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February 18, 2014

Comcast Purchase of Time Warner Looks Good

Comcast’s (CMCSK) pending purchase of Time Warner Cable (TWC) improves upon an already positive story for CMCSK shares. Assuming approval effective 1/1/2015, analysts are estimating 5-10% accretion in free cash flow per share vs. Comcast continuing as a standalone entity. Accretion emanates from synergies in operating expenses and capital expenditures, estimated by management at $1.5 billion and $400 million once fully implemented over a 2 year period. Analysts are being a little more conservative in their forecasts assuming a three year implementation period. Management is not assuming any synergies on revenue. This strikes me as conservative, especially for the already rapidly growing business services at each company. With cable lines in 23 of the largest 25 markets in the U.S., the enlarged Comcast seems particularly well-positioned to accelerate focus and growth in business services.

My experience with Comcast management and large mergers generally is that management synergy estimates are usually conservative in terms of scope and time to achieve. Within the cable industry, synergies are relatively straightforward as the companies do not compete head-to-head so savings are mostly in overhead and scale purchasing economics.

Presently, combining the companies for 2014 and assuming no synergies, free cash flow per share is projected around $2.85 based on analyst estimates. With CMCSA/CMCSK shares trading at an average price of about $53 that puts the multiple around 18.5x and the free cash flow yield near 5.5%. Assuming a 1/1/15 deal close, analyst estimates (admittedly with a wide variation) show free cash flow growth of 16% in 2015, 20% in 2016, and 23% in 2017. Growth accelerates as synergies and share repurchases kick in.

Given this growth outlook, I think CMCSK shares can sustain their current free cash multiple, equating to a price target of $65 on 2015 estimates. This provides about 20% upside, plenty to justify owning CMCSK shares.

CMCSK shares traded a little lower on the deal announcement as arbitrageurs began positioning long TWC/short CMCSK. Given that I found CMCSK undervalued even before the merger announcement, I think downside is limited even if the government rejects the merger or imposes even stricter conditions than assumed. I think approval is likely with an extension of the consent decree CMCSK already operates under from its NBC Universal acquisition. The consent decree runs through 2017 and I would not be surprised to see it extended for a few years on the enlarged company.

CMCSK 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 regulatory filings can be found at www.sec.gov. CMCSK and TWC are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Posted by Steve Birenberg at February 18, 2014 08:54 AM in Comcast