below, we provide a graphic from an FBA whitepaper, citing that the average family of four today only needs ~400 Mbps down (barely better than an FWA connect). Beyond this speed, most of the extra bandwidth available is effectively wasted.

Even looking well into the future, data demand is unlikely to exceed 10 Gbps for the average household in our lifetime, rending Fiber’s ability to scale to "100/100” irrelevant. Crucially, current HFC infrastructure already delivers speeds well beyond consumer needs (1 Gbps in most of the footprint). But even this is only a starting point. Legacy network speeds can be scaled at a relatively low cost by deploying modern protocols (DOCSIS 4.0), which will ultimately move cable to 10 Gbps down across the network, far beyond any reasonable expectation for demand over the coming decades.

2. Is FWA the future? Will it continue to absorb the majority of net additions?

Ramp in FWA has astonished market participants since its emergence in 2021. Both telcos and cable companies underestimated market demand for value-seeking broadband customers. Furthermore, demand clearly continues to be unmet, as evidenced by rapid net additions. AT&T’s purchase of SATS’s spectrum is a clear bid to get aggressive in the space. Meanwhile, T-Mobile and Verizon’s solutions show no signs of slowing down. Ultimately, though, there is a reasonable limit to FWA market share, both due to spectrum constraints and consumer preference.

FWA necessarily trades off speed and reliability for price. Moreover, in urban environments, network congestion reduces usability in peak traffic times. FWA satisfies specific niches in the market, such as rural consumers transitioning from DSL, price-sensitive urban consumers, and non-family households with low bandwidth requirements. FWA is, however, inadequate for larger families or those that need or prioritize network reliability at home. As a general rule of thumb, those who can afford the modest marginal cost for a better internet experience will happily pay that cost.

On the flip side, the supply side of FWA is finite. Selling spectrum as FWA is an inefficient use of limited spectrum assets by the telcos. FWA’s uptake has been limited due to the mass of unused spectrum in Verizon and T-Mobile’s networks, which incentivizes the “wholesaling” of the dead spectrum. In other words, almost regardless of long-term demand, FWA will eventually cap out the amount of spectrum reasonable to use on the service.

We haven’t reached equilibrium in FWA yet, but we can take solace in the fact that we must reach equilibrium sooner or later. Both supply and demand are necessarily finite.

3. Why do expectations reflect dire straits for Charter?

Sentiment may have never been lower in the cable space. CHTR’s stock has cratered as competition entered, whipsawed wildly for two years now, and left many long-term cable bulls disappointed. Many would-be buyers have been burned too badly or are currently bag-holders in size (Harris Associates, Dodge & Cox, and more). The last quarter's miss in expectations, coupled with a seeming total lack of awareness by management, shook investor confidence at a time when confidence was already on thin ice. Taking a step back, however, we see a significant disconnect between the tangible narrative and current multiples.

Charter is priced at 6x consensus forward earnings, implying cigar butt territory. Meanwhile, fundamentals paint a very different picture. Capital intensity is about to moderate significantly as recent edge buildouts and network upgrades subside. ACP roll-off is one quarter away from being completely worked out of the system, which will put net additions into ~flat territory y/y in 2026. Competition remains rational from the telcos as the industry still remembers pain from the T-Mobile price war years ago.

For reasons outlined above, we believe HFC will remain the dominant form of broadband, although the days of a 60%+ market share and consistently high growth are gone. Finding equilibrium is going to take time (1 – 2 years), but we’ll see re-rates in the stock well before we reach stability. In the interim? Charter is a cash machine, consolidating the #3 players, and only a few quarters away from flipping from investment cycle to capital return cycle. Too many investors have been burned for too long for the market to be acting rationale.

Cox Communications Merger

Given the competitive backdrop and pressure that legacy cable is now facing, Charter and Cox have proposed a cash-and-stock merger that will catapult Charter to #1 market share post-merger (32% pro-forma). With merger markets now seemingly wide open and the FCC more supportive of consolidation than ever before, we, along with most telecom pundits, believe the merger will close without issue. This case is further strengthened by the fact that Cox and Charter’s networks are non-overlapping, and Charter intends to reshore a significant number of jobs post-close, pursuing an explicitly “America first” messaging strategy.

We believe the Cox combination makes tremendous strategic sense for Charter from both a valuation perspective (pre-synergy, only 6.44x EBITDA for the enterprise) and a strategic growth perspective. Cox has ~12m passings with 5.6m internet subs but no meaningful mobile subscribers. Charter, meanwhile, has the fastest-growing mobile network in the U.S. with strong cross-sell on their internet products. Shifting to more converged customers will naturally reduce churn and increase ARPU across Cox. While CHTR hasn’t outright said this is the plan, we think it’s telling that Charter’s press release and investor presentation repeatedly placed mobile as the first product listed, despite mobile only accounting for <5% of the combined entity’s revenue.

We estimate the Cox mobile opportunity at $1 - 2b in mobile revenue, based on a $20 - $30/line/month and a 30-50% run-rate penetration. Assuming mid-point on our estimates, this implies a post-synergy multiple <6.0x EBITDA. Even lower when accounting for the recent decline in the CHTR equity component, with the implied multiple now approaching 5.0x EBITDA on today’s prices.

Idiosyncrasies in the modeling obfuscate true economics

Capital structure adjustments

Charter’s capital structure is complex. The following items need to be adjusted to accurate portray the stock.

• Advance/Newhouse (A/N) received Common Units instead of Common Stock in the 2016 TWC deal. GAAP accounting classifies this as NCI and excludes units from the diluted shares. We convert the units to a common and remove the NCI to correct the distortion.

• CHTR carries a significant deferred tax liability that is unlikely to reverse. Two-thirds of the liability is related to a step-up in basis resulting from the TWC merger, only reversible in liquidation. The balance is TCJA bonus depreciation, which will no longer reverse due to the passage of the OBBBA.

• Charter’s pending merger with Liberty Broadband (LBRDK) will decrease shares outstanding by ~9.3m and increase debt by $2.2b.

Liberty Broadband Merger

Charter entered a definitive agreement to merger with LBRDK in an all-stock deal that roughly amounts to a levered share buyback at a modest discount to market value. The mechanics of the deal are well covered in our prior article.

The initial timeline on the LBRDK deal was June 2027, but this has been accelerated in light of the Cox merger. LBRDK will fully merge with Charter prior to the Cox closure, once regulatory approval for the Cox transaction is obtained.

Given all this, we prefer to own LBRDK versus CHTR as a means of capturing the modest 4% merger discount currently in play. We believe it is extraordinarily unlikely that the deal will not close.

Cox Merger

Structurally, Charter intends to assume Cox’s name (seemingly a nod to the Cox family's interest in their legacy), but will retire the Cox cable brand in favor of Spectrum (this makes sense as Spectrum is a household name while Cox is not). The deal is structured as $4b in cash, $6b in 6.875% convertible preferred, and 33.6m common units. On a fully converted basis, the Cox family will own 23% of Charter pro forma.

Phenomenal Debt Stack

A unique and perhaps underappreciated aspect of the Charter capital structure is its long-dated and low-rate capital stack. The majority of Charter’s debt (89%) is fixed-rate with a WA interest of only 5.2%. This debt acts as an asset to shareholders as duration significantly lowers the value of the debt stack. We value Charter using the Level 1/2 fair market values of the debt to capture this benefit. Below we’ve snipped the 2040 and onward fixed rate maturities (par value on far right):

Valuation

Note: Our base case, as outlined here, does not account for the potential benefit of the pending Cox merger. It does capture the pending LBRDK capital structure shift and the impact of the OBBB on Charter’s financials.

Summary Financials

Key Risks

• Competition. Our base case, as outlined, suggests that:

  • (a) FTTH will not be competitive in pricing compared to bundled HFC and has no major benefit over legacy infrastructure.

  • (b) FWA service is inherently capacity-constrained, limiting long-term market share, and an inadequate product for most consumers.

  If FWA capacity or bandwidth improves significantly (perhaps through integration with LEOs), this could erode LT broadband subs. Alternatively, if consumer demand for data advances sufficiently, then FTTH could displace HFC.

• Irrational Competition. Currently, all three players are behaving reasonably. We’re seeing heavy discounting in sign-up bonuses and bundles, but no cuts to long-term pricing. If one player breaks ranks for share, we could see ARPU go into a tailspin.

• Accelerated cable death. Pay-TV continues to bleed subscribers due to cord-cutting. If cable sub losses meaningfully accelerate, this could weaken Charter’s bundled value prop and increase churn. There may be more fixed costs in the cable business than we believe.

Catalysts

• Net broadband subs. The key issue right now is stabilization in net broadband subscribers. As stabilization occurs, the bear thesis will break, and the stock will re-rate significantly.

• Merger synergies. Sell-side is reluctant to model upside for the Cox merger due to regulatory and timing uncertainty. As the merger strategy is more clearly articulated, we expect to see marginal buyers.

• Capex discipline. Moderation in rural buildouts and network upgrades is around the corner. Moderation will result in significant cash inflection and a return to aggressive buybacks.

Conclusion

CHTR remains a dominant force in the broadband landscape, a status unlikely to change anytime soon. It has been interesting to watch CHTR evolve from a competitionless monopolist in secular growth to an oligopolist in maturity. That shift has been painful and left many investors reeling, but we believe the resulting hatred of the space has opened up opportunity. Keeping a sanguine demeanor, we believe sentiment is far too low and remind investors, “it’s darkest before the dawn.” Equilibrium appears to be around the corner.

We see several ways this story can unfold. First, natural moderation in losses (and eventually a return to modest growth) in subscribers, as outlined above, will almost certainly drive a massive re-rate. This seems nearly inevitable given that most (perhaps all) of the last six quarters of sub losses were subsidy-related. Beyond stabilization, we believe the market underappreciates growth synergies in the Cox merger and the firepower Charter will bring to bear on buybacks over the next 12-24 months as capex abates.

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• American Axle (“AXL”), a Tier 1 auto supplier specializing in beam axles, is merging with key driveline competitor Dowlais (“DWL”) in a transformative deal that will create significant scale and market share.

• Credible cost synergies create material upside to the CombineCo, implying an outrageous 1.75x post-synergy FCFE even in a flat environment.

• AXL’s America-first positioning and over-indexing to U.S. SUVs and pick-up trucks set to provide long-tail core revenues, even as secular changes warp the global marketplace.

• We believe the upcoming merger creates a highly cash-generative market leader positioned to take share even in a stale production environment. At <2.0x FY29 FCFE, we believe AXL is far too cheap. Our base case implies 3.5x upside over the next five years.

Thesis Summary

Tier 1 auto manufacturers American Axle (“AXL”) and Dowlais (“DWL”) are set to combine in a fully ratified transformative merger in 4Q25. The resulting CombineCo will be the clear market leader in driveline and the sixth-largest auto parts producer in the world. We believe the market currently underappreciates the industrial logic of this deal, which presents massive cost synergies, material market share gain opportunities, and a meaningful derisking of the AXL legacy business.

Important for us, the current setup implies massive upside even in a flat GLVP1 environment, as AXL management has multiple self-help levers and ample cash flows to pull them. We anticipate rapid post-merger deleveraging, which will drive a material re-rate to the equity. Moreover, even if the market continues to underappreciate the business, run-rate FCF is so high that shareholder returns alone are sufficient to generate a market-beating IRR as the business hits equilibrium.

Even with tepid assumptions, we believe the CombineCo can deliver 350% upside (32% IRR) over the next five years.

Recent Events

• November 2016. AXL announces mega-deal with PE-backed Metaldyne (NYSE: MPG) for 6.8x EBITDA. AXL levers itself for the purchase.

• April 2017. Metaldyne deal closes.

• December 2020. Over the three years following, MPG goodwill is written down to zero as margins deteriorate due to “prior underinvestment in the business” by PE sponsors and a meaningful downturn in global production.

• January 2025. American Axle announces its intent to merge with Dowlais. The deal implies 4.1x EBITDA, far below a normal market price.

• April 2025. Trump announces brutal tariffs. AXL stock falls 30%+ on the month.

• May 2025. Concessions provide relief for auto tariffs. D3 OEMs set about reshoring production. AXL closes month 40%+ off its low.

• July 2025. July 15, shareholders at AXL approved the merger. July 22, DWL shareholders approved merger. Majority of regulators sign letters of approval.

Why Does This Opportunity Exist

• ICE Exposure. Legacy ICE platforms generate the majority of AXL revenue. Investors fear that AXL cannot shift its products to newer EV platforms and, as such, may have no terminal value. In reality, AXL sells virtually all of its product into SUVs and pickup trucks for the U.S. market, long-tail platforms unlikely to be displaced in the foreseeable future.

• Sentiment Malaise. Chinese auto production has warped the global market, as has recent fervor around EV platforms. Tariff and recession fears have created further uncertainty. Autos sentiment is at a multi-decade low, with many investors viewing the space as “uninvestable.”

• Leverage Concerns. In 2017, AXL purchased PE-backed Metaldyne (“MPG”) using significant leverage. As MPG and the broader autos industry deteriorated, AXL has struggled to delever, creating a persistent valuation discount.

• Complexity. Pro forma deal financials have not been published yet. DWL has several idiosyncrasies in accounting and is only now inflecting to higher cashflows. Currency and accounting translations further muddy the water.

American Axle: A Brief History

Legacy American Axle was formed in 1994 when General Motors divested the majority of its auto parts manufacturing and metal forming plants in a large-scale asset sale. Capitalizing on the sale, U.S. autos veteran and founder Robert Dauch (now retired) headed an investment group that purchased five plants, creating the base for American Axle. These plants focused primarily on beam axle manufacturing, supported by driveline-related metal forming, such as differential gear assemblies. American Axle’s legacy with GM positions it uniquely in the marketplace. Its primary customer remains GM today, and its geographic focus remains soundly in the North American market.

In the early days, AXL had virtually no customers outside of GM, which accounted for ~99% of revenue. Today, the business has worked to diversify itself more thoroughly, but GM remains its anchor customer, accounting for 42% of LTM sales. Ford, AXL’s second-largest customer, makes up another 14% of the sales, which heavily indexes AXL to North America (LTM Sales: 76%).

AXL’s crown jewel product line remains its namesake light truck beam axles (e.g., axles found in SUVs, pick-up trucks, and crossovers), which account for an estimated 30% of revenues today. AXL has a good reputation in the space and maintains a healthy global market share of ~6-8%, roughly in line with larger diversified peers such as Magnera. AXL’s business is long-term stable, as each OEM tends to use the same Tier 1 axles for next-generation driveline platforms as prior generations. This insulates AXL from switching costs but largely inhibits the company’s growth prospects as winning a new OEM is unlikely.

In 2017, in a bid to inject growth and scale into their business, AXL executed a transformative merger, purchasing publicly traded metal forming business Metaldyne Performance Group (MPG) in a cash and stock deal valuing the enterprise at 6.8x EBITDA. Management touted ~1.5 turns of cost synergies, reduced customer concentration, and diversification as key benefits of the deal. Unfortunately, the deal, ill-timed and seemingly improperly due-diligenced, has turned into an albatross around AXL’s neck for the last eight years.

From a broad market perspective, AXL couldn’t have bought MPG at a worse time. Global auto production peaked in 2017 and, nearly a decade later, has yet to recover. While no one fully understands why, we believe the market simply reached a global saturation point at the same time that technology improvements began to extend car lives. If true, this implies production may not reach peak levels again for decades, particularly in AXL’s primary North American market, effectively capping hope for a return to secular growth.

At the same time that volumes declined, underinvestment in the platform by PE sponsors created tremendous pressure on MPG’s metal forming unit, resulting in significant write-downs and margin deterioration. Subsequent COVID-driven demand destruction put the final nail in the coffin for the deal as volumes declined precipitously, reducing cashflow, and gutting AXL’s ability to delever on the schedule they anticipated.

While metal forming revenues have recovered and even grown post-COVID, margins remain deeply depressed due to persistent challenges related to input costs and labor inflation. Management has stated that we may be nearing a return to profit growth in the segment as AXL concludes a multi-year restructuring project aimed at bringing costs under control.

Past issues aside, we think the market is not taking a nuanced enough view of AXL’s idiosyncratic competitive position. Market participants appear to have lumped together and sold legacy autos as secular losers in the face of shifting EV demand and growing consensus that global OEMs are structurally disadvantaged relative to their Chinese counterparts.

We generally agree with this sentiment and, in fact, struggle to imagine why investors would want exposure to the vast majority of globally diversified Tier 1s or OEMs, despite eye-wateringly low valuations. The recent Trump trade war has injected even more near-term uncertainty into cost structure and demand, making an already troubled, cyclical industry even more unpleasant for investors.

Interestingly, AXL’s portfolio is uniquely insulated from many of these dynamics. U.S. EV penetration has been slow compared to Asian and European counterparts, primarily due to cultural aversion, lower regulatory incentives, and a greater need for long-distance driving than most other countries. Meanwhile, five years into the EV revolution, many consumers are rethinking battery electric vehicles in favor of extended range EVs and plug-in hybrids. These changes significantly extended the expected life of AXL’s core platforms and resuscitated OEM investment.

On top of this, AXL’s primary platforms are the least likely to be electrified of any in the world: heavy-duty U.S.-made pick-up trucks and SUVs. Full BEV electrification of these platforms is logistically infeasible today, given the heavier weight and performance-oriented use cases for the vehicles. Even if electrification were practicable, many core consumers are adamantly opposed to switching off ICE. Recent EV launch failures serve as a real-world case study corroborating this idea (Source 1; Source 2)

In the last few months, an additional tailwind has emerged: America-first reshoring of auto manufacturing. It’s too early to know if Trump’s goal of reshoring production will be successful, but if it is, AXL will inevitably be a disproportionate winner. AXL already has spare U.S. capacity and a well-developed U.S. footprint. Additionally, the majority of AXL’s parts manufactured in Mexico and Canada are USMCA-compliant and thus insulated from tariffs. We are already seeing OEMs begin to turn their wheels on product reshoring from Mexico and Canada, notably from anchor customer GM.

Note: We encourage readers to review our original Dowlais deep dive to better understand why we believe Dowlais is also unique positioned.

Meaningful Industrial Logic In The Combination

The proposed American Axle-Dowlais combination creates a unified, at-scale entity (the #6 largest Tier 1 supplier in the world by revenue) while simultaneously removing many of AXL’s most obvious overhangs. DWL’s driveline portfolio is majority propulsion agnostic, adding balance to AXL’s ICE-heavy product lines. AXL’s metal forming business is globally strong in forming and casting, but previously did not have sintering and powder met capabilities. Dowlais’ Powder Met business is a global market leader in these technologies, and by combining the two, the unified platform will capture the whole metal forming stack and be head and shoulders larger than their next closest peers.

DWL manages a diversified global customer base with strong exposure to China via long-standing, successful JVs. This base will help derisk AXL by diluting AXL’s single customer reliance and geographic focus and providing a solid foothold in the growing Chinese market (PF 24% GM revenue exposure; 54% North America).

Finally, the combined entity will be better equipped to compete for next-gen platforms as DWL’s eDrive is complementary to AXL’s eBeam systems, creating a more unified NextGen platform. Both companies have invested heavily in electric driveline systems that we see as synergistically strong, despite being relatively weak separately.

Beyond qualitative derisking in Legacy AXL’s portfolio, industrial logic from a cost perspective is exceptional. Management has cited $300m in annual run-rate cost synergies realizable over a three-year horizon. This means that expected cost synergies alone are nearly 50% of AXL’s current market cap. Generally, we are highly skeptical of underwriting synergy expectations, but in this case, we believe that savings are not only attainable but likely understated.

Unlike in the U.S., U.K. takeover law requires independent third-party auditors to verify the reasonableness of synergy estimates presented during a merger. Under this process, company management determines discreet synergy expectations, then the audit team conducts a feasibility study and assigns a risk discounting factor. Once the third-party auditor has signed off on the synergies, AXL’s own auditor must also review and sign off.

For example, management may believe that automating a production line will save $20m per year. Under U.K. law, the auditor will review this analysis, determine if it is credible, and then assign a confidence factor (let’s say 75%, in this case) by which it will multiply the synergy estimate. This means that management can then include the synergy in investor presentations at a $15m value, even though they expect $20m.

Because AXL and DWL are direct competitors, AXL was not able to conduct in-person factory visits or open certain books and records as they might in a normal process. This led to high uncertainty factors from the auditors in many key footprint optimization estimates. AXL management says that in these cases, synergy estimates were discounted by as much as 70% off face value.

Even without the benefit of a third-party audit, we find synergy estimates reasonable. DWL and AXL’s global manufacturing and research footprints overlap directly. In Auburn Hills, Michigan, DWL and AXL have research centers within a fifteen-minute drive of each other. In Luxembourg, DWL has two facilities within a one-hour drive of AXL’s R&D facility. Manufacturing footprints in Mexico and America are both reported to have spare capacity, suggesting potential for optimization there. In many cases, management simply needs to move employees from one building to another (with some downsizing) and sell the empty office to create cost savings.

Even more convincingly, half of the $300m in synergies are from purchasing power savings. This makes sense as the combined entity will be ~double the size of Legacy AXL. Basic inputs (steel, rubber, aluminum, etc.) are virtually 100% overlapping between the businesses, allowing for better logistics contracts and bulk input discounts across the entire entity.

Throughout the due diligence process, we were surprised by how uniformly credible industry experts and analysts found the synergies. We were repeatedly told that synergies not only appear realizable but that they are likely conservative, due to the audit process. On top of this, we believe current CEO David Dauch is incentivized to sandbag figures, given the recent black eye from the 2017’s MPG debacle. Dauch would rather outperform conservative figures and look like a hero than oversell the merger and look foolish again.

If the above wasn’t already enough, we believe a third, underdiscussed benefit is at play: revenue synergies. The post-merger entity will be the clear leader in driveline globally. DWL and AXL’s portfolios are both geared towards driveline but largely non-overlapping. DWL’s crown jewel sideshafts and propshafts directly interface with AXL’s beam axles and differential assemblies. This enables significant cross-selling opportunities post-merger, as AXL/DWL can now more precisely engineer their parts to interface perfectly with each other.

AXL salespeople can then approach OEMs offering an end-to-end solution where engineering teams have thought about not only each piece individually but the entire system holistically. We believe this will be highly value-added for OEMs, particularly those already using the DWL or AXL platform independently of each other, giving AXL the ability to increase content per vehicle by 150-200% in some cases.

Near-term internal uses for capital represent another significant advantage for the CombineCo compared to the companies as standalones. A major overhang on the AXL story has long been its leverage profile. Meanwhile, DWL has already completed its capex cycle and cash restructuring and is now inflecting to significant cashflows. This will afford the combined business massive cash flows, which it can funnel into debt repayment to “force” a re-rate in the equity.

As leverage stabilizes, if the market does not recognize the value of the combined entity, diverting FCFE into return of capital will create a substantial cash return stream to shareholders. This significantly derisks the thesis in our view, as we don’t believe we need other investors to agree with us mid-term to achieve a strong return.

Transaction Structure

AXL shareholders will retain 51% of the CombineCo, while DWL shareholders will receive 49%. Stock consideration will be paid at a 0.0881:1 ratio for DWL shares, with no fractional shares paid. This implies ~113m new shares of AXL will be issued (PF FDSO: ~240m). DWL shareholders will also receive 43 pence per share (~$0.57), for a total $811m in cash consideration.

AXL expects to finance the deal with $2.2bn in new debt ($800m for cash consideration + $1.6bn to replace DWL's existing debt). We expect new debt to be financed at a 7.5%-8.0% incremental borrowing cost. Management has guided the deal to be ~leverage neutral, which aligns with our math and implies a 3.1x net-debt-to-ebitda for the pro-forma entity.

Synergies are expected to be $300m at run-rate and require three years to implement. Implementation costs are expected to be roughly one year’s savings ($300m).

As many DWL shareholders are not allowed to own US-listed stocks by mandate, AXL intends to pursue a dual-list on the London Stock Exchange. This ensures that U.K. or Europe-focused funds are not forced sellers post-merger. We believe large shareholders explicitly negotiated this concession in exchange for approval. The dual-list (particularly if specifically requested by shareholders), implies minimal post-merger technical pressure.

Finally, DWL has offered a mix-and-match option. DWL shareholders can allocate more or less of their shares to new AXL equity or cash. Ultimately, total cash and share consideration will be unchanged, but this allows individual shareholders to adjust their consideration to the extent that shares are available. Imbalances in the mix-and-match will be filled pro rata.

Valuation

AXL is a classic (public) LBO. Value creation will primarily occur through debt-to-equity transfers, as substantial levered cash reduces debt, snowballing cash flows. The post-merger entity is poised to generate an enormous levered cash yield as synergies are realized, enabling deleveraging over 3 - 5 years:

Note that we have modeled a flat SAAR environment, e.g., no top-line growth on the go forward. We expect an LSD% PF revenue decline by 2026. Our industry work leads us to believe a flat GLVP environment is likely to persist indefinitely for most global auto companies.

Summary Financials

Key Risks

• Tariffs / Recession. Tariffs may lead to significant inflation in autos, which may create demand destruction. More broadly, tariffs could create a global or local recession, which would reduce SAAR, leading to much lower cash flow.

• Leverage. AXL is a highly levered entity in a cyclical industry. The upcoming merger will increase leverage at a time when the market is most uncertain economically.

• Merger Integration. Risks related to the merger include failure to integrate the company’s unique cultures and operational risks in realizing synergies. More broadly, management may not be competent at managing this new, larger entity.

• Secular Transition. AXL is highly exposed to ICE vehicles, which we expect to be in long-term secular decline. More immediately, Chinese OEMs are reshaping the global autos market, killing off European OEMs. DWL’s legacy customer base is concentrated in Europe. Secular shifts may turn AXL into a melting ice cube.

Catalysts

• Deleveraging. In LBO fashion, debt reductions quickly snowball into cash flows as reduced interest payments drop to the bottom line at a 100% margin. Further, we believe AXL’s share price is currently depressed due to the leverage overhang, which, when removed, should drive a re-rate.

• Synergy Realization. Currently, we believe no credit is being given to synergies in the CombineCo. We expect investors to come to the table as synergies materialize and initial restructuring bears fruit.

• OEM Reshoring. D3 OEMs are likely to reshore production (many have already begun), which is disproportionately beneficial for U.S.-first AXL.

• Cyclical Turn. AXL is highly levered to the GLVP. A return to SAAR growth would be tremendously accretive to shareholders.

Conclusion

Initially, we were outspoken critics of the AXL-DWL merger given our unfavorable opinion of AXL management, skepticism on synergy targets, and disinterest in giving away DWL upside. Having now fully diligenced AXL and the resultant entity, we’ve effectively come 180 on our initial beliefs. Our post-DD perspective is that the AXL-DWL deal will be extraordinarily accretive to shareholders. We view estimated run-rate cost synergies as probable and conservative. Further, we believe the combined entity provides a well-encapsulated self-help story as FCFE can be directed into debt repayment, and products cross-sell provides an avenue to share gains even in a flat environment.

As a DWL shareholder, we still firmly believe Mr. Buttersworth essentially gave our business away (I assure you, we will never buy a company with him in the C-suite again). On the flipside, as a soon-to-be AXL shareholder, we’re excited. We think the combination is a natural conclusion to the DWL story, as AXL is clearly the best strategic buyer for the assets. Moreover, the long-plagued auto parts space desperately needs consolidation and scale as the legacy operating environment is much weaker than it has historically been.

Our consideration now is around balancing risk and reward. Unlike our initial thesis in DWL, where we viewed downside as limited, with AXL, we see many areas where our thesis could go wrong, and badly. Significant leverage and a major transformative merger inject uncertainty into any situation, much less an industry already prone to cyclical downturns. We believe the upside is well worth the risk, with even our tepid base case implying multiples on our money, in relatively short order, but position sizing and entry points likely matter quite a bit here.

Please leave any feedback, comments, or pushback in the comment section. You can also find me on X @cornerstone127. Write-up suggestions welcome!

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Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. Please make sure to do your own due diligence. The opinions expressed are those of the author and are subject to change without notice.

Disclaimer: As of the time of writing, the author owns shares in the company described in this article. The author may purchase or dispose of these shares at any time without notice.

Introduction

Liberty Broadband is spinning off its wholly-owned subsidiary, GCI Liberty, on July 14th as part of its upcoming merger with Charter. Distributions will be made at 0.20 shares of GLIB for every share of LBRD (regardless of share class). The record date is June 30 at 5:00 PM. GCI is a difficult-to-research, odd-ball asset due to its complex M&A history, unique exposure to the Alaskan broadband market, and significant reliance on government subsidy programs. Complexity aside, we believe GCI’s assets are extraordinarily valuable given their quasi-monopoly status in the Alaskan market, particularly in its rural geographies.

The making of a heavily dislocated spin is all in place as Malone and company appear to be actively working to ensure GCI floats at a low initial price. Disclosures have been weak, investor communication has been poor, and transaction complexity is high, all of which we believe is a deliberate attempt to dislocate the spin for tax purposes.

GCI’s Complex History

GCI has a complex history with John Malone and Alaska. Founded in 1979 by current CEO Ron Duncan under Malone’s TCI sponsorship, GCI was the first mover in the Alaskan cable market. GCI first made its debut in the public sphere in 1987, when TCI spun the entity under the GNCMA ticker. GCI (at that time General Communications Inc.) operated as a standalone for several decades following the spin, accruing greater and greater market share as the dominant cable company in the state by a wide margin.

In 2018, Malone’s Liberty Interactive acquired GCI, merged the company with a series of other ventures (of which GCI was the largest), and rebranded the entity as Liberty GCI. This consolidation was short-lived, as in 2020, Liberty reformulated its media asset base again by merging its broadband assets (primarily its ~1/3rd stake in Charter) and GCI into a single entity, Liberty Broadband. Somewhat ironically, five years later, Malone is now reissuing GCI Liberty under the same ticker as before, albeit now on a much simpler asset base.

Malone’s fingerprints on the business have created a difficult-to-research entity. The pre-2018 GCI structure was somewhat convoluted, and the original filings can be challenging to locate. Following 2018, the focus shifted away from GCI, resulting in a decrease in disclosures and a decline in analyst attention. In 2020, GCI became virtually irrelevant in Liberty Broadband, given that its value was dwarfed by that of the Charter shares.

Company Overview

Setting aside GCI’s complex merger history, the company has operationally done wonders for Alaskan infrastructure over the last four decades. Since its founding in the late 70s, GCI has laid significant subsea cable infrastructure, scaled the first 4G and now 5G wireless business in the state, and built a massive combined microwave and fiber optic terrestrial network called TERRA, which connected many rural villages in Alaska that previously had no broadband internet. Today, GCI is the clear leader in broadband with a robust 50%+ market share.

GCI’s crown jewel asset is the TERRA network, a six-year terrestrial infrastructure project completed in 2011 that provides broadband access to the thousands of rural homes across the state. TERRA was an extremely complex project due to the unique issues faced in the Alaskan market, including the need to traverse a vast landmass with a limited critical infrastructure. Much of TERRA had to be constructed in areas with no roads, often accessible only by air. Maintaining GCI’s extensive network is laborious, as Alaska’s harsh environment can easily damage critical infrastructure, often in difficult-to-access areas. As an example of the difficulty of maintaining this infrastructure, GCI spokespersons have mentioned that some of the TERRA network is off the power grid and requires routine helicopter flights to refuel diesel generators that keep telco towers operating.

Challenges in Alaska render the geography not only unique but also fundamentally unattractive to operate in. Outside of Anchorage, Alaska, is sparsely populated, inhabited mainly by scattered villages and research stations with populations <200 people per community. Population density in the Lower 48 is ~9.5 persons / sq mi, while in Alaska, that figure is <1.0x. The high cost of operating broadband infrastructure in Alaska means that the incentive for new competitors to enter the geography is extraordinarily low. Barriers to entry for a second major broadband player in Alaska are virtually insurmountable, given the lack of economic viability for the projects.

Although GCI may operate as a rural monopoly in the state, the high cost of operating in Alaska dictates that GCI itself cannot earn an economic return without significant government subsidies. Alaska is a significant beneficiary of the FCC’s internet access subsidy program, the Universal Service Fund (USF), which accounts for a substantial portion of GCI’s revenues. In FY24, GCI received 42% of its revenue from USF subsidies.

Given Alaska’s unique market, GCI’s revenue composition is also differentiated from that of its peers. The majority (53%) of GCI’s revenues are Business related with the remainder focused on consumers. Business revenues focus on telehealth, e-learning, and government/research outposts. Unlike lower 48 broadband providers, Business margins are higher than Consumer margins, particularly in rural areas. Business revenues are also majority subsidy-related, with up to 90% of the cost of the broadband services subsidized for healthcare and education-related businesses.

Universal Service Fund (USF)

Central to the GCI thesis is an understanding of the Universal Service Program (USF) and its administration. The USF was first established under the Communications Act of 1932 as a means of subsidizing telephone service for low-income consumers and high-cost areas. The act defined telephone service as a “universal service” with a goal of providing this service to all Americans. The Communications Act delegated funding and administration of the program to the FCC. The FCC established a private entity called the Universal Service Administrative Company (USAC) to ultimately fund, administer, and distribute USF funds. USAC assesses funding needs and recommends a fee collected from telecommunications companies based on revenues received for voice services.

In 1996, the original Communications Act was substantially overhauled under the Telecommunications Act of 1996. This act expanded and formalized the definition of universal services to four key mechanisms: High-Cost Support, Low-Income Support, Rural Health Care Support (RHC), and Schools and Libraries Support (E-Rate), which remain the focus of the USF today. Universal service support was also expanded to include broadband internet. The USF is now a nearly $9bn program with about 50% of funds directed to subsidizing high-cost areas.

Alaska receives a disproportionate amount of RHC and E-Rate funds relative to its population (39% and 7% of total distributions, respectively). These funds are a lifeline to rural communities across the state, where the cost of unsubsidized broadband is prohibitively high at the same time that schools and clinics are often significantly under-resourced, requiring more distance learning and telehealth services than any other area in the country. GCI has established itself as a major supplier of rural broadband and, consequently, a significant beneficiary of USF funds. In 2024, Alaska received $587m in USF funds, c.72% of which accrued to GCI.

The USF has not been without controversy since its implementation. Although there tends to be bipartisan agreement that such subsidies are necessary, the extent to which they are needed and the method of funding them has become increasingly controversial. In 2023, a conservative activist group, Consumers’ Research, challenged the constitutionality of the USF in multiple circuit courts. The Sixth and Eleventh Circuits found the USF constitutional, while a surprise en banc Fifth Circuit decision found the funding unconstitutional in a split ruling. This led to an appeal to the Supreme Court, which was settled on Friday, June 27th, 2025, with the conservative SCOTUS finding the USF constitutional on all grounds.

While this eliminates the immediate overhang that may have troubled the spin, there is a very real need for USF reform that will likely take place in the next few years. The collection of USF funding is derived from a fee charged on voice services, which have been in structural decline for two decades (see chart above). Simultaneously, funding needs for the USF expanded from voice services to broadband, which has significantly grown the cost of supporting the USF since the ‘96 reforms.

By 2027, USF fees assessed on landline and long-distance services may account for as much as 50% of the service cost. By 2030, this figure is expected to be substantially higher. In other words, the FCC needs to either reduce USF spending or reformulate the cost base to more closely align it with the services subsidized by the fund.

Despite this situation, we believe USF funding is unlikely to be cut. The issue we see is not USF’s cost, but rather its funding mechanism. Reforming the funding mechanism appears straightforward: simply broaden the fee base to more closely align with the program’s cost structure, for example, by assessing a fee on broadband services going forward. Estimates indicate a 3 - 4% fee on broadband internet would cover USF funding without issue. The solution is parsimonious, and USF subsidies are crucial to low-income schools and rural life.

Competition

GCI is the elephant in the room by a significant margin in the Alaskan broadband market. GCI has significantly more infrastructure and experience operating in Alaska than any of its peers. In many rural villages, GCI’s services are the only available broadband connection. GCI’s competitors, such as Alaska Communications, generally are required to wholesale data from GCI to fill out portions of their middle-mile infrastructure, as GCI’s TERRA network is the only comprehensive terrestrial network in the state.

Unlike in the Lower 48, recent sources of competition are non-existent and non-economic in Alaska. Fiber overbuilding outside of Anchorage makes little sense, as the economics (already stretched in the contiguous United States) are untenable due to the high construction costs in Alaska. Fixed Wireless Access, a central flash point in U.S. broadband competition, is also non-existent in bandwidth-constrained Alaska. GCI controls the primary infrastructure throughout the state, which has given it a tremendous first mover advantage that appears nearly insurmountable for competitors at this point.

Some competition has arisen from new technologies. Specifically, low-earth orbit satellite (LEO) internet, such as Starlink, has introduced a semblance of fresh competition in the market and has certainly captured some market share at the margin over the last few years. While LEOs may appear to be a reasonable competitor, we believe it is unlikely that the product will gain substantial market share even in rural Alaska, given fundamental constraints on internet speed and reliability. Even if LEO internet becomes a viable consumer competitor to broadband-to-the-home, we expect that high-bandwidth business needs, such as telehealth, will remain largely unaddressable by the technology.

That said, Starlink has made some strides in the market in areas where no broadband internet option is available, and during recent outage periods when subsea cables have broken. We expect to see limited uptake on LEOs in the near future, but it will be crucial to keep an eye on the technology as it matures and potentially delivers greater speeds at lower prices.

In the wireless market, GCI faces stiffer competition. This market is consumer-oriented, and both Verizon and AT&T have made pushes into the state, with AT&T finding significant success. Tapping into consumer review websites, it appears users universally prefer AT&T for coverage, as coverage extends better outside of town centers, and cell service is in the Lower 48 without issue. GCI, on the other hand, offers a comparable product in urban environments at a significant discount to AT&T’s service.

GCI’s central selling point is its converged product offering (wireless + broadband + other services), which they sell at a bundle discount. Lower 48 peers, such as Charter and Comcast, have achieved great success with converged products, and we believe the substantial cost savings these bundles offer will help maintain a loyal wireless consumer base in major urban areas over time. Over the past five to ten years, this has proven to the true.

Transaction Summary

In typical Malone fashion, the GCI distribution is complex and highly engineered. We’ll spare readers the gruesome details and try to summarize the three key points.

Plan of Reorganization

Rather than spin GCI in the traditional sense, the company has opted for an opaque “plan of reorganization.” Optically, the spin transaction is executed identically to a regular-way spin; however, in the background, Liberty will undergo a significant restructuring of its corporate entity. The net result is a step-up in basis on GCI’s assets, which will act as a meaningful tax shield for the corporation going forward. Management stated this “could generate as much as $420 million in tax benefits” and that GCI “won’t be a cash taxpayer for quite some time.” Management has declined to comment further on the mechanics of this basis step-up and has not provided a typical pro-forma balance sheet in the S-1 filing.

Taxable Distribution

The plan of restructuring is not without drawbacks. Unlike most spins that are carefully structured to be tax-free events, this spin is explicitly taxable as a “boot”, i.e., an asset distribution made during a plan of reorganization. Boot taxation is exceptionally complicated, but management has guided shareholders towards treating GCI shares as qualified dividends and taxing them at a long-term capital gains rate, assuming they retain Liberty shares until the Charter merger. Based on my understanding of the S-1 disclosures, the disposal of Liberty shares prior to the Charter merger will result in taxation at the rate implied by the associated LBRD tax lot (e.g., long- or short-term, as usual). The value of the boot (GCI shares) will be equal to the average 20-day VWAP of the stock post-spin.

Insider incentives

One interesting dynamic that runs through the entire spin process is a distinct lack of communication on how the restructured entity will look. During the investor day, management stated, “…we do have some opportunity [for cost savings] within our SG&A…” but did not quantify the opportunities when asked. Similarly, guidance around capex was a bit confusing. The team was unwilling to quantify the stepped-up basis tax shield in detail and has been sparse in their description of how the step-up works. It speaks volumes to me that the GCI Investor Day was a 53-minute affair, titled 'Liberty Broadband Business Plan Update,' which provided virtually no new information to investors. For reference, a typical spin investor day is a full-day event that includes a strategy review and a presentation with over 100 slides.

In any special sit transaction, qualitative analysis of insider incentives is extremely important. In this case, we believe the qualitative element is painfully obvious: insiders are explicitly incentivized to spin GCI at the lowest possible price, given the boot tax treatment. Additionally, Malone famously uses options as a primary incentive for his management teams, and we expect that large option packages will be granted in the first month or two post-spin, based on the trading price. We think it's clear that Malone and company are under-disclosing on the reformulated entity explicitly to create a weak initial bid, effectively setting the table for opportunistic buying on our part.

Valuation

GCI is a mature, incumbent asset in a low-growth, but low-competition market. As such, we expect to see minimal year-over-year changes in net subscribers, minimal shifts in market share over time, and revenue growth roughly in line with inflation. We believe margins have some room to grow, given the increased focus on high-margin business data customers (such as healthcare, government, and education), and a reduction in low-margin video and voice subscribers, but margin accretion will be minimal.

GCI is officially shuttering its atrophying video business this year, which may create some revenue headwinds; however, video subscriber margins are ~zero, so the EBITDA loss should be minimal. Margins at GCI have averaged ~34% for the past decade, with some upward bias in recent years (driven by the pivot to business data). We expect 35% to be a reasonable average going forward.

The tricky aspect of valuing GCI is determining the correct multiple, as GCI has no peers and hasn’t traded independently for some time. Finding the appropriate EBITDA multiple requires us to review multiple sources1:

(1) Historic Precedent. GCI’s original ticker, GNCMA, traded at 5 - 6x EBITDA pre-2015. In 2015, GCI consolidated its wireless holdings in a $300m+ transaction with Alaska Comms. Post-transaction, GCI saw a multiple boost to 6.5x. Liberty purchased the company for 9x in 2018.

(2) Regional Comp. Publicly-traded Alaska Communications was GCI’s closest peer for many years. From 2000 to 2014, Alaska Comms traded at ~7x. Following the 2015 GCI wireless deal, Alaska Comms’ margins collapsed, resulting in a significant decline in multiples to 5.3x post-deal. In 2021, the company was taken private at a 5.3x multiple.

(3) Lower 48 Comps. Larger Lower 48 players have tended to trade at a premium to the Alaskan market. Peers2 trade at 7.5x median post-COVID or 8.5x pre-COVID. Given GCI’s size, growth prospects, and regulatory risks, we expect the stock to trade at a discount to its Lower 48 peers.

Putting this all together, we think 6.0x EBITDA should be a fair pricing for GCI. We are using LTM ~$1.0b revenue at a 35% margin to derive base EBITDA. Given that this is a somewhat hand-wavey valuation process, we’d like to see a substantial discount to this price before we would consider buying.

Risks:

• Subsidy reductions. GCI is heavily reliant on USF subsidies, which were 42% of the company’s revenue in 2024. Although a recent Supreme Court challenge was rejected, ongoing issues with USF funding will likely require reform sooner rather than later.

• Insider Misalignment. GCI has several governance red flags, including leases on private jets, a multi-share class structure, and low insider ownership, except for Malone himself. Typically, we would be more concerned about these issues, but in this case, we are willing to look past them due to Malone’s involvement.

• Competition. The emergence of LEO satellites and Quintillion's subsea fiber optic buildout has introduced potential competitors that previously did not exist. While we view LEOs as a non-issue today, we can envision a world where satellite internet becomes a genuine competitor to consumer broadband.

Conclusion

We expect Liberty GCI to spin far too low, given the current trading dynamics in the Liberty Broadband spread, word on the street regarding spin pricing, and clear incentives for insiders to depress the stock upon issue. Furthermore, we anticipate significant technical selling in the month or months following the spin transaction as arbitrage traders unwind their positions and large-cap funds exit orphaned small-cap GCI.

Upon reviewing GCI’s assets, we are impressed by their competitive moat and cash-generating ability. We believe many investors may be overly focused on recent regulatory headlines, which we consider almost entirely a distraction. While USF reform is necessary, subsidies for Alaskan consumers, schools, and telehealth are crucial to the functioning of those rural communities, and we doubt substantial cuts will be made under any reform package. At its core, GCI is an underlevered, FCF-generating machine with a fantastic capital allocator sitting at the helm. We expect the stock to do well over time.

We’re eager to watch the when-issued market develop and hope to see some buying opportunities over the next few months.

Please leave any feedback, comments, or pushback in the comment section. You can also find me on X @cornerstone127. Write-up suggestions welcome!

If you enjoyed this and want more of this type of content, please subscribe below. Also, be sure to share with friends, family, and colleagues. Thank you for reading!

Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. Please make sure to do your own due diligence. The opinions expressed are those of the author and are subject to change without notice.

Disclaimer: As of the time of writing, the author owns shares in the company described in this article. The author may purchase or dispose of these shares at any time without notice.

• For decades, Neogen (“NEOG”) was a GARP investor’s dream, delivering 19,000% TSR over thirty years for a 19% CAGR through 2021.

• In 2022, this all changed as the firm undertook an ill-conceived transformative merger that destabilized the business and led to an almost unprecedented multi-year fall from grace in its stock price.

• In April 2025, after three years of abysmal performance, the company fired its CEO, cut guidance, and reported a weak print. The stock dropped 40% that day for a cumulative fall of 90%+ from its pre-merger price.

• Although the price action looks dire, we believe reality is rosier than it appears, as NEOG’s core business is intact and growing. Further, we think NEOG is only a few quarters away from a pivotal inflection in its earnings.

• At 11x normalized P/E, we think this is a heavily discounted high-quality compounder nearing inflection in its turnaround story.

Thesis Summary

Neogen (“NEOG”) is a market-leading food safety firm undergoing significant operational hardship due to a failed transformative merger, legacy business restructuring, and a series of unfortunate macro headwinds. Following a protracted series of executional missteps, investors have essentially left the stock for dead, driving the price down 85% over the past three years. Although the situation appears dire, we believe NEOG’s fundamentally attractive business remains not only intact but growing. Further, NEOG has several near-term catalysts that we believe will drive a material re-rate over the next 12 – 24 months as the business moves past operational issues and unmasks core growth. Even assuming a modest re-rate (our base case), NEOG can deliver 85% upside over the next two years as issues abate and investors regain confidence. At <11x FY27 P/E, we view NEOG as an excellent opportunity to own a high-quality compounder in a secular growth industry at heavily discounted valuations.

Recent Events

• December 2021. NEOG and 3M announced their intent to merge 3M’s Food Safety Division (FSD) with NEOG in a complex multi-year carve-out transaction via a cash-and-equity deal.

• January 2022. Stock falls 20% in a month as the market worries about deal complexity, dilution, post-merger dependence on 3M, and required debt.

• September 2022. The CFO resigns, and the 3M merger is executed. At this point, the stock has fallen 60%+ since the deal announcement.

• March 2025. The COO resigns after ERP and product line launch failures.

• April 2025. CEO John Adent fired by the Board. Guidance cut again due to “bad macro.” NEOG’s price falls 40% for a cumulative 90%+ drawdown.

Why Does This Opportunity Exist?

• Market Pessimism. NEOG has had protracted stock price and business underperformance. Recent disappointing results, combined with tariff fears, have created a disconnect in the price.

• Opaque Performance. It isn't easy to understand why this business is so strong, and unadjusted financials screen terribly. Getting comfortable with the business is mosaic and qualitative.

• Dislocated Investor Base. GARP long-only investors historically owned NEOG, bidding it up to unsustainable multiples. These shops puked out the stock, but it wasn’t cheap enough until recently to attract value investors.

Business Summary

Lansing, MI-based Neogen is a market-leading food safety company offering a comprehensive range of SKUs that touch all nodes in the food production value chain. Core products include bacterial testing, sample handling, veterinary instruments, culture media, and genomic services. NEOG has historically been a high-quality compounder delivering excellent ROICs, consistent HSD organic growth, and a tremendous TSR. The stock appreciated 19,000% from Dec. ’91 – Dec ’21, supported by a robust 5 – 10% p.a. organic growth rate, augmented by accretive tuck-ins. For years, the firm operated debt-free, required little incremental capital investment, and ran at low dilution.

In December 2021, Neogen substantially diverged from its historic organic growth and bolt-on strategy by announcing a complex transformative merger with 3M’s Food Safety Division via a multi-year carve-out deal following a split-off RMT transaction. The equity-and-cash deal was worth more than its pre-merger EV and required significant operational restructuring on NEOG’s part. The resultant entity was (and is) the largest food safety company in the world with ~$900m in run-rate revenue. Legacy NEOG shareholders retained 49.9% of the equity, while 3M FSD tender holders[1] received the rest. NEOG also paid a $1bn cash dividend to 3M, financed with fresh debt, resulting in a 3.0x net debt leverage ratio.

Standalone 3M FSD had been a robust acyclical business with secular growth characteristics rivaling NEOG's. Its crown jewel product, Petrifilm, an agar petri dish replacement, has c.95% market share and 50%+ incremental margins. The product is a razor-and-razor-blade model that routinely delivers HSD to MDD growth and faces virtually no market competition despite being off patent for many years. Additionally, FSD has a successful LAMP ATP test and a high-margin sample collection franchise.

Post-merger, Neogen’s combined portfolio is enviable. It is comprehensively positioned, 95%+ recurring revenue, and globally diversified. The food safety industry is well-positioned to continue global secular growth as food safety regulations, consumer interest, and global population drive TAM expansion. Importantly, NEOG is in an excellent spot to capture the growing market opportunity given its strong global footprint and brand portfolio.

The last few years, though, have far from demonstrated this as NEOG’s stock price was hammered pre- and post-merger due to PMI complexity, numerous self-inflicted problems, and macro headwinds that have cast doubt on the company’s ability to operate at scale.

Merger Integrations: An Unmitigated Disaster

Since 2022, NEOG has faced numerous operational challenges related to post-merger integrations. Issues boil down to three key areas: (a) 3M actively mishandled its unit divestment and ongoing partnership role, (b) poor merger integrations created several major operational missteps, and (c) Legacy NEOG has required restructuring and catch-up investment beyond initial expectations which has created meaningful operating drag over the last few years. On top of these issues, NEOG has faced FX headwinds and tariff-related impacts that eroded top and bottom line, further worsening the market's loss of confidence.

3M Partnership Issues

Between merger announcement and closure, FSD’s margins deteriorated by 700 bps, and topline stalled. 3M insiders and NEOG management have stated that 3M, struggling with COVID-related logistics and supply chain issues, deprioritized FSD shipments and reallocated raw materials away from the business once the merger closed. This created a significant undersupply in FSD’s main product lines, damaging operations. Further, 3M neglected to raise prices appropriately in its normal pricing cycle, ultimately leaving NEOG to inherit an upside-down cost structure in some products.

Post-divestment, 3M issues continued. FSD products had no dedicated manufacturing base, meaning NEOG has had to build multiple fresh production lines before in-housing FSD’s most important SKUs. 3M agreed to a four-year carve-out deal under which it would act as a contract manufacturer while Neogen built a dedicated FSD factory footprint. Early in the contract, 3M systematically under-delivered FSD products, prioritizing its own manufacturing needs over NEOG’s. This drove FSD share loss, frustrated customers, and created revenue headwinds, further exacerbating margin pressure.

Operational Missteps

3M refused to transfer its FSD ERP system to Neogen, meaning NEOG needed to set up its own system before bringing manufacturing and distribution of FSD in-house. This became a significant challenge as the Legacy entity had no unified ERP due to historic underinvestment in IT. Neogen scrambled to stand up a SAP ERP system, which they deployed 24 months into the merger in January 2024. Unfortunately, the rollout had major issues, resulting in shipping delays across the business that allowed a core competitor, Charm, to take market share from their allergen testing business.

On the heels of the ERP debacle, NEOG transferred the first FSD product line, Sample Collection, to their newly built facility. Production issues caused a failed product ramp, creating a significant backlog and further shipping delays that have obfuscated growth in other core products.

NEOG management has made a series of other blunders, including failure to manage working capital, repeated guidance misses, significant misestimation of post-merger margins, systematic pre-merger underinvestment in marketing, far overpaying for the 3M deal, and a failed attempt to force 3M employees to relocate to Lansing post-merger that threatened to create attrition in key personnel.

Legacy Restructuring & Integration Costs

On top of merger integration failures, Neogen has faced various integration and restructuring costs that have created sustained one-time or inorganic pressures over the past few years, including:

• Downsizing non-core product lines and related inventory write-downs.

• Construction of a new Michigan-based factory exceeding its initial capex budget.

• Nine quarters of PMI costs average $5m per quarter or a 10% EBITDA headwind.

• $10m in ERP stand-up costs spread over multiple quarters.

• A $461m FSD goodwill impairment in 2Q25, essentially admitting to the market that they overpaid.

Adding more fuel to the fire, the Genomics sub-segment has significantly dragged growth and profitability. Historically, a MDD grower actively discussed on earnings calls, Genomics’ profile dramatically changed in 2022/23 as small animal genomics became commoditized, and COVID-19 era investment in companion animal genetics soured. Management began an aggressive exit of the business line in 1Q25. The business shrank 9% y/y with high decremental margins, creating a material headwind to earnings and revenue.

Macro Challenges

FX was a 6% revenue headwind in 2024 and a 3.4% headwind in the most recent quarter. Meanwhile, global inflation has created unprecedented softness in the historically acyclical food production end-market. In September 2024, NEOG’s specialty needles became subject to a 100% tariff. In the most recent quarter, Chinese food processors began moving away from U.S.-based companies. At the same time, distributors opted to draw down inventories in the face of macro uncertainty. These recent challenges triggered yet another guidance cut at the worst possible time, driving the stock down 40% in one day.

Inflection on the horizon

Although many investors seem to have thrown in the towel, we believe NEOG’s core business remains not only intact but growing. Revealing this growth requires significant qualitative research and careful examination of historic quarterly revenue sub-accounts. The most recent print showed unadjusted headline revenue growth of -3.4% y/y. Unpacking this, FX headwinds explain essentially all of this decline. On top of FX impact, ERP- and production-related issues drove an estimated ~$15m of additional headwind. Growth was further impaired by the dramatic decline in Genomics revenue and the closure of several legacy production lines. Taken together, we believe the core business grew 5% y/y versus -3.4% y/y as reported. This represents a massive disconnect in perception versus performance.

Extensive scuttlebutt research (piecing together scraps from transcripts, expert network interviews, competitor reviews, extensive line-by-line analysis of sub-accounts, and multiple conversations with Neogen) corroborates MSD core growth. This research paints a mosaic picture of a market-leading business with an excellent brand.

We believe underlying core business growth and profitability will be unveiled over the next 12 – 24 months as FX headwinds abate and the firm laps production and ERP issues. Fully ramped Sample Collection manufacturing should act as a tailwind as the firm works through an extensive order backlog. Management has indicated that they have pursued aggressive cost takeout for genomics over the past few quarters, which we believe is lagging relative to the revenue declines. On top of all this, headwinds in topline genomics and SKU rationalization will be less impactful in the future, given that genomics is a smaller portion of the business today and product line restructuring appears near completion.

From a profitability perspective, capex should renormalize towards maintenance levels by EOY26 as Neogen finishes its factory build-out and IT updates. At the same time, ERP and integration-related charges will dwindle. This will create a massive swing in FCF and margins, further juicing margin accretive reductions in non-core product lines and genomics.

Repositioning the business

NEOG has undertaken a strategic review of its non-core Animal Safety portfolio. We believe this makes a great deal of strategic sense and provides a self-help angle to the thesis. In April 2025, $60m in animal safety revenue was announced for divestment for gross proceeds of $130m. The team indicated another $70m of revenue is in late-stage discussions. Proceeds are earmarked for debt paydown, but IR has mentioned they are also open to share repurchases. These divestments will be margin accretive and benefit top-line organic growth as Food Safety has higher growth and profit than Animal Safety.

In addition to portfolio repositioning, management and governance overhauls are also underway. Per a May 14^th 8-K, a “board refresh” is underway. The day before the 8-K filing, James Tobin, the chairman of the Governance and Sustainability Committee since 2016, stepped down. In March 2025, Doug Jones, the firm’s COO, stepped aside. In the April earnings call, it was announced that long-time CEO John Adent was also asked to resign by the board. The May 14^th update presentation notes that LTIP incentives are being reworked into “more performance-based equity grants.” Overall, we view all of these changes as positive, as we believe Mr. Adent and Mr. Jones’ decision-making was a major contributor to NEOG’s abysmal multi-year performance.

In the wake of these changes, insiders have bought the stock aggressively.

Valuation

• Assumes renormalization by FY 2027, with the only residual adjustment being the add-back of acquisition-related amortization.

• We are using a 20x exit P/E, which we believe is conservative as NEOG historically traded >35x avg LTM P/E, as have near comps.

• Through the forecast period, we assume 100% of FCF is directed towards debt paydown as management works towards a <2.0x net debt level.

Pre-COVID / Pre-merger Multiples:

Summary Financials

Key Risks

• Petrifilm Failure. The final major FSD merger integration is in-housing production of Petrifilm. Petrifilm accounts for 20% of NEOG revenue and is, by far, their most important product. Failure to ramp Petrifilm production would be catastrophic to the thesis.

• Customer attrition. Repeated issues with product availability have opened the door for competition and created share loss. There may be a snowball effect if NEOG’s brand is damaged.

• Personnel Attrition. Mismanaged merger integration has created personnel attrition. The loss of key 3M scientists and engineers may create headwinds for successful production rollout and weaken the firm’s sales and marketing capabilities.

Catalysts

• Growth unmasked. NEOG’s core business is growing at mid-single digits, which is obfuscated by operational and macro issues. We believe alleviation of these issues will drive a material re-rate in the stock.

• Strategic divestment. Animal Safety divestment should help catalyze the story, as proceeds can be used to buy deeply discounted stock or deleverage.

• Post-merger renormalization. NEOG requires significant restatements to evaluate today. The roll off of capex, one-time charges, and other merger-related complexities should encourage more investors to get involved.

Conclusion

NEOG is a hairy story requiring extensive restatement of financials and deep qualitative research. Underneath the hair, we think the NEOG quality growth story remains intact despite significant challenges. There are multiple smoking guns in earnings transcripts and revenue sub-accounts that, contextualized with expert interviews and discussion with management, provide sound evidence of NEOG’s operating strength. Even if we are wrong about NEOG's ultimate growth profile, downside appears limited, given that the business can overcome near-term merger integration hurdles.

Further, the idea appears deeply asymmetric. Even in a highly punitive scenario where growth flatlines and multiples remain depressed (as outlined in our bear case), the stock still only represents c.20% downside. Meanwhile, a return to more normal multiples and growth implies several hundred percent upside!

NEOG fits into our favorite bucket of stock ideas: Highly researchable, well catalyzed in the short term, and high probability of converting into a long-term buy-and-hold.

Please leave any feedback, comments, or pushback in the comment section. You can also find me on X @cornerstone127. Write-up suggestions welcome!

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Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. Please make sure to do your own due diligence. The opinions expressed are those of the author and are subject to change without notice.

Disclaimer: As of the time of writing, the author owns shares in the company described in this article. The author may purchase or dispose of these shares at any time without notice.

• CYND is a high-quality, nanocap VMS SaaS business serving hair salons in the Japanese market.

• The firm is a well-established market share leader and first mover in the secularly growing digital market for salon bookings and management.

• On top of this, the business is highly profitable, founder-led, and has consistently grown top line at high double-digit rates.

• The story is not complicated or hairy; however, stark illiquidity has prevented institutional money from investing.

• For 10x Adj. P/E, investors can participate in a secular growth story that is already generating piles of cash.

Thesis Summary

Tokyo-based CYND Ltd. (TSE:4256) (“CYND”) is a rapidly growing vertical market software (VMS) business serving the Japanese hair and beauty salon niche. CYND’s software solves a core issue for Japanese salon owners: connecting disparate customer acquisition and booking channels into a unified platform. Over time, CYND has diversified its core booking management solution into a “run-the-store” platform that integrates into the POS system, provides e-storefront solutions, manages loyalty rewards, and more.

CYND has a dominant 27% market share in its niche, four times that of its next closest competitor, and continues to widen the share gap as it fills in meaningful white space in the secularly growing salon bookings space. Robust growth in contracted relationships has led to sustained LDD% top-line growth with healthy 25% EBIT margins and a 95%+ ARR base. CYND is well-positioned to compound for many years to come as it incrementally captures the growing market opportunity.

This high-quality stock is inexpensive at only 10x Adj NTM P/E despite having a long tail of growth ahead. CYND is a rare opportunity to buy a high-quality business riding secular growth trends at a discount to the overall market. We estimate CYND has c.300% upside over the next five years and trades with a meaningful margin of safety due to high insider alignment, a net cash position, and ample pricing power.

Recent Events

• December 2021. CYND IPO’d on the TSE at ~17x Sales (~12x FWD) on the back of a COVID growth bump. The stock fell precipitously after the flotation as growth returned to normal.

• February 2023. The firm purchased competitor Pacific Porter in an all-cash deal for ~9x Sales. Domestic investors viewed the acquisitions as too expensive and punished the stock.

Why Does This Opportunity Exist

• Liquidity. CYND is extremely small (Market Cap: JPY 5.6b; USD$41.0m) and has a low float (~25%). 90D ADV is also thin at 7.5k shares.

• Market Misunderstanding. Optically, CYND is showing slowing growth and deteriorating margins, directly following an expensive acquisition and precipitous drop in share price. CYND looks like a broken company.

• Research Difficulty. CYND has no sell-side coverage and provides sparse details in its filings. There are no other public comps. CYND publishes no English IR materials.

The Market Opportunity

There are an astonishing number of small, local salons across Japan; in fact, 2023 Gov’t Census data estimates that there are ~270k beauty salons alone. More comprehensive third-party estimates place total salon count at ~575k when accounting for barbershops, nail salons, eye salons, and spas. This creates a unique challenge for Japanese individuals. How do you select a salon in a sea of choices? Aside from word of mouth, it can be difficult or impossible to find an unknown hair salon. Moreover, even if a friend recommends a stylist, individuals generally want to see prices, menu options, and sample pictures before booking. At the same time, salons face the opposite problem. They struggle to maintain high utilization rates solely on word of mouth, and customer acquisition is highly competitive due to market saturation. Staff are often stretched thin as demographic shifts have created a persistent labor shortage in the country, which makes it difficult for salon owners to find time to create a website or run a marketing campaign.

These issues have given rise to highly popular salon-focused review sites (otherwise known as “coupon sites”, “booking sites”, or “salon boards”). For consumers, these sites are trusted review portals and booking platforms (think Yelp or Google Reviews). For salons, they are quintessential customer acquisition and marketing channels. Recruit Co.’s Hot Pepper Beauty (HPB) is the largest coupon site, with other major players including Rakuten Beauty, EPARK, and minimo. These websites provide a consolidated customer base, offer much-needed online booking, and enable salons to easily present themselves to potential clients.

Booking site popularity continues to grow rapidly. Salon listings have grown at >10% per year for the last decade without any signs of slowing. At the same time, consumer entrenchment in booking sites continues to grow year by year. In a 2024 HPB industry survey, 32% of female respondents said booking sites were their primary source for finding a salon, exceeding even word of mouth recommendations (only 23%). Young people are even more likely to find their salon through a booking site with higher penetration in use across all metrics. Japanese consumers also place a high value on online booking capability. In 2024, survey respondents of all ages ranked “Ability to make online reservations” above “Closeness to home” and “Price” when choosing a salon, sustaining a multi-year trend.

Structural labor declines have led to a need for greater efficiency in operations. Consumers have also increasingly come to expect digital services, particularly in a post-COVID world. In response, the average mid-tier salon now uses 2–3 booking websites, often combining these sites with LINE Business, Google, and social media. We estimate the average salon has a minimum of five disparate acquisition channels. Each channel adds a layer of complexity to managing bookings as calendars are silo’d and require manual reconciliation resulting in the risk of double booking and significant admin.

Business Background

Takashi Okuwaki (CEO) and Naoya Takahashi (VP) founded CYND in 2011 to solve the growing calendar integration issue described above. Before CYND, the founders worked at a parallel VMS concept called Temairazu (2477.JP), which operates a verticalized booking management system targeted at Japanese ryokan and hotels. Temairazu is a phenomenally dominant and profitable business with 70%+ EBIT margins and >50% market share in its niche. After seeing the firm’s commercial success firsthand, the co-founders began looking for other markets to create a similar platform. At the time, booking sites were just gaining traction (<10% of hair salons had listings), but the necessity of digitalization was becoming increasingly apparent. With this in mind, the founders left Temairazu, bootstrapped CYND with one million yen of their own capital, and began product development. Today the founders still lead the company and are highly aligned with shareholders via their 70% equity stake.

CYND’s product really took off during COVID as the firm rode universal digitization tailwinds that fully capitalized on the past decade of coupon site growth and labor market tightening. In 2021, with 400% revenue growth over the five years prior, the firm floated a small public offering at a ludicrous 17x trailing sales, fully capitalizing on the pro-SaaS zeitgeist.

The business almost immediately tumbled after flotation. As COVID growth waned, eye-watering valuations ultimately couldn't be supported. By December 2022, CYND stock was down 70% from its issuance price. The price took another tumble in January when the board announced an all-cash acquisition of its only real competitor, Pacific Porter, for ~9x Sales, resulting in a 16.5% single-day sell-off.

The Pacific Porter acquisition was undeniably expensive, but we believe ultimately necessary to cement CYND’s future success. It added a complementary lower-end product to CYND’s portfolio, doubled their market share, and eliminated the firm’s only real at-scale competitor. The team financed the transaction with <1% interest rate notes, and cost synergies between the businesses allowed Pacific Porter to turn a profit for the first time in its history within a few quarters. We believe there are strong upsell opportunities as customers come in with the low-cost, low-feature Pacific Porter offering and eventually upgrade to CYND’s original premium offering.

The Pacific Porter acquisition has, unfortunately, complicated financial analysis. EBITDA margins were diluted by Pacific Porter, leading to a few percent of overall compression. On top of this, significant amortization charges now obscure strong fundamental performance on an accrual basis as goodwill is amortized on a 10-year straight-line basis. In addition to acq amort, there have been some one-time integration expenses related to the transaction.

We think potential investors (and some current ones) have misunderstood recent developments as indicative of fundamental problems with the business. Slowing organic growth, an expensive debt-fueled acquisition, and margin compression are a bad look for any stock. Peeling back the onion, however, we believe CYND has never been stronger. The business is now a quasi-monopoly in its space, growing new contracted stores at a double-digit clip with no real competitors.

Product Summary

CYND offers two core products, BeautyMerit (“BM”) and Kanzashi. BeautyMerit is CYND’s original product. It started as a simple calendar integration tool but has since evolved into a salon-focused ERP platform with a comprehensive feature suite:

• Calendar Integration. Integrates 11 out of 12 booking sites. For example, if a client books on Hot Pepper Beauty, BM will automatically reserve time on other booking sites’ calendars.

• Own Booking Channel. BM has an internal booking system/calendar allowing salons to shift their clients away from 3rd party booking sites and into their own ecosystem. This is important as many booking sites monetize via commissions and customer churn is higher when clients book through 3rd parties versus directly through the salon.

• LINE integration. LINE is Japan’s ubiquitous superapp. BM integrates with LINE, allowing salons to send push notifications, manage their LINE Business calendar, and DM customers.

• Loyalty program. In Japan, many salons have punch card loyalty systems. BM manages these loyalty programs virtually without the need for paper-based cards.

• CRM. BM manages customer contacts and relationship histories. It also has lightweight marketing features such as blast emails and coupon distribution.

• Customizable app. Salons can create a whitelabeled app with a message center, punch card, coupon book, booking channel, and more.

• E-commerce. Salons can set up beauty product store fronts a la Shopify. E-sales are fully integrated with distributors, so customer purchase fulfillment is fully taken care of by 3rd parties (dropshipping model).

• POS integration. POS system integrations create a streamlined record-keeping system and check-out platform.

BeautyMerit is a premium product targeted towards multi-salon operators, brand-focused boutiques, and multi-tenants. ARPU is JPY15.5K/mo ($100/mo) on average, with subscription pricing flexible based on features. BM is in a league of its own in terms of value-add, with no other product on the market coming close to its rich feature set.

Sister product, Kanzashi, has historically been a core competitor to BeautyMerit. The product was developed in 2013 by Pacific Porter and integrated into the CYND brand in 2023 in a previously discussed acquisition. Kanzashi is a simple calendar integration app that neatly streamlines into the POS system. Integration features are essentially the same as BM (11/12 booking sites; LINE integration; own booking channel manager), but the product lacks the BM’s flashy features. Kanzashi is offered at JPY5.5k/mo ($38/mo) and is most suitable for small single salon operators or teams that already have a strong brand and back office but need to digitize admin operations.

TAM Analysis & Growth Algorithm

Defining the opportunity

The broadly defined total addressable market is Japan’s ~575k stores related to the beauty services industry, as estimated by Yano Research. This cohort is forecast to grow at 0.5% per year over the next decade. CYND’s current product and marketing efforts target their core “hair and beauty salon” vertical. This sub-segment of salons is ~270k stores, which we expect to grow at 1.5% p.a. In reality, CYND is only able to address the subset of stores that are listed on booking sites, e.g., ~150k salons as of April 2025. Booking site listings have grown at a 10-year CAGR of 15%, and we expect continued growth of ~10% p.a. going forward.

Some salons on a booking platform don’t need calendar integration services as each site offers its own internal calendar management system. If a salon only needs an online booking portal and “webpage” its likely to use a single site and leverage that platform’s calendar manager system rather than pay for CYND’s software. It's hard to know how many salons fit into this category, but with the help of management estimates, we can guess.

Management believes 10% of booking site listings are multi-salon operators. Another ~10% are brand-oriented salons (boutique or high-end). These categories are excellent clients for CYND’s premium BM product. Of the remaining 80% of listings, we estimate ~50% are target clients who would drive meaningful benefit from CYND’s product either via labor savings or reduction in churn/client ownership. There are mostly mid-sized and multitenant salons. This implies ~60% of salon board listings are addressable. For conservatism, we’ll round our estimate to a flat 50% of listing.

Using this narrow TAM, ~75k stores should be interested in CYND’s product. At 20k contracted stores, CYND has 27% market share today and, using the same math, has taken share every year since it began reporting. Further, core competitors’ share is minimal today. Reservia, CYND’s closest comp, has <6k relationships. Two other core comps (LiME1, RE:RE) are newer and less popular solutions with (we think) only a few thousand stores between them. A generous estimate of competitor install base is ~15k stores under contract (Combined share: 20%). This indicates >50% of addressable stores are white space ripe for growth opportunity.

Estimating growth

CYND has historically grown new stores at a ~15% CAGR. Assuming addressable listings grow 10% annually, the company would achieve ~50% market share by 2036. While new market entrants or industry consolidation may shift this calculus, TAM expansion and existing white space lead us to believe a 5 – 10% contracted store growth rate is more than attainable for the next five to ten years.

CYND management has been adamant that they will not grow revenue through pricing until they have achieved industry saturation. Given the nascent state of the industry and high LTV of contract relationships, this makes sense to us. In the past, ARPU has grown ~1% per year, but CYND provides discounts to chain stores that tend to dilute ARPU every few years. In aggregate, we think pricing will be ~flat over the next five years while CYND establishes its share. In the long term, CYND will have strong pricing power given the high switching costs, de minimis opex expense to users, and mission-critical nature of the software. Similar business models (Paychex, SAP, Oracle) have demonstrated long-tails of 3 – 6% p.a. pricing growth.

Summary

Putting it all together, we think CYND can conservatively grow ARR at a 10% clip purely through new contracted stores for the next five years. Product mix and one-time installation revenue dilute total revenue slightly to an HSD% growth rate through 2030. We think there’s plenty of room to surprise to the upside here. Surprises would include >0% pricing increases, growth in CYND’s nascent 3P e-commerce offering, or sustaining >10% contracted store growth over the five-year forecast.

Valuation

Valuation notes:

• Assumes 0% growth in ARPU through the next five years. We don't think mgmt. will exercise significant pricing until the market share is solidified.

• 3% perpetual growth in our terminal year, driven primarily by pricing.

• 20x exit multiple implies modest growth in contracted stores beyond 2030.

• Margins are assumed to accrete 900bps+ due to operating leverage as the business achieves greater scale and sales per employee increases.

Summary Financials

Key Risks

• Competition. Several other calendar integration products have emerged. LINE Business has become a more popular booking platform and may become the de facto booking manager over time. Once installed, users are unlikely to switch platforms, so gains by competitors may be permanent reductions in market opportunity for CYND.

• Salon board consolidation. CYND currently benefits from a fragmented booking site market structure. If the market consolidates, CYND’s product may become less valuable.

• Distribution failures. Many of CYND’s net new stores are inbound referrals from channel partnerships with distributors and POS integrators. If CYND loses these channel distribution relationships, it may struggle to grow.

Catalysts

• Liquidity Improvement. With more liquidity, we expect to see institutional buyers bid the stock up. Liquidity may improve through price appreciation or founder divestment.

• Continued Growth. We think investor hesitancy is centered around the recent growth slowdown and margin compression. As CYND continues to grow and accrete margins, the stock will re-rate.

This isn’t a catalyst-driven investment. Eventually, the stock will re-rate, but it will probably stay flat until the right person notices.

Conclusion

We believe CYND has all the makings of a high-quality compounder in its infancy. We think the stock can grow at 5-10% for many years on conservative assumptions. Typically, we would expect to trade off profitability or price for growth, but with CYND, we don’t have to do either. Healthy 20% FCF margins are a massive tailwind to valuation, and a rock-solid net cash balance sheet gives us meaningful downside protection. At 10x P/E, you’re not paying for the growth opportunity, and if the business just survives, the IRR should eventually work itself out via capital returns. We like the insider ownership, the management, and the end market. Honestly, there’s very little we don’t like about CYND. At a 10% cash yield, this feels like a slam-dunk.

Further reading sources: An excellent VIC write-up and fellow substacker Made in Japan’s piece.

Please leave any feedback, comments, or pushback in the comment section. You can also find me on X @cornerstone127. Write-up suggestions welcome!

If you enjoyed this and want more of this type of content, please subscribe below. Also, be sure to share with friends, family, and colleagues. Thank you for reading!

Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. Please make sure to do your own due diligence. The opinions expressed are those of the author and are subject to change without notice.

Disclaimer: As of the time of writing, the author owns shares in the company described in this article. The author may purchase or dispose of these shares at any time without notice.

Warning: This idea is highly illiquid and bears significant risk. While I believe and will go on to argue that the risk-reward is favorable, buyers need to be aware that total loss of principal is possible.

• YuHua Education (“YuHua”) is a Chinese for-profit high school and higher education operator trading 95% off its 2021 peak.

• Declines have been driven by margin collapse, regulatory uncertainty, and, more recently, the restructuring of a convertible note.

• Our work indicates that YuHua’s margin compression will moderate going forward, that CCP policy will remain supportive of the space, and that an aggressive capex cycle is at its end, giving way to significant cashflows.

• The stock is poised to inflect sharply higher as the market realizes the situation has stabilized. Meanwhile, YuHua is obscenely cheap at 2.0x UFCF and 3.0x P/E.

Thesis Summary

YuHua Education (HK:6169) (“Yuhua”) is a Chinese for-profit educator operating four universities and five secondary schools, primarily in the Hunan province of China. Once a seemingly unstoppable highflyer, YuHua now trades 95% below its 2021 high due to broad regulatory overhang, a surprising and recent default event, and the collapse of its once-high FCF margins.

Despite this frightening backdrop, we believe YuHua stock is poised to inflect sharply higher as its recent capex cycle abates and cost pressures moderate. Further, we believe the recent convertible bond restructuring has derisked the business significantly compared to peers as it eliminated offshore debt and gave a stronger voice to activist shareholders. We expect Yuhua will gush free cash flow in the next twelve months and that this, in combination with the recent bondholder agreement, will allow a reinstatement of the company’s dividend, which will ultimately catalyze the stock higher.

Restructured YuHua trades at 2.8x NTM P/E and 2.2x NTM UFCF, even under conservative assumptions. The company is in a net cash position, and more importantly, all residual debt is held onshore and renminbi-denominated. We believe YuHua will cashflow >100% of its market cap within three years and nearly twice its market cap within five years.

At today’s trading price, barely anything needs to go right for the stock to appreciate. Even if a re-rate fails to materialize, based on a conservative dividend distribution assumption, we expect to receive a solid IRR over the next few years.

Recent Events

• July 2021. China rocked investors with a 2021 education policy reform banning for-profit afterschool tutoring and making ownership of compulsory schools (Grades 1 - 9) illegal. YuHua was forced to deconsolidate 19 schools in response.

• December 2022. YuHua trading was suspended due to its inability to file annuals, as its auditor was unsure of its ability to repay offshore debt.

• January 2023. The company successfully renegotiated bond terms and retired HK$500m in par value of offshore convertible notes. Conversion price on the remaining issue was significantly lowered.

• February 2023. Audit financials were released, and trading resumed.

• December 2024. Trading suspended again as Yuhua defaults on remaining convertible bond and fails to publish audited year-end financials.

• December 2024. YuHua disposes of Thai university (Stamford U) for HK$240m to raise capital for bond repayment.

• February 2025. YuHua and bondholders restructure HK$914m convertible into new shares, warrants, and some cash repayment. YuHua shares resume trading on February 27.

Why Does This Opportunity Exist

• Investor confidence. The last two years have annihilated investor confidence in the stock. In addition to a default event, margins collapsed, capex spiked without explanation, and IR is unresponsive. If industry sentiment is on the floor, Yuhua sentiment is in the basement.

• Regulatory Overhang. In 2021, the CCP blindsided the market by eliminating for-profit tutoring and appropriating private K-9 schools. This sent a message that investors will not soon forget, making the sector untouchable for many funds.

• Margin Collapse. YuHua historically earned 60%+ gross margins and spent <10% of sales on capex. Over the past four years, margins have collapsed to <40% while capex has increased 6 - 8x. Investors fear margins will continue to collapse and that capex will never moderate.

Industry Summary

Before digging into Yuhua specifically, let’s first dig into the broader Chinese education industry and its recent woes. The sector is fascinatingly complicated and, ultimately, has been central to China’s emergence from poverty, which has made it a focus of CCP policy. Over the last five years, rapid policy reform campaigns have been implemented to realign the education sector with perceived PRC long-term needs. In a 2021 memorandum, the education system saw a vast overhaul that sent investor sentiment spiraling. Policies included:

• Banning of for-profit after-school tutoring that had become ubiquitous and necessary for successful entry into China’s elite university systems.

• Banning of for-profit compulsory education (Grades 1 - 9) and a crackdown on foreign investment in compulsory ed.

• Requirement that school curricula reflect “Xi Xingping Thought on Socialism with Chinese Characteristics” and a refocus on education as a tool for instilling “Xi thought” in the Chinese youth.

• Policy support for vocational education, specifically higher vocational education (e.g., U.S. equivalents of technical colleges).

• A focus on fostering for-profit private higher education, specifically within vocational institutions.

The 2021 policy update sent the entire education space into an overnight nosedive. EdTech companies TAL Education (NYSE: TAL) and New Oriental (NYSE: EDU) were rendered effectively worthless, losing 90% of their value following the announcement. Smaller for-profit K-9 educators, such as FHSE, were reduced to VIE shell companies only months after listing in the U.S. Anything remotely exposed to Chinese for-profit education became untouchable due to the risk of appropriation and policy shift.

One corner of the Chinese education market received tailwinds from the 2021 policy: for-profit vocational education. However, this did not stop stock prices from plummeting, as shown in the figure below.

CCP policy support towards vocational education and laxer quota distributions has been a tailwind to the comp group's top-line growth. However, significantly higher reinvestment rates in capex and teaching quality have offset this, leaving EPS roughly flat since the reforms.

Chinese support of the for-profit universities is, at first pass, surprising given their intense crackdown on compulsory and after-school ed. In the broader macro context, however, we believe the CCP is highly incentivized to support for-profit higher ed investment, particularly in the vocational space. China has significant education needs, particularly in rural areas and within specialized vocational services (such as robotics operations or semiconductor fabrication). At the same time, national and provincial budgets are already stretched thin, allowing little room to increase educational capacity.

To continue advancing the middle class, the CCP needs for-profit institutes and private investment to create and maintain the infrastructure required to educate the working class.

This dynamic is clearly displayed when reviewing the details of CCP policy reforms. In the 2021 memorandum, the party explicitly encouraged for-profit higher educational institutions by clarifying that schools could designate themselves as for-profit, allowing greater flexibility in setting tuition and distributing capital.1

Business Summary

Yuhua operates four universities and five secondary institutions (Grades 9 – 12) in China’s Hunan and Shandong provinces. Its primary asset is Zhengzhou Technology and Business University (est. 2002), an independent private general university offering 41 undergraduate majors and 12 vocational programs.

Second to Zhengzhou U is Hunan University of International Economics and Business. Established in 1997, the college was approved in 2000 as a key vocational college in the Hunan province. In 2005, regulators upgraded the college to a fully accredited undergraduate university. Hunan U remains a core resource in the region for applied training (e.g., specialized vocational work) and broader undergraduate programs. We believe Hunan U will be integral to the regional application of Xi's vocational reform policies, as discussed above.

Shandong Yingcai University (est. 1998) is located outside Hunan in the adjacent Shandong province. The college offers 38 undergraduate programs and 37 vocational majors. Provincial administrators have repeatedly selected Shandong U for key educational programs to raise technical ability in the province. They have been recognized as national and provincial leaders in applied engineering.

Zhengzhou Software Vocational and Technical College is the newest entrant to Yuhua’s portfolio, officially opened in Fall 2023. Zhengzhou Tech has the unique distinction of being one of the only official for-profit private higher education institutions in China, as it is one of the few new vocational schools opened since the 2021 for-profit election reform. Zhengzhou was opened in direct response to provincial and party guidance and focuses on new-age technical training (e.g., cloud computing, AI, cybersecurity, and IoT).

Yuhua’s remaining portfolio of high schools primarily operates under single K-12 banners, typically with a Grade 9 - 12 boarding school campus and separate K-9 campuses. Yuhua is actively converting/shuttering these schools due to regulatory risk. Disclosures on the conversion process are poor, but we believe, where possible, dormitories are being repurposed for university use, as evidenced by sustained -15% revenue CAGR in the high school segment despite a stable student population. High schools account for only c.6% of revenue and <5% of gross profit.

Restructuring & Go-Forward Entity

In December 2019, Yuhua issued a HK$2.1bn 0.90% 2024 convertible note to a consortium of offshore investors. The note's conversion price was HK$6.82, a modest markup to the Common’s trading price at issue. Unfortunately for bondholders, Yuhua’s stock plummeted only months after the issuance due to policy changes discussed above. A year after flotation, the note’s strike price was hopelessly out of the money, leaving the debt trading at a considerable discount to par.

In late 2022, bondholders exercised the note’s put provision to cut their losses; however, to everyone’s surprise, Yuhua claimed to be unable to come up with the money to repay the bond. In response, their auditor (PwC Hong Kong) refused to issue audited going-concern financials, resulting in a trading suspension.

This revelation shocked the market as Yuhua had ~HK$4.5bn of cash and equivalents on their most recent balance sheet, far above the HK$2.1bn needed to repay bondholders. Management stated that they could not distribute these funds outside of China and that a significant portion of the cash was earmarked as university operation reserves. As an aside, Chinese firm’s inability to access their capital has become a recurring and disturbing trend leading to bizarre capital allocation decisions, as shown here. Bondholders ultimately accepted a partial repayment of HK$1.1bn in exchange for a restrike on their conversion option.

In December 2024, the remaining convertible par value of HK$930m came due with the restruck call option still far out of the money. Again, Yuhua stated they could not fully repay bondholders. PwC refused to approve the company’s financials, HKEX suspended trading, and Yuhua was cast into a default event, all while having significantly more cash on balance than needed to cover the bond.

Yuhua stock remained suspended for three months while bondholders negotiated a restructuring deal. Ultimately, Yuhua agreed to sell its foreign subsidiary (a Thai-based university) for HK$240m to raise offshore capital. The asset sale was then supplemented with other limited expropriated funds altogether, repaying HK$430m of par value converts. The residual HK$500m par saw forced conversion at HK$0.733 (c.100% higher than the pre-suspension close!). Bondholders also received 182m HK$0.50 strike 3-year warrants.

There are a few critical takeaways from this story. First (and perhaps foremost), Yuhua clearly does not have complete discretion over its bank accounts. China seems to, in principle but not in policy, require universities to collateralize prepaid tuition. Further, there appears to be strict management on how economics are distributed to university owners. We corroborated these beliefs in conversations with Yuhua’s peer Edvantage (HK:0832).

Second, we think Yuhua (and its peer XJ) illuminate a risk not readily apparent to investors. Interest coverage ratios and large cash positions are not inadequate solvency measures in this space. Investors must judiciously review what cash is distributable, what country domiciles the accounts, and to whom / in what currency debt is owed. Yuhua is the only stock in the comp group that is liquid enough to invest in and fits a clean bill of health (e.g., no offshore debt).

Finally, Oasis, a feared East Asian activist fund, underwrote a significant portion of the education boom convertible debt. Oasis already owned 5% of the common, and we expect now owns a substantial portion of the equity. PAG, another highly regarded APAC fund, underwrote XJ debt, and we think also held significant amounts of Yuhua converts. These are not silent partners. Yuhua is the only comparable with an activist shareholder registry and less than 50% family control.

Profit margins stabilizing

Yuhua has seen tremendous margin collapse since its 2021 peak, leading to concerns that the business is fundamentally broken and calling into question where floor margins might be. After 18 months of decline in FCF margins, we believe stabilization is in sight.

Since implementation of 2021 policy, the entire comp group has seen gross margin declines driven by multiple factors. Curricula have needed to be updated or, in some cases, completely rewritten to align with party needs. Campuses have required refreshes for the benefit of students, such as modernizing training labs and expanding campus programs. Student-teacher ratios were required to be brought up (generally targeting 18:1 or better), and scholarship and training opportunities are now required to be supported by the schools.

We don’t view these changes as punitive but rather as a much-needed refresh of the vocational system. Many vocational schools and rural universities have been effectively run as degree mills, with vast underinvestment in student resources and ludicrously poor student training opportunities. Classrooms were often crowded, and teachers were unqualified.

This behavior is no longer acceptable under the new regime. CCP officials will now visit each school and re-accredit the universities. Provincial officials are implementing rules that will require higher education standards, such as minimum post-grad job placement rates and minimum student-teacher ratios.

It’s evident that Yuhua has spent the last decade significantly underinvesting in its campus programs. We estimate that Yuhua entered 2021 with a 30:1 student-teacher ratio and that student training programs were essentially non-existent. Yuhua’s celebrated 67% gross margin was, in hindsight, totally unsustainable. Yuhua’s campuses were also older, and we expect its labs were far out of date. Yuhua had to expedite the turnaround of its campuses in 2022 when it learned that party members would visit the province to recertify the school in 2024.

Through Yuhua's footnote disclosures, we can get a glimpse into the overnight pivot into reinvestment. Teacher headcount increased 50% y/y in February 2023 and moved from 60% of total staff to 80%. Wage expenses alone pressured margins by 8%. We believe university hiring will moderate going forward as Yuhua now has a healthy 16:1 student-teacher ratio.

Another primary cost pressure was scholarship and training awards, which historically accounted for 1.5% of revenue or less. These jumped to 6% in 2022 post-policy reform and have stayed at this level ever since. We don’t see training moderating, but the subaccount has stopped growing now.

Depreciation expense has been the main cost driver of margin compression as Yuhua plowed enormous sums into its fixed assets, raising depreciation as a % of revenue by 300%. Examination of PP&E accounts shows that most additions were marked as “decorations” that depreciate over 5 years. This, in turn, ran capex reinvestment through the PnL at an accelerated rate compared to the past. This corroborates our belief that Yuhua has systematically underinvested in its campuses, requiring dramatic catch-up expenses.

Again, we see moderation here. Party officials visited Yuhua’s schools in mid-2024 and recertified them without issue. With recertification in the rear view mirror, capex fell 99.5% compared to 1H. We expect that Yuhua will be more capital-intensive going forward than it has in the past, but there was a significant fixed asset pull forward to impress party officials and ensure smooth recertification.

Taken together, we think margins have roughly troughed. Inflation in teacher wages might continue to pressure things, but renormalization of capex will flow into depreciation to offset. 2H24 inflected 1000 bps compared to 1H24, which even adjusting for cyclicality, indicates a few hundred basis points of potential run-rate improvement in the pipes.

Valuation

Given the space’s long-term uncertainty, we find traditional multiples-based or terminal value approaches inappropriate. We believe these for-profit ed assets are at high risk of appropriation at some point in the future, and thus, there may be no asset terminal value. Instead, we’ve opted for a three-stage DCF, which allows us to decompose value into three separate and distinct time periods. Our base case assumes that investors receive only five years of cashflows before the business is appropriated.

This model shows our 10-year and 15-year assumption sets:

Valuing only the next five years of cash flow indicates a significant margin of safety on already extremely punitive assumptions. If the business has a TV, the stock is priced at a 60% discount to fair value.

Inputs Notes:

• We expect Yuhua’s universities will convert to for-profit in 2027, degrading earnings due to a 15% corporate tax rate requirement.

• We use a punitive 15% discount rate due to the high risk of the investment. The company discloses its Goodwill impairment testing uses a 15% rate.

• We assume capital intensity remains permanently higher going forward, which we believe is moderately conservative.

• Our Base and Bull case imply current fair P/Es of 4.8x and 7.3x, respectively.

Summary Financials

Key Risks

• Appropriation risk. The CCP may ban for-profit higher education, rendering the Yuhua stock worthless. We view this as a mid-to-long-term risk and believe the near-term is well insulated.

• Inability to distribute cash. The recent off-shore bond default highlights strict capital controls. Despite significant cashflows, offshore investors may never see those profits.

• Margin deterioration. The PRC is forcing reinvestment into Yuhua’s schools. Continued reinvestment may further deteriorate margins, possibly until schools are uneconomical. Tuition caps may also be implemented, which would significantly pressure margins over time.

• Governance issues. The founding family controls the entity’s common (46% ownership) and owns the licenses through structured contracts. The company’s CEO (37 y/o) is the founder's daughter. Offshore ownership is via a VIE entity, a regulatory grey area. IR is nonexistent; no earnings calls, presentations, or email responses have been provided.

Catalysts

• Dividend reinstatement. YuHua suspended its dividend in 2022 due to its convertible bond crunch. With this resolved, we expect a dividend to be reinstated. Even a conservative payout ratio implies a 10%+ yield.

• Margin / FCF stabilization. We expect margin declines to moderate as capex drops to maintenance levels and most reinvestment is finished.

• For-profit election. YuHua intends to elect for-profit for its schools. It’s unclear what benefits this brings (our model assumes none), but clarifying the for-profit framework should alleviate some investor anxiety.

Conclusion

YuHua clearly bears more risk than the average investment, but we think the option value is significant. At 2.0x UFCF, investors must believe very little about the stock's future to make money. While recent margin collapse and capex are alarming, a detailed review of the expense subaccounts reveals stabilization. We expect Yuhua’s schools will be much healthier going forward, given refreshed campuses, rewritten curricula, and meaningfully improved student-teacher ratios, which will, in turn, improve their brand reputation, possibly driving higher tuitions.

Perhaps counterintuitively, we view the recent convert restructuring as a blessing for prospective shareholders as it eliminated offshore debt, reduced leverage, and put bondholders in control of ~25% of the business. Further, given the binary nature of outcomes, we are excited for warrant trading to begin as we believe the warrant asset may be the best way to play the situation. We expect an optimal position will be a blend of equity and warrant holdings.

YuHua is priced for bankruptcy even though bankruptcy risk has been defrayed. We expect the business to gush cash for the next five years, even under conservative margin and capex assumptions, and we expect a resumption of capital return in short order. YuHua trades at <70% NPV on its next five years’ cash flow or a 60% discount when accounting for a potential TV. Assuming the stock isn’t stolen from shareholders, we expect holders will do well at these prices.

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Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. Please make sure to do your own due diligence. The opinions expressed are those of the author and are subject to change without notice.

Disclaimer: As of the time of writing, the author owns shares in the company described in this article. The author may purchase or dispose of these shares at any time without notice.

Base Case & Quick Notes

• Dowlais is a discarded Auto Parts SpinCo at the tail end of a multi-year restructuring process, down 40% from its flotation price.

• Dowlais's earnings power is obscured by years of restructuring and one-time expenses, many of which will roll off in the next twelve months.

• Adjusting for idiosyncracies, core earnings imply exceptional multiples of 4.7x P/E and 8.8x UFCF, even on today’s cyclically depressed volumes.

• At a 20% levered cash yield with no bankruptcy risk, our base valuation implies ~140% upside from today’s share price.

Thesis Summary

London-listed Dowlais (“DWL”) is a Tier 1 auto parts manufacturer with decades of expertise in drivetrain systems and specialty manufacturing. In April 2023, the firm floated via a demerger transaction from ParentCo Melrose PLC after undergoing significant restructuring and optimization within the parent. DWL is a market leader in its subsegments and holds a substantial global market share within its niche verticals.

Unfortunately, the firm spun into an extremely difficult macro environment. Global light vehicle production (GLVP) fell by several million units over the past 18 months, with many of Dowlais’s core geographies and end markets bearing the brunt of the decline. The net result has been a nearly 10% top-line drawdown over the trailing twelve-month period.

Despite the challenging environment, we believe DWL offers an extremely attractive risk-reward profile. The firm is coming out of a multi-year restructuring period in which it has optimized its global manufacturing footprint and supply chain. As this restructuring moderates, we expect incremental improvement to gross margins, moderation in capex, and the roll-off of significant cash restructuring charges.

DWL trades at an extremely attractive 4.5x Adj NTM P/E and 9x UFCF, assuming no future recovery in the auto market. A return to more normalized auto production, particularly in key North American and European geographies, has the potential to supercharge Dowlais’ earnings via attractive 30% incremental EBIT margins.

Further supporting the fundamental thesis, Dowlais offers an attractive set of near-term catalysts. The firm is working to approve a cash-and-stock merger with U.S.-listed peer American-Axle, and current deal terms offer an extremely attractive upside/downside ratio of 13% deal premium vs 2% breakage. If or when the merger breaks, we expect management to resume the strategic review of non-core assets and continue to put cash into buybacks.

Recent Events / Firm History

• March 2018: Melrose Plc (LSE:MRO) acquires Aerospace and Autoparts manufacturing firm GKN Plc (LSE:GKN) for GBP 8bn through a hostile bid.

• October 2018: Melrose lays out a multi-year GKN restructuring plan, including a complete rework of the global labor force within GKN’s Automotive unit.

• April 2023: With restructuring almost complete, Melrose spins non-aerospace assets into a new company, Dowlais.

• August 2024: The Dowlais management team announces a strategic review of the non-core specialty manufacturing unit, Powder Met.

• January 2025: Dowlais shocks the market by announcing plans to merge with American-Axle (NYSE: AXL) at 4.0x EBITDA in a cash-and-stock deal.

Why Does This Opportunity Exist?

• All the bad words. Dowlais is at a confluence of things people hate. It’s a European-listed, small-cap, legacy auto manufacturer with a limited operating history, trading down close to 40% from its list price.

• Opaque and limited financials. Dowlais has a limited operating history due to the recent demerger, and financials require significant adjustment to uncover economic reality due to demerger costs, restructuring, elevated CapEx, etc.

• Cyclical Headwinds. The last year has been challenging for global autos, particularly Battery-Electric Vehicles (BEVs). Global volumes are down, the top line has weakened, and margins are depressed. Dowlais is no exception.

• Technical selling. Capital Group and some others have indiscriminately dumped shares on the market over the past year. Many funds that owned much larger Melrose aren’t able or interested in owning deep-value small-cap Dowlais.

Business Summary

Dowlais operates two essentially separate business units: GKN Automotive and GKN Powder Metallurgy. These businesses are supported by a global manufacturing footprint of 77 facilities in 19 countries. Dowlais parts are astonishingly ubiquitous in the industry, with an estimated 50%+ of the global light vehicle fleet containing at least one part made by Dowlais.

GKN Automotive

GKN Auto specializes in driveline and ePowertrain components for internal combustion engine (ICE) and electric vehicle (EV) drivetrain systems. In both areas, Dowlais sets itself apart as a #1 market leader across multiple niches with decades of specialized industry experience. While we fully admit that auto parts manufacturing is an unattractive (often downright bad) business, Dowlais may be the exception to the rule, given its market-leading portfolio and highly consolidated position. Autos broadly divide into two segments: driveline and powertrain.

Driveline: Driveline includes sideshafts, prop shafts, and constant velocity joints (CVJs), all of which are integral to transferring torque from a vehicle’s engine/motor to its wheels. These components are critical for the smooth function of a vehicle, are relatively low-cost per part, and require high levels of engineering to ensure reliability and durability over time. While prop shafts are primarily found in ICE vehicles, sideshafts and CVJs are propulsion-agnostic pieces needed in all drivetrains.

Dowlais’s sideshaft business is by far its crown jewel, which truly sets the business apart from global competitors. Dowlais is the undisputed market leader in the space, with over 40% of the global market share, more than double that of its next closest competitor. Dowlais is also the #1 market share leader for prop shafts, with an estimated 10% global share.

ePowertrain: Dowlais’ ePowertrain system comprises all-wheel and four-wheel drive (AWD/4WD) and propulsion-agnostic electronic components, such as electronic torque controllers.

Dowlais has long been the global leader in AWD/4WD, maintaining roughly 30% market share, with particular dominance in U.S.-based pickup trucks and SUVs. We expect this exposure to be insulatory to business, as the U.S. has been slow to transition away from ICE vehicles, particularly within the pickup truck and SUV submarkets.

Historically utilized primarily in AWD systems, electronic powertrain components have recently become key inputs for managing multiple aspects of the EV drivetrain. Dowlais is a market leader in these components, and we believe component sales will increase as EVs become a more prominent proportion of the GLV fleet.

Until this year, ePowertrain also housed Dowlais’s eDrive sub-segment, a previously high-growth unit that engineered end-to-end drivetrain systems for BEVs. Dowlais entered 2024 with concentrated exposure to only four BEV platforms, each in partnership with legacy OEMs. As BEV sales cratered, platforms were delayed or shuttered, and eDrive revenues plummeted. Management has stated that they are pulling future R&D for the systems and laying off or realocating eDrive engineers. We believe eDrive no longer comprises a meaningful percentage of segment or group revenue and that eDrive revenues will not return.

GKN Powder Metallurgy

Powder metallurgy (or “Powder Met”) is another market-leading business in Dowlais's portfolio. Operationally unrelated to the autos business, Powder Met has its own unique manufacturing footprint, C-suite team, and end-market profile. The business is a global market leader in the space and stands apart as one of the few at-scale global players and one of the only vertically integrated operators.

Powder metallurgy is a specialty manufacturing process in which scrap metal is processed into fine powders. These powders are then hydraulically pressed into custom molds, producing high-precision, low-density metal parts. The parts are then sintered in high heat to harden the alloy and imbue the part with unique metallurgical properties.

Powder Met is fully vertically integrated, the #1 global producer of sinter metal components, and the #2 producer of raw powdered metals. The business is heavily exposed to the automotive space (c.80% of segment revenue) and indexed primarily to ICE vehicles, with components used in engines, transmissions, and exhaust systems. Transitioning away from ICE exposure has been a slow process, but to date, management has successfully stabilized revenue and margins. We feel that this year’s carnage in global BEV volumes implies a much longer tail for Powder Met’s SKUs than might have been previously expected, and we are confident in the business’s ability to transition over time. Multiple expert checks on the unit have corroborated this belief.

Other businesses

China JV: Dowlais has operated in China for 35 years under a series of JV partnerships, the largest of which is with HASCO (SHA:600741). China JVs have been high-growth, high-margin businesses recognizing strong ~10%+ EBIT margins and achieving significant size and market share. The Chinese market is one of the fastest-growing auto markets in the world, and DWL’s legacy exposure to geography should be a boon going forward. 

China JV revenue accounts for 11% of group sales and generates significant operating profit. However, due to equity accounting under IFRS, the group does not recognize these earnings via P&L, leading to some confusion about group revenue and margin.

Management recommends evaluating DWL using Adjusted Revenue and Adjusted EBIT by adding pro-rata JV sales and profit to IFRS figures. We believe this is appropriate and have presented the financials as such. Most of China JV revenue is related to driveline / sideshaft sales.

Hydrogen: Closed in 2H24, GKN Hydrogen was a legacy unit handed to Dowlais in the spin. Dowlais maintained this business for the first year before closing the money-losing unit. Hydrogen contributed ~zero revenue and 15 - 20mn GBP in annual losses.

Multi-year restructuring plan

In 2018, Melrose poached Delphi Driveline CEO Liam Buttersworth to fix up the recently acquired and severely mismanaged GKN Automotive (now Dowlais). Since then, Mr. Buttersworth has implemented an aggressive refresh of the unit, which we believe has significantly improved the quality of the business. We believe Dowlais’s transformational progress is underappreciated by the market today, as volume declines have masked significant margin advances while cash and non-cash charges related to the restructuring have depressed headline earnings for years.

Since initiating restructuring, Dowlais has seen an impressive 25% workforce reduction as the footprint has been consolidated and shifted from the U.S. and Western Europe to lower-cost geographies. By year-end '23, GKN Automotive had reduced its permanent workforce from the FY18 level of 24.4k to today’s 18.3k. Similarly, Powder Met saw its full-time employees shrink from 7.4k to 5.5k over the same period.

Not only have full-time employees shrunk, but labor location has also meaningfully shifted as DWL completely overhauled its footprint geographies and consolidated its overall global capacity. Rework of the manufacturing footprint led to 15 plant closures in high-cost geographies, line expansions in low-cost areas, and the construction of brand-new facilities in Mexico and Hungary.

Low-hanging fruit was also tackled with impressive results, such as renegotiating onerous purchasing contracts and consolidating suppliers, leading to several % of gross margin expansion and a reduction to networking capital of nearly 50%.

These changes have not been without costs. From 2020 - 2023, the firm recognized GBP 445mn in cash restructuring costs, with an expected 110mn in additional costs in FY24. Further, capex outlay spiked to ~1.2x depreciation as plants were constructed and expanded.

Management has guided that restructuring is near completion. Capex is moderating this year, and we believe it will hit a run-rate of <1.0x going forward. Cash restructuring was primarily driven by workforce reductions, which are now winding down. We expect to see ~GBP50mn in cash restructuring charges in FY26 with minimal charges thereafter.

These shifts will drive GBP80mn in cash tailwind this year, 110mn next year, and 150mn in run-rate reduction in cash needs by FY27. We believe there is a further tailwind in run-rate cost savings as we lap FY24 workforce relocations.

Valuation

We believe a 1 - 2% topline CAGR for Dowlais over the forecast period is a reasonable base case driven by primarily by GLVP slowly returning to FY19 levels. Further, we believe the business's incremental EBIT will be between 20% and 30%, driving significant cash flow accretion as sales recover.

In the long term, we think China will become a more prominent player in the global autos market, and many ex-China OEMs will suffer. As such, we model DWL as a long-term GDP-minus player at 1.5% perpetuity growth, implying a fair value of 12x NOPAT or 5.5x EBITDA.

Based on these conservative assumptions, Dowlais's intrinsic value is 165 pence, or an astonishing c.140% upside. Crucially, even assuming zero growth into perpetuity, Dowlais is undervalued by more than 30%, given its extremely strong cash generation profile.

Not only does our base case imply significant dislocation in value, but scenario analysis indicates a highly favorable skew to shareholders. Even in recessionary macro outcomes, we believe Dowlais will remain cash-generative and able to shift earnings into deleveraging, insulating shareholders from the worst outcomes.

Merger call option

On January 29th, Dowlais announced a stock-and-cash merger with U.S.-listed peer American-Axle (AXL). Outlining the pros and cons of the merger transaction in detail is for another article, but here are the cliff notes.

• Meaningful cost synergies. AXL and DWL have natural synergies, given AXL’s specialization in complementary portions of the drivetrain and parallel units in specialty manufacturing. Management cites ~$300m in synergies, which we believe are largely achievable.

• Deal favors AXL shareholders. DWL’s total consideration amounts to ~4.0x EBITDA pre-synergies on trough earnings, a nose-bleedingly low price that we find offensive to DWL shareholders.

• AXL shareholders frustrated. Interestingly, AXL shareholders are also frustrated by the proposal, which caused their stock to fall 10% on the announcement and another 10% over the following week.

A more detailed presentation of the merger terms can be found here.

Despite both companies’ Boards approving the merger, the market continues to imply an extremely low probability of closure, as shown by the excellent merger arb spread offered: 13.5% up and only 2% down. Given strong fundamental support and limited downside to the pre-announcement price, we view the merger as a free high IRR call option.

Summary Financials

Key Risks

• ICE exposure. DWL's portfolio is heavily indexed to ICE vehicles, which are expected to become an increasingly small portion of global SAAR. The business may be terminal if DWL fails to transition its portfolio to newer EV platforms.

• China market share loss. Today, Dowlais is a significant player in the Chinese market, but we worry this position has been weakening since COVID.

• U.S. tariffs. Roughly 40% of LTM revenue was from the U.S. The current administration is threatening punitive tariffs on auto imports, which could meaningfully decrease profitability or sales within the business.

• Merger / Strategic Divestiture Failure. If the current merger fails, we expect Dowlais’ stock price to return to at least the pre-merger undisturbed close (68.5p). Further, if management declines to restart the strategic review of Powder Met or fails to sell the unit in the wake of a failed merger, the stock may drop significantly due to a lack of confidence by the market.

Catalysts

• Merger consummation. If the merger closes, shareholders will receive a cash and stock consideration of 79 pence, roughly a 13.5% premium to today’s share price.

• Unmasking of cashflows. DWL screens poorly due to significant distortions to its financials, which will abate over the next 12 - 24 months. Over the next year, we expect its earnings power will be unmasked.

• Cyclical tailwinds. The Autos sector, particularly ex-China, saw a significant volume drawdown this year. A rebound in GLVP should drive a meaningful re-rate in the sector, benefiting DWL.

Conclusion

We believe Dowlais offers shareholders an extremely attractive risk-reward ratio. At a 12% unlevered cash yield and <5.0x Adj P/E, we see significant upside in the stock even if nothing positive happens to the Autos market beyond stabilization. The roll-off of cash charges and development of greater institutional knowledge should begin to drive incremental interest over the next 1 - 2 years. In the interim, management intends to put cash to work via share buybacks and special dividends, which we expect to be highly accretive given today’s multiples. If sentiment towards autos shifts and revenues return to growth, shareholders should see enormous price appreciation likely overnight. All of this is backstopped by a merger deal that, however unlikely to close, indicates very little downside on breakage and an excellent annualized IRR to shareholders.

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Quick Notes

• Liberty Broadband (NYSE: LBRDK) is a complex John Malone Holdco whose primary asset is a 28.5% stake in publically traded Charter Communications (NYSE: CHTR).

• LBRDK has traded at a persistent discount to NAV due to complexity, uncertainty around taxes, and lack of visibility on the rationalization of the Holdco structure.

• On November 13, 2024, Charter and Liberty finalized deal terms that ensured the Holdco would be wound down by June 2027.

• LBRDK now trades at a c.15% discount to merger NAV with a guarantee that this discount will collapse in the next 18 months, if not sooner. Further juicing returns, CHTR itself appears to be trading at a meaningful discount to intrinsic value, providing fundamental support and upside to the transaction.

Thesis Summary

Liberty Broadband (“LBRD”) is a Holdco comprised of a 28.5% ownership of publicly traded Charter Communications, 100% ownership of dominant Alaskan telco and cable company GCI, and an attractive debt stack of busted converts and low interest preferred. LBRD has persistently traded at a 15 - 40% NAV discount, but this will soon be resolved as a recent all-stock merger struck with Charter in November 2024 has finalized terms of rationalizing the structure. Per the merger terms, on or before June 2027, LBRD shareholders will see their shares convert into CHTR stock at a 0.236 CHTR:LBRD ratio. In addition to receiving 0.236 CHTR shares, LBRD shareholders will also receive GCI as a standalone entity via a pre-merger spin transaction with spin-related taxes covered by Charter up to $420M. Charter will assume or retire LBRD’s group-level debt as part of the Holdco collapse.

Under the merger terms, LBRD trades at an attractive 15% NAV discount, implying a 10% annualized IRR to LBRD shareholders over the next 18 months. We suspect some combination of an accelerated merger consummation, interim period LBRD share buybacks, and underlying CHTR stock price appreciation will juice IRR math during the hold period.

While LBRD trades at a 15% discount to today’s CHTR price, a review of Charter shares reveals that the cable company is likely itself undervalued at 8.5x NTM P/E. Accounting for our estimated 40% upside to CHTR’s stock price, LBRD trades at a healthy 35%+ discount to the adjusted merger NAV, or 60% upside from current levels.

We see LBRD as a “heads I win; tails you lose” dynamic. Investors win in an accelerated merger scenario, win in a protracted merger scenario, and win on a fundamental CHTR re-rate, which we view as more likely than not to materialize. We believe negative investor sentiment around Charter Communications is bleeding into LBRD’s valuation and that complex merger terms and a far-off merger date are leaving the stock largely in limbo.

Recent Events

• September 15th, 2024, Charter proposed to purchase LBRD at an exchange ratio of 0.228x, conditional on the disposal of GCI.

• September 23rd, 2024, LBRD counteroffered a 0.290x exchange ratio, stipulating that GCI would be included in the exchange.

• November 13th, 2024, CHTR and LBRD reached a definitive merger agreement specifying a 0.236x exchange ratio contingent on the disposal of GCI before the merger given that CHTR would foot the GCI spin-related tax bill.

Why Does This Opportunity Exist?

• Misunderstanding of GCI. LBRD trades at an 8% discount to CHTR shares alone before crediting GCI. We estimate GCI is worth $5 - $10 per share and believe the asset is a well-positioned, dominant telco in its market. We think investors don’t understand this business and don’t appreciate the value that the spin will unlock. Thus, they see it as a “bonus” to the merger rather than a valuable asset to shareholders.

• Poor Sentiment Around Cable. Charter’s valuation has been pummelled over the last few years as the industry faces sweeping disruptions. Chord cutting has accelerated, and new market entrants are slowing legacy broadband internet subscriber growth. While these fears are, to some extent, founded, we suspect they are overblown relative to the actual risks, creating a fundamental mispricing in the underlying.

• Complexity. The CHTR-LBRD merger is complex and long-dated, and LBRD’s structure is also complex. Further, the long-dated merger has encouraged analysts to postpone their review of the business. In short, we think many analysts haven’t sat down to the work yet and believe there is an opportunity to front-run merger arb traders.

Business History

Liberty Broadband is one of the many vestiges of John Malone’s Liberty Media empire. LBRD has been a long-standing vehicle created initially to isolate Liberty’s Charter ownership and later as a home for Liberty’s Alaskan telco, GCI. Several idiosyncrasies within the LBRD vehicle have long made it difficult to analyze (e.g., multiple share classes, complex debt instruments, and opaque tax liabilities). Long-time followers of Malone’s escapades will be familiar with LBRD’s brand of complex antics and financial engineering. For readers less familiar, I highly recommend picking up a copy of Cable Cowboys. It’s a fascinating read that reviews Malone’s storied history in legacy media and will provide context to the type of shenanigans that have made Liberty so famous.

Below is a brief summary of Liberty Broadband’s development as a standalone entity:

• Liberty Media first invested in Charter in 2013 when the firm purchased 27.3% of the company from a consortium of private investors.

• In November 2014, Liberty Broadband was spun from Liberty Media to isolate the Charter shares and provide investors with a clearer understanding of the asset’s value.

• In May 2016, Liberty Broadband orchestrated a merger with Charter, TWC, and Brighthouse. This merger effectively created Charter Comms as we know it today.

• In December 2020, Liberty GCI merged with Liberty Broadband in an all-stock deal. The merger with GCI simplified the broader Liberty Media structure but muddied the waters for Liberty Broadband’s financials.

Peppered throughout LBRD’s history has been Malone’s signature financial engineering. LBRD has persistently traded at a discount to NAV. In response, Malone has spent most of LBRD’s lifetime exploiting this discount through creative financing. In fact, the LBRD debt stack arose primarily through creative ways of arbitraging the NAV gap. Is the discount between LBRD and Charter too wide? Perhaps take a margin loan against the CHTR shares and use the proceeds for LBRD buybacks. In a handful of particularly well-designed maneuvers, LBRD issued convertible debentures against CHTR at elevated multiples and extended NAV discounts and used the debt proceeds to accelerate the buy-in of LBRD shares. As CHTR fell and the discount widened, LBRD refinanced the notes at a discount to par and bought even more shares. Alongside creative financing, LBRD has also been a routine seller of CHTR shares, with proceeds plowed into accretive buybacks.

Charter Communications: High-quality business trading at a discount

Charter Communications is one the most dominant broadband internet providers in the United States. The firm controls 28% of broadband infrastructure and serves 30M+ internet customers nationwide via the Spectrum brand. In addition to high-speed internet services, CHTR also provides cell service, landlines, and legacy cable TV to millions of additional subscribers. Although Charter’s broadband internet offering has increasingly faced competition from new technologies, for much of the U.S., Charter’s legacy HFC (Hybrid Fiber-Coaxial) network remains the best, cheapest, and often only option for internet services. The critical infrastructure footprint Charter controls is an enormous, long-lived asset to the firm that would cost tens of billions, perhaps hundreds of billions, of dollars to replicate today.

Due to the high cost of entry, CHTR operates with a substantial moat around its services and generally enjoys a monopolistic or duopolistic position within its regional submarkets. CHTR leverages these strong regional positions into robust margins as new broadband subs come onto the network at incredibly high incremental EBIT. Cable infrastructure is long-lived, and we believe a substantial portion of CHTR’s infrastructure will outlive (or has already outlived) its depreciable life, leading to long-term annuity-like income at a generally increasing EBIT margin over the life of the asset.

Perhaps somewhat surprisingly, CHTR has been a secular growth story for the past 10 years. The company has invested heavily in rural internet buildout and has seen excellent ARPU growth and margin expansion as customers shifted from lower-margin cable TV packages to high-margin cable internet bundles. Through its pivot to broadband internet, CHTR has effectively transformed itself from a legacy media player into a major critical infrastructure firm that has been a broad beneficiary of the increasing need for connectivity across America. As a stark example of this transformation, we estimate that legacy cable TV packages may be run at roughly EBIT breakeven with their primary purpose to firm as a bonus for internet bundling in an attempt to create stickier subscribers, reducing lifetime customer churn. Bearing this in mind, we want to take a moment to emphasize our belief that legacy cable TV sub decline is largely a red herring for investors as the business's broadband internet and growing wireless services will be the primary dictators of future growth and profitability.

For the better part of the last decade, the stock has produced solid MSD% top-line growth, with 25bps or more in EBITDA expansion per year, thanks to a favorable revenue mix shift and operating leverage afforded by broadband infrastructure. While cable subscribers have been in secular decline for 5+ years, pricing power has remained extremely strong for the service and has more than offset chord cutting until recent quarters. We believe cable declines will create 25 - 75 bps of top-line headwind over the next few years, after which declines will be de minimis relative to group revenues. Interestingly, we expect margin declines in the cable TV segment to be EBITDA margin accretive to the broader group.

Despite robust business characteristics, CHTR has faced a number of operational challenges over the past few years. COVID and COVID-era policies were once a significant tailwind as they created meaningful demand pull forward. A major contributor to this pull forward was the Affordable Connectivity Program, or ACP, a stop-gap subsidy measure designed to provide low-income consumers access to broadband internet during lockdowns. Today, COVID tailwinds have shifted to headwinds, as broadband internet penetration has essentially hit saturation, leading to a slowdown in industry growth. Further, the roll-off of ACP subsidies in June 2024 has driven elevated churn in broadband over the past few quarters, which has hit Charter particularly hard since they leaned into subsidy participation heavier than competitors such as Comcast.

On top of general market dynamics worsening, competition in the broadband space has intensified significantly in recent years. First, fiber overbuilders (Lumen, Altice, AT&T, Verizon, and others) have leaned into the costly process of ripping out old dial-up lines and replacing them with ultra-high-speed fiber optic cables. Fiber projects are hitting the densest urban areas hardest, as overbuilders need to reach significant penetration to achieve a return on costly buildout, which brings key Charter markets under threat of competition. Overbuilders are also offering aggressive debt-subsidized promotional packages to try to rapidly take market share, which has sent some sub-markets into a price war tailspin (previously unthinkable under the old HFC broadband regime).

More alarmingly, Verizon and T-Mobile have begun packaging their excess 5G/LTE data into fixed wireless broadband internet for the home (e.g., FWA packages). Initially dismissed by market participants as a passing trend, FWA has borne out to be much more popular and stickier than expected. FWA is cheaper than HFC broadband, and speed and reliability have proven sufficient for many consumers. Although many industry analysts have pointed out that telcos have limited spare bandwidth, judging by the growth rates and language from management teams, capacity constraints are much less of a concern than the market initially thought.

Given that today’s broadband market is effectively fully saturated, advances in new technologies such as FWA necessarily imply market share loss for incumbents such as Charter. FWA and Fiber continue to grow at an alarming clip, which has called into question the sustainability of Charter's broadband subscriber growth. Only a few years ago, the stock traded at rich multiples implying an unstoppable and secular growth story. Today, the name has been left for dead and trades at a dumpster HSD multiples across the board. With increased overbuilding and low-cost wireless options eroding Charter’s ability to win price-sensitive and rural customers, markets worry that Charter’s broadband crown jewel will become a melting ice cube.

While we admit this is a dour backdrop, we think market participants are failing to see the forest for the trees. Charter has become a popular whipping boy for pod shops interested in trading around earnings revisions driven by broadband subscriber misses. Meanwhile, the sell side struggles to recommend the stock due to a lack of near-term visibility given FWA’s rise and ACP roll-off.

Setting all this aside, CHTR trades at <9.0x NTM P/E and is a dominant infrastructure player with millions of customers. CHTR provides an excellent value offering due to its converged product services and bundling. Even modeling minimal go-forward broadband sub growth and highly punitive cable TV sub losses, we believe 1.5% - 2.5% p.a. topline growth is easily attainable over the next five to ten years.

From a competition standpoint, while it's hard to say when FWA will level off, we think it’s clear that fixed wireless subscribers can’t grow forever. Excess spectrum is limited for the telcos, and even if it wasn’t, the product only appeals to a niche price-sensitive customer. On the opposite end of the spectrum, fiber may offer near limitless symmetric up-down speeds, but as we start hitting 3, 5, or 10 Gbps, consumers aren’t able to tell the difference. Charter is rolling out its DOCSIS4.0 upgrade across the legacy network, which will provide consumers with internet speeds well beyond their utilization ability and, in theory, undifferentiable to Fiber offerings.

Further solidifying the firm’s value-add, Charter can offer meaningful discounts to customers based on bundling. We think the company’s converged product offering (internet + wireless + TV) offers an extremely compelling and difficult-to-replicate value to consumers that can translate into meaningful cost savings and, ultimately, much stickier subscriber relationships.

All in all, we believe investors need to grit their teeth and endure the short-term volatility. Charter’s trading price has been driven down due to near-term uncertainty and a few weak quarters. Looking ahead, once we lap the ACP roll-off, start to see FWA finding its limit, and allow for CHTR’s wireless business to achieve more significant scale, we think Charter’s sub counts will stabilize, and the stock can return to LSD% top-line growth with meaningful margin expansion.

GCI Communications: Currently unpriced by the market

GCI, Alaska’s premier broadband and telecoms company, is a unique asset that has been discussed little since its merger into the LBRD structure in 2020 and, frankly, saw limited discussion even before as a standalone business. LBRD, for its part, has maintained excellent reporting standards around GCI, which has allowed for detailed analysis over the duration of the firm’s life. Despite robust disclosures, limited analysis appears to have been done as GCI’s value has been vastly overshadowed by the CHTR shares, and many investors have been happy to accept it as a free kicker while focusing primarily on the CHTR-LBRD NAV gap. Despite little fanfare, GCI has demonstrated itself to be a market-leading duopolist with an enormous share in the Alaskan market.

Alaska is a rather undynamic low-to-no-growth market. The Alaskan population has seen minimal growth over the past decade. Communities across the state tend to be extremely small and rural, with limited access to critical infrastructure and services outside of Anchorage. Against this backdrop, GCI has carved out a near monopolist position in many areas across the state through legacy broadband infrastructure and buildout on the margin funded by government subsidies. GCI has ultra high-speed internet passing across ~80% of the state and high-speed broadband passing across 90%+. The company clips stable 35% EBITDA margins and shows a healthy 15 - 20% FCF margin on no-growth capex levels.

The firm maintains ~200K wireless customers and ~156K cable internet subs. U.S. Census Data indicates that Alaska has only 267K households and ~645K persons aged ten years or older. This implies a 50%+ broadband share and c.33% wireless share. GCI’s only real competitor in the state is AT&T, which primarily competes in Anchorage and Fairbanks.

In short, while GCI may have limited growth opportunities, we find its market position challenging to replicate. We believe GCI has ample pricing power, some room to grow through government subsidies, and an extremely wide moat in its niche.

Misc. Merger Notes

Merger Timeline

The merger must be consummated by June 30th, 2027, at the latest. The merger can occur sooner than this date, and we highly suspect both parties would like to accelerate the process. So why is the deal dated out so far? We think the primary reason is that GCI needs to be prepped for its spin-off. We think LBRD believed GCI would go with Charter during the merger and that there may be significant work to prep the company for floatation. Once the spin occurs, we expect to see the merger consummate rapidly.

Stock Options

There is quite a pile of out-of-the-money stock options outstanding on LBRD shares. OTM LBRD options will be restruck as CHTR options with a new strike price equivalent to the current strike on LBRD (e.g., restruck based on exchange ratio). This is good news for shareholders, as options represented a potential 2.9% dilution if converted.

GCI Spin-off

GCI will be spun off to shareholders before the merger date. The spin is a taxable event, but CHTR has agreed to cover taxes up to $420M. We believe this amount should fully cover the tax burden for shareholders. However, there is a risk that LBRD will bear any excess tax liability.

Interim Share Repurchases & Debt Retirement

Per the merger terms, Charter is obligated to repurchase $100M CHTR shares per month from LBRD until the merger is consummated. LBRD is required to use these proceeds to reduce debt. Management has indicated that stock sale proceeds directed toward debt reduction will be tax-free.

Valuation

We will employ an SOTP valuation to build into LBRDK’s value.

Charter Communication Valuation

We forecast FY25 - FY29 explicitly capturing the ramp-up and down of the current rural buildout and DOCSIS4.0 upgrade cycle. In our terminal year, we move Charter to “equilibrium” capex which we estimate to be 11% capex/depreciation as % sales.

Note that we view growth as challenged for the company going forward fixing top-line at +1.5% p.a. (GDP minus) in the long-term. We think this accurately reflects future broadband competitive dynamics.

GCI Valuation

GCI is a straightforward business. Revenue should exhibit 1 - 2% run-rate growth, and EBITDA margins are essentially stable. Based on market share and growth opps, cable and telcos have historically traded in a 6 - 8x EBITDA range. We’ll use the bottom of the trading range for conservatism even though we see GCI as worth a roughly middle-of-the-pack multiple given its dominance.

Sensitivity analysis around margin and multiple:

LBRDK Valuation Build-up

LBRDK trades at a healthy NAV discount on the current CHTR price. When accounting for CHTR's intrinsic value, the discount widens significantly, providing a healthy upside to shareholders.

We are ignoring LBRDK's group-level debt (convertible debentures, margin loans, and preferred shares), as CHTR will eliminate these during the merger.

Key Risks

• Tax obligations. The GCI spin will be a taxable event; however, Charter will cover up to $420M in taxes, with any excess borne by GCI shareholders. Additionally, any issue in the RMT transaction may leave LBRD shareholders with a significant tax burden.

• Charter valuation. The LBRD thesis is contingent on the underlying CHTR valuation. A fundamental deterioration in CHTR will dominate the LBRD shareholder return. This risk cannot be isolated as hedging CHTR is prohibitively expensive given the 18-month merger duration. This likely partially explains the elevated merger arb discount.

• Merger delays and breakage. As with any merger deal, particularly one with such a distant date, delays and breaks can ruin the trading dynamics.

Catalysts

• Consummation of merger. Ultimately, this is a midterm thesis in which value is unlocked as the NAV discount collapses during the merger.

• GCI Spin. We believe the GCI spin will unlock meaningful shareholder value by significantly simplifying the story. Moreover, we believe the market assigns GCI close to zero value, and as such, its distribution will have no impact on LBRD’s stock price, effectively gifting value to shareholders of record.

• CHTR Fundamental Improvement. A re-rate in CHTR stock is pari passu to a re-rate in LBRD. CHTR has a number of fundamental drivers. We believe chief catalysts will be the re-acceleration of broadband subs, discipline on capex, and a position of strength on buybacks.

Conclusion

Liberty Broadband offers investors an interesting risk-reward dynamic. Mid-term merger dynamics and the potential to roll up the NAV gap as the merger date approaches should yield reasonable risk-adjusted returns. Longer-term, LBRD is a much cleaner way to own a dominant broadband asset, Charter Communications, at an attractive entry point. Charter trades at <9x P/E, further discounted to <8x on a pass-through basis when owned via LBRD.

The transaction's complexity and 18-month time horizon are keeping larger market participants on the sidelines for now. However, this can’t last forever, and as we approach June 2027, malaise should naturally dissipate, tightening deal spreads. We believe there is an opportunity for an accelerated value unlock if either GCI is spun early or the merger deal is consummated sooner than anticipated.

One final thought we’ll leave readers with. Charter and Liberty Broadband shareholder registers are very attractive. While we wouldn’t base an investment case around other people’s ownership, we appreciate that we are in good company. On the Charter side, a litany of value investing mainstays appear in the top shareholder ranks. Oakmark Funds, Dodge & Cox, Pzena, Ruane Goldfarb, and Berkshire Hathaway are all prominent shareholders. Liberty Broadband counts many the same investors, in addition to significant skin in the game from John Malone and Malone’s prodigy Greg Maffei as well as a supporting cast of elite activist and event-driven investors, most notably Elliott and Farallon Capital. This is an astonishingly concentrated roster of top-tier asset allocators, many of whom we suspect are unlikely to sit by idly for 18 months.

Please leave any feedback, comments, or pushback in the comment section. You can also find me on X @cornerstone127. Write-up suggestions welcome!

If you enjoyed this and want more of this type of content, please subscribe below. Also, be sure to share with friends, family, and colleagues. Thank you for reading!

Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. Please make sure to do your own due diligence. The opinions expressed are those of the author and are subject to change without notice.

Disclaimer: As of the time of writing, the author owns shares in the company described in this article. The author may purchase or dispose of these shares at any time without notice.

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