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December 07, 2007

Morgan Stanley Upgrades Comcast

Morgan Stanley, which was early, aggressive, and correct with a bearish outlook for cable stocks upgraded its industry outlook yesterday to attractive. Comcast was raised from a sell to a buy. Here is a summary from the morning notes on Comcast: "We base our upgrade on three factors. First, concerns over a maturing product set have shifted to fears of an all-out price war, which we believe is unlikely, and multiples have compressed to historical lows. Second, consensus has moved to our camp of higher capital spending related to competing on high-def with satellite, and we see lower risk of capex misses going forward. Finally, voice share gains, HD/DVR deployments, and increasing data speeds should all help support 15-20% normalized EPS/FCF growth – compelling growth at this historical low multiple."

Morgan's upgrade is consistent with my post from yesterday: fundamentals for cable are actually pretty good with double upper single digit to low double digit revenue and EBITDA growth and a probable resumption of free cash flow growth in 2008....

....At current valuation levels, the problem for the stocks is sentiment is terrible and investors will be in "show me" mode for at least five or six months. Assuming Morgan Stanley is right that capital spending misses are now unlikely, the bottom should be right around here. But you'll have to have a lot of patience if you expect to make good money on new positions or make a meaningful portion of losses back.

One last point on cable before I shut up. Comcast does not count a customer who upgrades to an HD DVR as a revenue generating unit even though this customer pays a bigger monthly bill. Thus, when Comcast raised capex and lowered RGU guidance, it was overlooked that a major portion of the capex increase was generating incremental revenues. Management stated that the bulk of the capex increase came from HD DVRs and claims the return on this capex is very good.

This raises the final issue as to what might turn the stocks around. Investors are going to have to shift their focus from subscriber metrics to overall trends in revenue per household and total revenue, EBITDA, EPS, and free cash flow growth. This is not as much of a reach as you might expect. After all, AT&T and Verizon shares have overcome the fact that access line losses remain at all-time high levels. I still fail to see how AT&T losing a wireline telephony household (and all the add on triple play services they can sell that household) is different from Comcast losing a basic cable TV subscriber (and all the add on triple play services they can sell that household). Nevertheless, as the bear to bull view transition on AT&T and Verizon proves, it takes time for a shift in investor analysis focus for an industry to take hold.

Posted by Steve Birenberg at December 7, 2007 12:38 PM in Comcast