Description

Background:

In the fall of ‘17, Comcast was rumored to have bid 16% higher than Disney for the majority of Fox assets. Those rumors, and weakness in cable stocks generally, pushed CMCSA from a summer high of ~$42/share to the mid-$30s. As rumors subsided and tax reform became reality, CMCSA stock rallied back to the highs. In recent months, video sub losses at Charter, fears of 5G, a CMCSA bid for Sky Plc, and a $35 bid (as of yesterday) for Fox have conspired to push CMCSA stock into the low $30s, which represents 12.5x NTM EPS.

We don’t know how Disney will respond to Comcast’s topping bid or who will ultimately end up with the Fox and Sky assets. Headlines suggest a bidding war is imminent. When you combine these fears with the secular challenges in linear video and the apparent threat of 5G to broadband, you get a stock that is considered uninvestable by many.

Thesis:

The uncertainty created by the events described above have pushed CMCSA to attractive levels. For 12.5x earnings you can buy the largest domestic cable video and broadband provider with a monopoly position in 40% of its cable footprint, 1Gb speeds in most of the plant (better than other cable and telco peers), a quarter of the pay-TV market (giving leverage over programmers and >20% EBITDA margins while smaller players are breakeven), and a great capital allocator at the helm. Comcast has returned 231% over the past 10 years and has compounded at 17% since the 1972 IPO.

In this write-up I’ll put bounds on the uncertainty created by recent events, value Comcast’s current business, and show why under most scenarios the stock is cheap.

Deals:

Rather than model out what a Fox and/or Sky deal would look like I’ll approach it backwards by asking how much value could be destroyed by these deals. Value destruction could include the value of stock not repurchased at a discount as well as the signal sent by Comcast’s desire to own these media assets, but for our purposes I’ll stick to the net of the overpayment for these assets and the synergies expected from them.

Fox:

Disney’s bid for Fox assets includes the RSNs, film and TV studios, cable nets, Star India, stakes in Sky and Hulu and other assets (call these “RemainCo”), leaving Fox News, Business, FS1, FS2,  Fox Broadcasting and TV stations (“New Fox”) to be spun out. Comcast is interested in the same assets. Disney’s bid valued RemainCo at ~29.40/share, so with Fox trading in the mid/high $30s this spring we can assume that New Fox was valued at ~$8 (embedding deal risk & time value but also a potential bid from CMCSA).

Before the DIS bid, FOXA traded high $20s, suggesting ~$20 fair value for RemainCo. I’ll assume $17.50 - $27.50 is the range of fair value for RemainCo. I’ll use $35 - $41 as a range for what Comcast might pay for RemainCo (the lower bound being what’s on the table now and the upper bound being what would push CMCSA to ~5x levered). Using synergies of $2 billion at 8x and costing $2b to achieve, the net value destroyed per Comcast share is between zero and ~$6.50/share. Note that in the worst case where you assume $41 is paid for RemainCo worth $17.50 (with $3 in synergies) you’re assuming 100% overpayment.

A similar analysis for the Sky shares Fox doesn’t own (not all shares, because a scenario where Comcast gets Sky and not Fox is within our overall bounds) shows potential value destruction of  between zero and $1 per CMCSA share (assuming Sky worth as little as £8 with CMCSA paying £13.50 and synergies of $500mm).

Brian Roberts has a history of sensible dealmaking. When I combine that with the significantly less than 100% odds that Comcast ends up with both assets for top dollar, I get to potential value destruction somewhere in the middle of my $0 - $7.50/share range. And I’m doing this analysis to bound the uncertainty of the critics. I’m not convinced that these deals destroy any value.

Business Overview:

Overview:

I’m going to give a brief overview of the business with a focus on my key assumptions.

FY’17s $28b of EBITDA is comprised of $8b of NBCU EBITDA, $21b of Cable EBITDA, and corporate overhead. Within Cable’s $21b of EBITDA , I estimate that Video is under $7b (24% margin) and phone is under $2b.

I estimate that EBITDA can grow from $29.2b in FY’18 to almost $34b in FY’22 and higher in out years even as video profitability goes to zero.

Broadband:

I’m assuming broadband penetration grows by 100bps/year from 80% penetrated today.

Comcast competes with overbuilders in 60% of its footprint (and in 40% competes with DSL). Comcast should hold share with fiber, take share from DSL, and lose some share to 5G over time as Verizon builds out 5G. Note that I’m giving full credit to their plans even though I think they are unrealistic.

One way to think about my projections is that half of the new subs come from new homes passed, while another third come from new broadband households within the footprint. I’m assuming steady share against fiber and gains against DSL.

Video:

I assume that overall video subs (traditional + vMVPD) decline over time as vMVPDs take more of the pie. Within traditional Pay-TV, cable will take share from DBS.

Video margins are a key controversy in this and other cable names. People will probably quibble with my math below, but it’s roughly accurate to say (and Comcast and other companies will confirm it) that Broadband has roughly 2-3x the margins of Video. Smaller pay-TV providers claim they earn nothing on video, and so over time this should slow down the pace of programming cost increases.

The loss of video subscribers over time will be offset by price increases in Broadband as customers mostly migrate to single-play Broadband. I’m modeling about 4% price increases in broadband for the foreseeable future, and at least 1/5th of that comes from customers going to single-play. Over time I expect Comcast to get paid for the content moving through their pipe, whether it’s their own content or someone else’s.

NBCU:

The NBCU segment consists of broadcast television, film studios, theme parks, and cable nets. The cable nets are considered “must have,” and they can be found in most traditional and vMVPD providers. Content spend, quality, and affiliate fees stack up well against the competition. This is also a diversified collection of assets: film studios and theme parks provide over 40% of segment EBITDA.

Advertising dollars will decline in this segment, but theme parks, filmed entertainment, and distribution (within broadcast TV) should grow. I project segment EBITDA to grow nicely in the coming years.

Valuation:

My model includes Video margins going to zero, low growth in Broadband, and a relatively stable NBCU segment. A DCF gets me to the low-mid $40s. Put a market multiple on NTM earnings and you can get there too. If you put 9x EBITDA on the NBCU business (a discount to peers still), you’re paying 6.5x for the rest of it. If you take the mid-case of my value destruction analysis above, the stock is worth $40.

Conclusion:

The narrative has shifted from Comcast (and other cable names) owning the best pipe as consumers demand ever-faster connections to Brian Roberts being desperate to diversify away from a melting ice cube. People say Brian is an empire builder with a grudge against Iger that can only be settled by wresting Fox away from him.

The reality is that Brian has been a shrewd dealmaker over time and that you’re buying a dominant and diversified business with a near monopoly in parts of its footprint.

Risks:

Comcast loses pricing power in Broadband.

Government targets Comcast’s Broadband monopoly and oligopoly positions.

Brian Roberts gets into a bidding war because he knows his business is more secularly challenged than I believe.

Catalyst

Clarity on FOXA