Since I first published my bullish article on Time Warner (TWX) here, the stock has soared 27.4%, more than doubling the returns of the S&P 500 over the same range. While analysts still rate the company near a "strong buy", I find that much of its value gap has been closed. Ditto for Comcast (CMCSA), which is highly sensitive to ever-changing market psychology. Based on my multiples analysis, DCF model, and review of the catalysts, I find that Time Warner is more undervalued.
From a multiples perspective, Time Warner is the cheaper of the two. It trades at a respective 14.5x and 12.1x past and forward earnings while offering a dividend yield that is 80 bps higher at 2.5%. Comcast, meanwhile, trades at a respective 18.7x and 14.1x past and forward earnings. In terms of macro sensitivity, Time Warner is more volatility with 30% greater volatility than the broader market. Since I am bullish on the overall economy, this only means higher-risk adjusted returns for the media company.
At the third quarter earnings call, Comcast's CEO, Brian Roberts, noted solid results:
I'm pleased to report another quarter of strong performance across key financial, operating and product areas. Our primary focus has been on great operational execution and on extending our industry leadership.
Let's begin with Cable, which really had an outstanding quarter, making this the fourth consecutive quarter of improving customer metrics. Our combined video, voice and data customer additions increased 13%. In addition to customer growth in high-Speed Internet and voice, we saw a continuing improvement in video, where we reduced our customer losses by 110,000 over last year's third quarter.
High-speed Internet was, once again, the largest contributor to Cable's revenue growth. Every quarter this year, we've added more high-speed Internet customers than in the same quarter of 2010, and we continue to take share as we expand the differentiation between our high-speed service and DSL.
Comcast recently signed a 10-year agreement with Disney (DIS) whose terms are not fully known. What we do know is that the deal covers broad programming wherein content will be supported across a variety of medium from TVS to tablets to smartphones. It monetizes LTE and broadband via network integration. At a time when programming and content costs are rising, this arrangement helps add much needed visibility around earnings. Comcast customers will also now be able to watch ESPN online through the application, Watch ESPN.
Consensus estimates for Comcast's EPS forecast that it will grow by 18.9% to $1.51 in 2011 and then by 23.2% and 17.2% more in the following two years. Assuming a multiple of 17x and a conservative 2012 EPS of $1.77, the rough intrinsic value of the stock is $30.09, implying 15.2% upside. If the multiple were to fall to the level that Time Warner is at and 2012 EPS turns out to be 7% below consensus, the stock would fall by 3.9%. Accordingly, while the downside is limited, the reward is not the most favorable within media.
A major catalyst that Time Warner has going for it - which I expect will be getting an increased amount of attention - is UltraViolet (UV). UV is a new DRM system that runs on the cloud and distributes purchased content for streaming on various mediums. Households are able to create multiple UV accounts on its website here and choose up to 12 devices in which to store purchased content. There are several issues, however, that this product needs to work on. First, content needs to come down with digital copies being priced at a target of $35. Second, the system needs to provide for greater compatibility. iTunes and some PC models have been unable to stream the content. While multiple media companies are pushing the platform, Time Warner has the most to gain due to its interest in Flixster, which powers UV to begin with.
Consensus estimates for Time Warner's EPS forecast that it will grow by 17.1% to $2.82 in 2011 and then by 12.1% and 14.9% more in the following two years. Assuming a multiple of 14.5x and a conservative 2012 EPS of $3.10, the rough intrinsic value of the stock is $44.95, implying 17.6% upside. Modeling a CAGR of 14.6% for EPS over the next three years and then discounting backwards by a WACC of 9% yields an even greater fair value figure of $45.94. Thus, aside from the catalyst in UV, Time Warner has strong fundamentals to outperform peers.