After a difficult 2018, Comcast (CMCSA) shares have rebounded to challenge all-time highs reached at the beginning of last year.  This might be hard to understand given the constant drumbeat of news stories about cord-cutting.  Well, guess what?  Cable is actually a good business and getting better financially speaking.  Lost in the cord-cutting hysteria is that the cable industry is transitioning to a broadband first business model.  Broadband is a more profitable business and even more importantly, broadband has much lower capital intensity.  Thus, as the contribution of revenue and operating cash flow from broadband rises at the expense of video, Comcast becomes more profitable and produces more free cash flow.  At Northlake, we view operating cash flow and free cash flow as the primary metrics to value equities.  We have believed in this thesis for the cable business for some time and it is why we held firm to Comcast even as the stock struggled in 2018.  Comcast’s 1Q19 earnings report fully supported our view as (1) revenue grew 4%, (2) operating cash flow grew 10%, (3) margins expanded by 200 basis points, (4) 2019 margin guidance was raised materially, (5) cable capital intensity fell, (6) broadband subscriber and pricing growth beat expectations, and (7) video subscribers declined but not at an accelerating rate.

However, it was not just a misunderstood cable business that pressured Comcast shares for a year.  The company’s pursuit of assets being sold by Fox and the ultimate purchase of Sky led investors to question management’s confidence in the cable business (why diversify?) and long-term corporate strategy.  We did not like the decision to pursue Fox and Sky and still believe purchasing Sky was a mistake.  So far, two quarters in, Sky is performing as expected.  Revenue is barely growing but operating cash flow is declining as programming expenses, especially sports rights, are rising sharply.  Sky will likely stabilize over the next year but we still see the purchase as a poor use of capital against the challenges facing traditional TV content and distribution globally from the rise of Netflix and direct-to-consumer OTT viewing.

Comcast already faces those challenges at NBCU Universal and adding in Sky brings TV content and distribution to nearly 50% of revenues.  NBCU plus Sky is probably the best positioned traditional media company besides Disney but given the likely need to invest heavily in content and technology, we prefer to not dilute the outstanding financial characteristics of the cable business.

Fortunately, for now, NBC Universal’s cable and broadcast networks, theme parks, and filmed entertainment are performing relatively well.  This should allow investors increasing understanding and appreciation of the cable business to drive the shares higher.  Prior to the 1Q19 report, we had a target price of $46.50 on Comcast.  Given what we expect will be slightly higher operating cash flow and free cash flow estimates for 2019 and 2020, we think upper $40s is achievable.  As long as we see current positive trends at cable and no acceleration in the challenges facing NBCU and Sky, that is good enough for Northlake to continue to hold Comcast.

CMCSA 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.  CMCSA 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.