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March 08, 2006

Does the AT&T-BellSouth Merger Hurt Comcast?

Some observations and thoughts related to cable and media on the AT&T (T) - BellSouth (BLS) merger after reading through all the stuff that my email inbox:

• I've been bullish on Comcast (CMCSA/K) using a thesis that the shares had room to rise as long as the window remained open for a year or two of double digit EBITDA growth, flat capital spending, and rising free cash flow. I had been assuming the window would be shut gradually as the RBOCs slowly rolled out their TV packages. My initial reaction to the merger is that the window may stay open a bit longer as T will be distracted for another year with regulatory issues but once the window beings to shut, it may do so more quickly. A couple of reasons for this view. First, BLS had not indicated it would be an aggressive player in launching multichannel TV and had shown little interest in T's faster to market IPTV approach. This may now change. Second, BLS has not been a discounter when it comes to DSL as T has been. This is also likely to change. Mix all this together and a decent working thesis seems to be a less aggressive T in the near-term but a more aggressive and larger T in the long-term.

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• Cable will see the merger approval process as an opportunity to push for some favorable regulatory rulings. Specifically, cable will ask for a restriction on the granting of statewide franchises for RBOC multichannel TV. If granted, this would slow the TV rollout. Second, cable will ask for an increase in its ownership cap that restricts the number of subs any one operator can own. I don’t see that as a positive for CMCSA because the street will react negatively to large acquisitions at this point as investors want free cash flow returned to them. As far as potential acquisitions go, only Cablevision (CVC) is an obvious and large target but as Ray Katz eloquently put it today, CVC will sell when the Dolan's want to sell and not sooner so big acquisition opportunities don’t really exist for CMCSA or Time Warner (TWX).

• Another regulatory issue, network neutrality, is likely to get a lot of play during the approval process. My impression thus far is that it is VZ and T that have been the bad guys on network neutrality while cable has stated it is not interested in breaking neutrality. The regulatory process could enforce network neutrality but the anti-RBOC sentiment during the debate could modestly help the public image of cable. Cable is in a win-win on this issue as long as it stays in the background. It could reap the benefit, of which I doubt there is much, of lost neutrality if the RBOCs win the fight but not get tarnished in the battle with regulators. It sure would be a nice change if cable actually got a boost to its image.

• Cable may accelerate its shift towards an all-digital network. This will raise fears of another leg up in capital spending. Consequently, I see this as the potentially the most negative impact of the T-BLS merger on cable stock valuations. Of course, an all-digital network has competitive and financial advantages for cable beyond the capital spending so an acceleration in the transition might help the long-term investment case.

• Cable will push harder, if that is possible, to lock up VOIP telephony subs. The churn reduction of triple play households is real. The more telephony subs added before the merged company is competing full throttle, the more defensible cable's competitive position. This could lead to more aggressive pricing for bundles in the short-term or higher capital spending driven by spending on customer equipment. Both might be viewed negatively in the short-term by investors.

• Lots of discussion of the fact that T uses Echostar (DISH) for satellite TV while BLS uses DirecTV (DTV). Conventional wisdom has quickly formed that DISH is the winner because BLS is likely to drop DTV in favor of DISH. This is logical but for DISH shares the long standing rumors of a T takeout of DISH are down the drain for at least the rest of 2006. Furthermore, with the enlarged footprint, it seems to me that when T gets aggressive with its IPTV rollout, the satellite option will quickly become marginalized.

• BLS is getting taken out at about 6.9 times 2006 estimated EBITDA, a premium to CMCSA. Analysts currently forecast a negative low single digit long-term revenue growth rate for BLS and a positive long-term low single digit EBITDA growth rate. Both growth rates comfortably trail assumptions about long-term growth at CMCSA, so on this comparison, CMCSA looks cheap. On the other hand, Verizon (VZ), T, Qwest (Q), and Sprint Nextel (S) all trade between 5 and 6 times 2006 estimated EBITDA so CMCSA looks appropriately valued at a premium to the survivor group of RBOCs.

• T and BLS have a combined advertising spend of about $3 billion, according to Merrill Lynch analyst Lauren Fine. Given the negative impact of prior mergers of major advertisers in telecom and retailing, this is another blow to ad-supported media stocks. On a combined basis, newspapers appear most at risk as both T and BLS spend heavily in that arena, although T proportionately at a much lower rate relative to its revenues. Network and spot TV have the next biggest share of the merged company's ad spend but most of this spending is by T. In fact, what struck me from Lauren's data is how little BLS relied on national advertising platforms like TV. On the flip side, BLS used a lot of radio while T sued little. This local focus makes sense given BLS's narrow regional footprint and lack of enterprise exposure. Consequently, the risks to traditional media from the merger probably are focused on specific newspapers and radio stations in the BLS geography.

In summary, I find surprisingly little investment impact on cable and media from the T-BLS merger. If you buy my bull case on CMCSA, I don’t see that your opinion would wobble much. If you are a bear on cable, you got some new ammunition. The implications for ad-supported media companies are much less and probably will get little attention from Wall Street. Seems like an awful lot analysis today for just a little action in the media stocks.

Posted by Steve Birenberg at March 8, 2006 02:01 PM in Comcast/Cable TV