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July 27, 2006

Comcast Reports Another Good Quarter: Time For The Bears To Hibernate

Comcast (CMCSA/CMCSK) reported another strong quarter with most key financial and subscriber measures beating estimates. On top of similar strength in 1Q, management is raising guidance. Revenue growth in the cable division (well over 90% of the company) is going up to 10-11% from 9-10%. EBITDA growth is now projected "at least" 13% higher vs. prior expectations of 10-11% growth. Revenue generating units are now expected to grow 60%, or by 4.2 million, up form previous guidance of a 3.5 million gain. The higher RGU growth means more equipment in customer homes so capital spending guidance is also going up by about 10%. There is no change to guidance for conversion of 25-30% of EBITDA to free cash flow.

Overall, the strong quarter and increased guidance indicates that Comcast's offer of the triple play bundle is driving financial results. More importantly, the accelerating gains in revenue generating units is improving Comcast's position for the day (at least several years from now) when AT&T (T) and Verizon (VZ) are competitive with their own bundle on a broad geographic scale. In other words, the triple play is driving near-term growth in revenue, EBITDA, and free cash flow while also improving the company's long-term competitive position. That should lead to a better valuation shares whether you use EBITDA, free cash flow, or EPS. Consequently, I see Comcast shares continuing to move higher with a target in the upper $30s increasing realistic in 2006.....

For 2Q06, Comcast reported revenue growth of 11% vs. expectations for 9%. The top line surprise flowed through to EBITDA which rose 14% at the cable division well ahead of estimates for gains of 10-11%. Revenue generating units or the total of video, high speed data, and telephony services held (I take all three and consume 3 RGUs) rose by 61% vs. a year ago due to strong growth in all three areas. The rollout of telephony is the key driver and given that Comcast is still marketing to just a portion of its footprint these gains should hold at least through 2007.

In most telecom subscriber businesses, better than expected RGU growth would lead to lower EBITDA due to the expenses of adding new services. Comcast is managing to buck the trend and increase margins simulataneous with accelerating growth. This is due to excellent expense control and better than expected pricing. Yes, that's right despite all the fears about competition for TV, high speed internet, and telephony, pricing is holding up much better than expected. Maybe the bears will finally acknowledge the strength of Comcast's competitive position due to its superior network. That strength is not going away anytime soon.

I also think that the bears that were bashing Comcast as little as six months ago because the company was growing slower than other cable companies and not yet offering the triple play should realize that maybe the decision to slow the rollout of telephony until the network, the company, and the servicing infrastructure was ready for prime time was the right decision. I suspect that 8% expense growth vs. 11% revenue growth is at least partially the result of the strategy toward telephony.

There is one nugget for the bears to chew on in the quarter. Capital spending guidance is rising by about 10%, or $350 million. This is a direct result of higher RGU growth which means Comcast is buying more modems, digital set tops, and DVRs. Of course, the higher RGU growth is driving near-term EBITDA above expectations so it might be a good thing, especially considering the long-term benefits of locking up more customers ahead of the long-term competitive threat form T and VZ.

My math on this is as follows. Capital spending is going up by $350 million vs. an increase in EBITDA expectations of $200 million. This $150 million is buying an additional 700,000 RGUs. Looking at unit pricing, each RGU is worth about $45 per month. Therefore, the $150 million is buying close to $400 million in incremental revenues. At a margin of 40%, that is an extra $160 million in EBITDA making the payback on the investment just year. Seems like a smart move to me and maybe the bears should reconsider their view that rising capital spending at a near-term cost of free cash flow is a negative. Someday maybe, but not now when T and VZ pose no serious threat outside of a few isolated communities. Comcast uses a simpler explanation explaining that the extra capital spending produces a 30% after-tax levered return.

I don’t mean to be overly positive with this summary but at the beginning of 2006 everyone hated Comcast. The stock is now up over 30% this year. The lesson here is that sometimes you have to look beyond the short-term action in the stock and stick with your long-term fundamental analysis. Sometimes the stock price is wrong.

Posted by Steve Birenberg at July 27, 2006 03:28 PM in Comcast/Cable TV