Description

Overview:

In our view, shares of Comcast Corporation (“Comcast,” “CMCSA,” or “the Company”) represent an excellent opportunity to own a premier cable business and content company at a very favorable valuation. VIC member eigenvalue posted a well-timed write-up on Comcast last year with shares under meaningful pressure at the onset of the COVID-19 pandemic. In this write-up, we focus on the key catalysts for the shares in a post pandemic world and detail the favorable risk/reward of the current situation. At current levels, we believe investors are effectively purchasing Comcast’s top notch cable business at a discounted valuation and receiving the Company’s various content assets (NBCU’s national, regional and international cable networks, NBC and Telemundo broadcast networks and local stations, Universal theme parks, Universal Pictures, Dreamworks, Illumination, Comcast Spectacor, etc.) including Sky for free. But wait, there’s more! Investors are also receiving a free call option on the success of Peacock, NBCU’s fledgling streaming business. 

Why Does This Opportunity Exist?:

Capital allocation uncertainty: Comcast’s 2018 acquisition of Sky hasn’t worked out as planned and is one of the rare blemishes on Chairman/CEO Brian Roberts’ esteemed capital allocation track record. Many investors have stayed away from the shares following the acquisition and Comcast’s shares have underperformed as a result. In fact, over the past 5 years, Comcast’s shares, which have posted a total return of 100%, have significantly underperformed pure play cable peers including Cable One (+293%) and Charter (+228%) by a wide margin. CMCSA shares have also underperformed the S&P 500, which has returned 129% over that same time frame.  With Comcast approaching targeted leverage levels after focusing on delevering in the wake of the Sky transaction, there’s likely some investor apprehension that the Company will pursue another large deal and recent speculation about the Company potentially having interest in a number of media companies (Roku, ViacomCBS, Warner Media, etc.) could give investors reason to continue to say on the sidelines. Although some of the recent speculated transactions would not be small deals, we believe there would be strategic rationale for a number of large transactions, at the right price/structure, that would give the Company additional scale to more effectively compete in today’s streaming environment. 

Near-term debt reduction focus: Following its aforementioned acquisition of Sky, Comcast paused its buyback and focused on returning leverage to its targeted ~2.0x-2.5x range. Since the Sky acquisition closed, Comcast has reduced debt by ~$20 billion. CMCSA’s deleveraging focus has likely pushed investors/prospective investors to the sidelines. Comcast had been a strong repurchaser of its shares prior to the pandemic, with $15 billion in repurchases (average price: $42.61 a share) between 2016 and 2018. 

Covid pressures: Although Comcast’s cable business has proven resilient during the pandemic, thanks in large part to its broadband business, the NBCU and Sky segments have not been as lucky. A number of the businesses in the NBCU portfolio have been at the epicenter of the pandemic—most notably NBCU’s theme parks, which reported an adjusted EBITDA loss of $541 million during 2020, compared with adjusted EBITDA of $2.5 billion in 2019. The broadcast business at NBCU faced pandemic-related pressure in 2020 with the absence of live sports for a portion of the year, including the postponement of the Summer Olympics. Meanwhile, Sky’s results in 2020 were impacted by the pause in professional sports during 2020, which had an impact on its subscription and advertising revenues. Although one would have expected Comcast’s shares to be aided due to its status as a reopening play, shares have only appreciated modestly since the beginning of the year advancing just ~8%, below the ~14% gain registered by the S&P 500. 

Conglomerate discount: In our view, Comcast’s shares are also currently suffering from a conglomerate discount. Comcast is not a pure play cable business, though it does generate the majority of its revenues and profitability from its core Cable Communications segment. During 2020, Comcast generated 56% of its revenues and 75% of its EBITDA from its cable segment. In a normal year, these amounts are slightly lower due to the pandemic-related pressure experienced by its other business segments, NBCU and Sky. We note that the publicly traded valuations of Comcast’s cable peers and precedent transactions of its media/entertainment businesses are at significant premiums to Comcast’s current consolidated valuation of ~10.0x its 2019 adjusted EBITDA (proxy for normalized earnings). Although it wouldn’t appear that Comcast would do something (spin offs, divestitures, etc.) to eliminate the conglomerate discount, we wouldn’t rule it out. Activist investor Trian took a stake in Comcast in 2020 and could potentially push for meaningful change at the Company. In the early 2000s, Comcast sold a large stake in online retailer QVC for ~$8 billion, so there is a precedent in terms of a meaningful divestiture that could suggest that CEO Roberts could be amenable to a large-scale transaction to unlock shareholder value. One possible transaction could be a combination of NBCU with the currently proposed WarnerMedia/Discovery tie up. In May 2021, media mogul John Malone stated, “If the regulatory environment permitted, down the road, all kinds of relationships could be contemplated between this enterprise that we’re creating and Brian’s enterprise. I think there are many opportunities for [Warner Media-Discovery] to work with NBCUniversal to develop successful businesses.”

Key Investment Considerations:

Crown jewel cable business under appreciated with strong growth potential: In our view, Comcast’s crown jewel cable business is not receiving the appropriate multiple under the Comcast umbrella. The business accounts for approximately two-thirds of the Company’s normalized EBITDA and the operating fundamentals of Comcast’s core cable business have been extremely strong. Revenue and adjusted EBITDA have increased at a 5.1% and 5.7% CAGR over the past 5 years, respectively, with capex as a percentage of revenue declining to 11% of revenues, down from 15% over that same time frame (2015-2020). Meanwhile adjusted EBITDA margins have expanded by nearly 150 bps to 42.1% at the end of 2020. 

Results have been driven by the Company’s non-video businesses (residential and commercial broadband, etc.) where the future outlook is very robust. Notably, broadband margins are significantly higher than video margins, which should help to drive continued margin expansion as the broadband business grows further. During 1Q 2021, broadband revenues were up by 12% due to additional customers and rate increases. Meanwhile, broadband churn improved for the 13 consecutive quarters registering the lowest rate in the Company’s history.  Xfinity Flex, a free voice controlled streaming device for Comcast's broadband customers that helps aggregate a customer’s streaming apps, such as Netflix, Prime Video, Hulu, etc. is helping to drive broadband growth and increase customer loyalty. On its 1Q 2021 earnings call, Comcast noted that it had already deployed 3.5 million Flex devices (households can purchase additional Flex devices for a fee), up from just ~1 million in May 2020, making it one of the fastest-ramping products in the Company’s history. During Comcast’s 4Q 2020 earnings call, CEO Roberts stated that, “Flex has been a major win for us, and we continue to have really high hopes.” Comcast is currently exploring ways of deploying Flex outside of its cable footprint (including in Smart TVs at Walmart), which could go a long way toward boosting its streaming ambitions. Although Comcast’s broadband results have been impressive (15 consecutive years of over 1 million broadband net additions; 12.1% revenue CAGR over past 10 years), there is plenty of opportunity for future growth. Comcast’s broadband penetration stands at just 51%, providing for additional market share gain opportunities. Moreover, broadband is not fully penetrated in the U.S. (~80%) and there are still ~4 million DSL customers in the Company’s footprint.

Comcast’s wireless business is also emerging as an important growth driver for the Company’s cable segment. During 1Q 2021, CMCSA’s wireless business reached breakeven profitability for the first time since its 2017 launch thanks to a 50% increase in revenues due to increases in customer lines and device sales. Results were aided by 278k wireless net additions, which was the highest new customer count since the business’ inception. Comcast now has 3.1 million wireless lines and has recently made some adjustments to its packaging to drive continued growth. Continued growth in Flex and the wireless business could help to insulate Comcast's cable business from the potential threat from 5G (multiple product customers tend to churn less). 

Theme Parks recovery and growth opportunities: The Company’s theme parks have been at the epicenter of the COVID pandemic, but after a difficult 2020 (Adj.  EBITDA loss of 541 million in 2020 vs. $2.5 billion in Adj. EBITDA in 2019), their prospects are looking up. During 1Q 2021, the Theme Parks posted breakeven results for the second consecutive quarter (excluding pre-opening costs for Universal Beijing). The breakeven results were achieved despite the continued closure of the Company’s theme park in Hollywood (reopened at 25% of capacity in mid-April) and with minimal capacity at its Orlando Park (~35%) and amid a halt in international travel. The Company’s theme park in Beijing, which will be its largest, is expected to open in early July 2021. The new park will have a minimal impact on earnings in 2021 but become more meaningful in 2022. The Beijing park is expected to ultimately be the third-largest contributor to the Company’s Theme Parks business. Although it will be the largest park, the JV nature of its ownership limits the amount of earnings it generates for NBCU versus the earnings for a wholly owned operation. Meanwhile, a new Nintendo attraction (Super Nintendo World) at Universal Studios Japan is expected to be stronger than its Harry Potter attraction was. A recent review of Super Nintendo World by The Verge stated that, “Super Nintendo World is a gleefully surreal experience that pushes surprising technological boundaries. Once travel starts to open up again, it’s going to drive a huge number of visitors.” Meanwhile, at Universal’s U.S. parks several new attractions recently opened up that are expected to be a big driver of traffic including the VelociCoaster (Jurassic roller coaster) in Orlando and a Pets attraction in L.A., which management noted has received “stellar” reviews. Earlier this month, Universal’s parks in Orlando and Hollywood returned to full capacity, which should go a long way toward ensuring improved profitability in the Company’s Theme Parks business. 

Peacock potential: NBCU’s streaming service Peacock is a promising new service that is poised to better monetize the more than $20 billion a year that the Company spends on content (does not include affiliate fees) and offset adverse industry trends of its traditional linear business. Early results of Peacock, which was formally launched in July 2020, have been very favorable and have been achieved without the service’s strongest programming. The 2020 Olympics, which was supposed to serve as a key promotional vehicle for the service was postponed, while The Office, which is owned by Peacock’s parent NBCU and was Netflix’s top TV show, just became available on Peacock in January 2021. During Comcast’s 1Q 2021 earnings call, Comcast provided a number of details about Peacock that give reason to be hopeful for the service’s success including 42 million signups to date, the fact that it has exceeded the guarantees that it made to the service’s 10 initial advertising partners, and monthly users are consuming 20% more programming than its traditional audience on NBC. Peacock also recently crossed 1 billion total hours watched, which was nearly double the Company’s plan when the service was launched. The two upcoming olympics including this year’s summer olympics in Japan and next year’s winter olympics in China should serve as a nice promotional vehicle for the service. International expansion could also serve as a nice growth opportunity for Peacock down the road and Comcast would likely leverage Sky to secure distribution for the service.

Reinstatement of repurchases and continued higher dividends: Comcast’s leverage (net debt/EBITDA) increased to ~3.5x following the acquisition of Sky in 4Q 2018. However, Comcast’s strong free cash flow generating abilities and decision to pause its buybacks have enabled it to delever quickly. At the end of 1Q 2021, Comcast’s leverage stood at 2.7x and is expected to return to the Company’s targeted ~2.0x-2.5x during 2H of 2021 at which point it is expected to begin repurchasing shares. Although Comcast has paused buybacks, it has continued to reward investors via increased dividends. Comcast announced in January 2021 that it would be increasing its quarterly dividend by 9%, for an annual dividend of $1.00 a share (yield: 1.8%). Comcast’s recent dividend increase represented the 13th consecutive year that its payout has been increased, with the Company’s dividend having risen by more than fourfold over the past 10 years.

Comcast’s stake in Hulu (~33%) could also provide Comcast with additional financial flexibility and provide the impetus for outsized share repurchases or even a special dividend. In 2019, Comcast entered into an agreement with Disney that will allow it to sell its stake in Hulu beginning in 2024 at a valuation of at least $27.5 billion, with Comcast guaranteed at least $5.8 billion for its stake. Although Comcast has monetized a majority of the guaranteed sale price by borrowing $5.2 billion against the guaranteed Hulu sale amount, there could be additional upside if Hulu’s valuation/fair market value appreciates in the coming years above the guaranteed amount. In our view, Hulu’s future valuation could surprise to the upside, as the pandemic has accelerated the adoption of streaming content. It should be noted that at Disney’s 2020 investor day, management stated that Hulu would achieve profitability in FY 2023, versus its 2019 forecast of 2023 or 2024, and that its subscribers would total 50-60 million in FY 2024, versus a prior outlook of 40-60 million subscribers. Hulu ended with 41.6 million paid subscribers and the end of 1Q 2021. Although Comcast has reportedly stopped funding Hulu, which would lower its future proceeds, Comcast is guaranteed an ownership floor of at least 21%, which could still see it walk away with a meaningful amount of proceeds for its Hulu stake. 

Sky Improvement: Sky was particularly hard hit by the pandemic. During 2020, Sky’s revenues and adjusted EBITDA declined by 4.2% and 38%, respectively, on a constant currency basis. However, future prospects are looking up with management committed to doubling Sky’s EBITDA from 2020 levels over the course of the next few years. Sky’s improvement is expected to come from a pandemic recovery (key “pubs and clubs” customers were shuttered during the pandemic), cost reduction initiatives (both programming and organizational) and a number of growth opportunities (residential and commercial broadband, mobile, etc.). Notably, Sky is expected to leverage Comcast’s commercial broadband expertise in capitalizing on this untapped market opportunity for Sky.

Valuation:

At current level, Comcast trades at just 10.0x its 2019 consolidated EBITDA (a proxy for normalized earnings). The multiple represents a discount to pure play cable businesses including Charter (12x) and Cable One (~18x). We believe Comcast’s cable communications segment will be able to generate ~$29 billion revenue by 2022. Applying a 12x multiple to this projected amount approximates the current enterprise value of the Company. Accordingly, investors are effectively acquiring the core cable business at a discounted valuation and receiving the Company’s remaining assets, representing at least $30 billion in additional value (conservatively valued), for free. It should be noted that we have assigned no value for Peacock, so investors are also receiving a free call option on this fledgling streaming service. 

Risks

Two of the most noteworthy risks for Comcast include the potential threat from 5G and regulatory uncertainty. The limitations of the 5G technology including signal reliability have been well documented.  Accordingly, we believe this threat is more perceived than real. We may not be the only ones that believe that the cable threat from 5G is overblown. Cable guru/cowboy John Malone recently agreed to effectively strengthen the balance sheet of AT&T (as part of Discovery’s proposed merger with WarnerMedia), which is a 5G competitor to Charter, a company where Malone has a significant investment. In our view, we believe this provides a good read through of the potential risk of 5G to the cable business model. Regulatory risk including price controls and the like may be a bigger risk for cable especially under the current administration. Comcast has managed to escape any significant regulatory controls over various administrations. What’s more, Comcast has invested heavily in building its own broadband network (some $30 billion over the past decade alone) and this network proved very instrumental during the pandemic for business activity to carry on when physical locations around the country were shuttered. Although we would be naive to completely dismiss the prospect for regulation as a risk, we believe the potential for some sort of overly penal regulation may be overblown. 

Catalyst

• Continued growth in the Company’s cable communications business 

• Return to profitability within the Company’s theme parks business as key parks in Orlando and Hollywood have recently returned to full capacity and a new park in Beijing is set to open

• Resumption of buybacks in the 2H of 2021

• Activist investor Peltz, who established a position in Comcast in 2020, could push for measures that unlock shareholder value

• Upcoming olympics could provide momentum for Peacock, the Company’s fledgling streaming service