In response to yesterday’s post about the Bernstein analysis of Comcast as a private equity buyout candidate I received an email from my good friend and media confidante KG, who is also a hedge fund manager. As usual, KG is thought provoking:
I read that Moffett analysis yesterday, and also read your piece. Such rationalization for an attractive stock price actually worries me a bit, which shouldn’t surprise you. His whole thesis is predicated on the EV in five years being over 8x EBITDA at that time. The math works at that level, but what if the exit multiple was, say, 6x? That $10 billion of upfront equity will have grown all the way to……….$11.7 billion, hardly great LBO economics.
Extrapolating the crazy present LBO environment into the distant future could be dangerous. I think CMCSK is on the cheap side of “reasonably valued” and I own it in my fund. But the way I look at it is if they do everything they say they will do by 2009, FCF/share might be about $2.25. At a reasonable 6% FCF yield, the ’09 stock price would be $37.50. Assume that happens in late ’09, 30 months from now. That gives us a prospective stock price appreciation of 15% per year for the next 2 1/2 years, decent for a big cap quality cable play but hardly “stupid cheap”.
KG is an appropriately skeptical investor and is currently bearish on the market which explains the “shouldn’t surprise you” comment. His points are valid and I would point to another stock he and I often discuss, Virgin Media (VMED) as evidence supporting his case. VMED trades around 6 times current year EBITDA reflecting slow growth in the brutally competitive UK environment for triple play services. One could certainly make the argument that the US will trend toward the UK environment over the next five years as AT&T (T) and Verizon (VZ) go national with their multichannel TV offerings, higher speed wireless data offerings become prevalent, and browser based video becomes more widely adopted….

On the other hand, US cable companies still have several growth levers to pull while telephony and high speed data growth remains robust. An article in yesterday’s Wall Street Journal referenced cable’s growing focus on interactive advertising. Additionally, cable companies are ramping up services for small and mid-size businesses. Both areas could be multi-billion dollar revenue generators five years from now.
The bottom line is that KG is right to be skeptical and throw some cold water on the Comcast buyout thesis but if cable is able to sustain upper single digit revenue growth and stable margins in the out years, the numbers work. I am a believer.