Comcast (CMCSA) reported in line results for 3Q17 although admittedly expectations on subscriber metrics had been reduced after the company adjusted its guidance. Financial results matched initial expectations and were never adjusted lower despite the lower subscriber counts. Comcast shares fell 15% from all-time highs since the company announced in September that they would lose 100,000-150,000 video subscribers in the third quarter against expectations for a very small gain. They also indicated a lower rate of growth in broadband subscribers. Despite the sub losses, the company said financial results would not be impacted and that turned out to be the case. Investors worry that steadily declining video subs and falling growth in broadband subs will eventually halt or reverse financial growth. We think this scenario is unlikely and find Comcast shares to have overreacted. We do not expect a quick move back to new highs and some further downside is possible. However, we remain confident the shares will regain their footing and can move to the mid-$40s in 2018. This is more than 20% upside against what we now see as minimal downside. Comcast has a very strong balance sheet and improving free cash flow which gives us comfort in showing patience.
The rise of OTT services like Netflix and skinny cable packages like DirecTV Now that are delivered over the internet is leading to people cutting the cord or slimming down the video package they buy from their cable company. This transition has happened faster than Northlake expected and appears to be accelerating. It would clearly be better for Comcast if they could hold onto more customers with big channel bundles. However, the company is still able to grow revenue and cash flow because it controls the best broadband pipe to your house or workplace. Comcast is gaining market share of broadband and can raise broadband prices as the connection becomes ever more valuable in an OTT world. In fact, a cord cutter loses the discount on the bundle of video and broadband creating a built in price increase for Comcast. Additionally, broadband is a much higher margin product for Comcast than video since Comcast does not have to effectively transfer half or more of the video price subscribers pay to the TV networks. The bottom line is that as Comcast becomes primarily a broadband supplier with various services riding on their network, they are protected financially. We believe this will become apparent over the next several quarters, allowing Comcast shares to regain recent losses and set new highs.
One final point…Comcast is well prepared for the transition from a cable TV company to a broadband company. The X1 set top box is clearly the best user interface and has been licensed by other leading North American cable companies. Netflix and YouTube are already integrated and the navigation and voice remote rival anything in the OTT world. The company has also focused on growing its commercial service and expanding into home services like security systems. Commercial and home security are more than 20% of revenue and growing double digits. X1’s success can be noted by the fact that Comcast sub losses are well under 1%, while peer cable and satellite companies are losing 2% or more of their subs. Thus, another reason we are sticking with Comcast is because management has proven quite competent and alert to the changing marketplace.
CMCSA is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. CMCSA is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.