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February 02, 2006

Comcast: Not Good Enough But I'd Hold On

Comcast (CMCSA/K) reported 4Q05 earnings that were pretty much inline across all metrics. Revenue exactly hit estimates, EBITDA might be considered light but that is certainly not the case if hurricane losses of $48 million due to the loss of 20,000 subscribers are considered. Subscriber additions were on target with basic subs growing 40,000 (60,00 ex-hurricane losses), data subs growing slightly above expectations and digital TV subs growing as expected. ARPUs were stable to higher across the board as expected.

Despite a generally inline report, CMCSA shares will trade lower due to confusing 2006 EBITDA guidance that in the headline EBITDA number is probably considered light. CMCSA project revenue growth of 9-10% in 2006, as expected. However, EBITDA growth of 10-11% is below expectations by 100-200 basis points. Management explained at length that the broad rollout of VOIP and investments in content assets would each cost 100 basis points in growth next year. A major new product push like VOIP brings forward customer acquisition costs thus negating year one cash flow from the new subscribers. If you buy that argument and assume analysts had not factored the lag into 2006 estimates then guidance is fine. Based on numerous questions on the call, this is clearly the issue facing the shares today. The questions also suggest that analysts had not considered these factors....

One good question about the VOIP rollout was "given the enlarged footprint it seems that your 1 million sub growth in 2006 could be low, if so can we assume that you could beat the sub guidance without penalizing EBITDA?" Management didn't really answer yes or no but if this turns out to be the case that would be a bulish development.

Something else that arises out of VOIP growth drag in 2006 is what abut 2007 and will there be a payoff? Management addressed this confidently and while they would not provide 2007 EBITDA guidance they did imply they expected EBITDA growth to accelerate in 2007 vs. 2006. This is good news but given that the RBOCs will have another year to rollout video and DBS may find a broadband product, investors will be unwilling to pay for 2007 growth. So the bottom line off this quarter is that the hoped for acceleration in EBITDA growth that is necessary to attract momentum and growth investors will not occur in 2006.

While this will make it tough going for CMCSA shares in the near-term, investors should not lose site of the fact the company is consistently growing its top line at close to 10% and producing operating cash flow growth above that level as margins expand. Free cash flow of $2.5 billion is at least stable in 2006 and should grow in 2007. This is a pretty good financial profile for such a large company and to me it is worthy of an EBITDA multiple above the current 6.5 to 7 times 2006 estimates.

Typing that made me realize that many of the issues that are holding back CMCSA shares are due to "bigness." This is a giant company which means that rolling out VOIP Telephony across the entire country leads to operational and financial challenges. IT is still the right thing to do but the period of actual rollout increases expenses relative to the cash flow payoff. Similarly, to make Content meaningful tot a company this size requires substantial investment. Again, near-term it restricts the growth rate but it is still the right thing to do.

Wall Street wants near-term results. In the case of CMCSA that means a pickup in the growth rate. CMCSA seems to be managing for stable growth rates but to insure that the growth rate is sustained as far into the future as possible. I think that is the right move. I'd rather have 5 years of 10% growth than one year at 14% followed by a slowdown to single digits. This situation likely means CMCSA shares will remain frustrating. Yet, they are also cheap and offer good growth and free cash flow. I plan to stick around as that fits my profile as an investor.

Posted by Steve Birenberg at February 2, 2006 12:07 PM in Comcast/Cable TV