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November 03, 2014

Another Good Quarter and Maybe Regulatory Clarity for Comcast

In a tough year for media and entertainment stocks, Comcast (CMCSK) has been a good performer rising 11% through October, a bit ahead of the S&P 500. As the just reported third quarter revealed, performance would be even better if not for the headwinds that have buffeted media and entertainment stocks. The good news is that the headwinds for the group and specific to Comcast are likely to diminish in the months ahead. Comcast remains one of the most attractive large cap stocks Northlake follows with upside of 20-30% looking out one year.

In the quarter ending September 30, 2014, Comcast reported results right inline or a bit better than analyst estimates. Overall, revenues grew 4%, operating cash flow rose 7%, free cash flow rose 27%, and EPS gained 12%. This is the math that works for Comcast shareholders as the free cash flow is used to sustain the company’s dominant competitive position through (1) investment in the business or acquisitions, (2) payment of a healthy dividend, and (3) aggressively repurchasing shares. The math gets even better after Comcast’s acquisition of Time Warner Cable closes next spring.

The acquisition of Time Warner Cable is one of headwinds Comcast and the media and entertainment stocks are facing this year. The regulatory review of the merger is closely related to net neutrality debate, which in turn is tied to the fears about the competitive threat and business model interruption surrounding emerging over-the-top (OTT) video services. Over the past few weeks, investors began to fear that the government might block the merger as part of increased regulatory oversight of the media and entertainment industries. This was evident as the spread on the between the value of the merger and Time Warner Cable’s stock price rose form 5% to 10%. However, late last week the spread narrowed back to under 8% after the FCC floated a trial balloon

I believe that the trial balloon floated last week by the FCC is the first concrete step toward resolving these issues in a way that should not greatly impact Comcast’s long-term growth and releases the upside related to the acquisition of Time Warner Cable. It appears the FCC is looking at a compromise solution on net neutrality where the interconnection between Comcast and other internet service providers (ISPs) and large websites or web services would be under FCC jurisdiction but the relationship between ISPs and their subscribers (that would be you and me) would remain unregulated.

This compromise is important to Comcast because it also signals that approval of the merger with Time Warner Cable is likely. The FCC can use the new net neutrality rules and apply other constraints when it approves the Comcast-Time Warner Cable merger including prohibiting the new larger company from charging websites and service providers for interconnection. Applying conditions to Comcast post-merger also is a good signal to the rest of the industry as to what the FCC is looking to accomplish as it applies regulation in the future. More regulation is never welcome o Wall Street but this compromise probably works for all players and will ease investor and uncertainty. Comcast can thrive under this regulatory framework, which is why I think another quarter of solid earnings can allow the shares to continue to outperform.

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’s regulatory filings can be found at www.sec.gov. CMCSK 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.

Posted by Steve Birenberg at November 3, 2014 12:21 PM in Comcast/Cable TV