Media Talk

Comcast Reality Ahead of Fears

Comcast (CMCSA) reported an inline quarter with upside in the closely watched video and broadband subscriber metrics.  Consolidated revenues grew 4% and adjusted EBITDA was flat after taking into account $171mm in employee bonuses related to tax reform.  The cable business grew revenues 3% and adjusted EBITDA 4% as margins expanded. NBC Universal had 4% revenue growth and 6% EBITDA growth.

Comcast raised the dividend by 20% and announced another share buyback of “at least $5 billion” after repurchasing $5 billion CMCSA shares in 2017.  Other guidance commentary for 2018 was positive with cable margins expected to expand by up to 50 basis points and capital spending intensity in the cable business expected to fall.

CMCSA shares continue to be a battle between the bull case of modest growth in financial measures and the bear case of increased competition for video and broadband subscribers.  Our favorite analyst of the cable sector, Craig Moffett of MoffettNathanson Research put it well:

“By now the litany of worries that has kept investors on the sidelines should be familiar to everyone.  Video subscribership is being hammered by cord cutting.  Video margins are being squeezed by vMVPDs.  Broadband industry growth is hitting a wall.  AT&T is expanding its fiber footprint.  Verizon is deploying 5G wireless.  Cables growth phase must be over.

Against this bleak narrative, it may come as a surprise that Comcast’s Fourth Quarter video subscriber losses were better than expected (just a little over 1/10th of 1% in the quarter), broadband subscriber growth was also better than expected, and consolidated revenue growth was healthy 4.2% for the quarter and 5.1% for the year.”

The key to the bull case on Comcast is the balance sheet.  The company guided its long-term leverage ratio of net debt to EBITDA to the current level of 2.2X.  This is among the lowest in the media and communications industry and is a real strength for the investment case given secular headwinds.  This target also strongly suggests that the “at least” part of the buyback announcement is conservative.  Free cash flow should be north of $10 billion again and the new buyback and dividend will only consume about $8.5 billion.  EBITDA growth will add another $3 billion of free capital against the 2.2X leverage target. Looking out several years, Comcast should have annual excess free cash flow of $10 billion.

On the call, management said its balance sheet was of “strategic value.”  We interpret this to mean that the company may be looking to participate in the wave of consolidation underway in the media industry.  We know Comcast was a player for the Fox assets being purchased by Disney.  Discovery Communications and Scripps Interactive are merging.  CBS and Viacom merger discussion may be back on.  AT&T is trying to buy Time Warner.  T-Mobile and Sprint came close to merging and may try again.

We strongly suspect that Comcast is awaiting the outcome of government review of all these mergers, especially the upcoming court case between the DOJ and AT&T.  Once it is clear what can pass antitrust review, Comcast will deploy its strategic value.  Importantly, whether that is done through acquisitions or additional share buybacks, it is accretive to the value of CMCSA shares.

Northlake concludes that the bull-bear battle rages on but the shares are worth holding as the valuation on a free cash flow basis outweighs the long-term growth concerns that we believe are worse than the current reality.

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.

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