Roger S. Conrad's  Instablog

There’s nothing like a blockbuster merger between household names to raise the blood pressure of every so-called defender of the public interest. And that’s definitely the case with the proposed union of Comcast Corp (NSDQ: CMCSA) with NBC Universal, currently owned by General Electric (NYSE: GE).

The long-rumored deal became a reality last week, as NBC Universal minority owner Vivendi Universal (Paris: VIV, OTC: VIVEF) finally agreed to unload its 20 percent stake for the princely sum of $5.8 billion. That removed the last obstacle to a deal GE and Comcast have allegedly been negotiating behind closed doors for many months--and by extension cleared the decks for regulators to swing into action.

The deal basically calls for Comcast to combine its cable-based communication network with NBC Universal’s content empire, in exchange for a 51 percent stake and controlling interest in the overall venture. Comcast serves 24 million basic subscribers in 39 states. The real value of the enterprise in recent years, however, has been the company’s ability to sell bundles of advanced services, including digital cable, voice communications and broadband Internet.

It’s the up-selling of these services that has kept Comcast’s cash flows growing rapidly throughout the recession, even as its numbers of “basic” cable customers has stagnated. For the cost of an initial contribution of $7 billion to the venture--which will also issue $9 billion in debt shortly--it will dramatically boost its ability to up-sell by being able to combine and package content as never before.

Comcast, of course, has profitably operating programming for some time and currently owns such cable channels as E! Entertainment and The Golf Channel. Buying Universal will add one of the country’s premier networks in NBC along with numerous opportunities for programming as well as Universal Studios theme part and a wealth of movie archives.

Beefing up programming has been a central goal of Comcast’s for several years, its most recent attempt being the failed attempt to grab The Walt Disney Company (NYSE: DIS) earlier in the decade. Gaining control over assets valued by the players at $30 billion may not be as great a prize as snaring Mickey Mouse & Co. But it certainly gives the company a real opportunity to move to the next level of the connectivity revolution.

One particularly promising area will be the fast-growing Spanish-language space, where it will now own Telemundo, the second-largest distributor of such content with operations in over 100 countries.

As with any deal, there are potential costs and risks. If Comcast is unable to run NBC Universal any better than General Electric has been lately, for example, the additional debt and operating costs it’s taking on will be a drag on its results. That’s despite the $1.1 billion in free cash flow the company generated in the third quarter alone and the $4 to $5 billion it’s on track for annually in 2009 and beyond. That will make investors forget in a hurry the 40 percent dividend increase management announced at the same time it released details of the NBC Universal deal.

On the other hand, this deal has far less of an immediate financial impact on Comcast than the Disney takeover would have had, when the cable giant was a smaller company besides. That’s clear in the positively benign way ratings agencies have been handling the move, in stark contrast to the universally negative opinions typically issued in the wake of major mergers and acquisitions. S&P has even boosted the company’s credit outlook to “positive.”

Another difference is Comcast has proven itself skilled at integrating programming with its network, a consequence of its heavy emphasis on boosting its Internet business in recent years. In fact, the company is beginning to offer programming via the Internet, in contrast to other cable television companies that seem more content with just milking the cash out of their networks.

Finally, the bar set by investors is without a doubt extremely low, and therefore won’t be tough to hurdle. One money manager even went so far as to comment that “(CEO) Roberts was looking to build and empire and we just didn’t want to be part of that.” Others scorned the dividend increase as an attempt to “appease” investors by paying out only “a token.”

That’s pretty much in line with commentary Comcast has attracted in recent years, no matter how good its numbers have been. And it’s a good sign that this deal will more than exceed projections. That’s a quite stark contrast to the widely hyped AOL/Time Warner merger of the past decade, which one major shareholder at the time called “better than sex” but which actually became one of the biggest busts in history.

Low expectations and good numbers are a very good reason for investors to stick with common shares of Comcast now, which are still barely half their early 2007 highs and trade for just 1.07 times book value. Meanwhile, favorable credit commentary--even in the face of this deal’s scope--is a good reason to stick with the company’s fixed income issues, which would seem to be more secure than ever.

Best of all, the bull case holds even if the NBC Universal deal is not successful. And that’s a good thing too, since it looks like regulatory approval is not a foregone conclusion, at least not without a bevy of conditions attached.

As part of their initial presentation of the deal, GE and Comcast offered a series of concessions to US regulators. These included commitments to increase local and children’s programming, as well as offering rivals access to NBC stations on “fair terms.” That’s not likely to mollify critics, however, many of whom have already been critical of Comcast’s policies regarding its broadband network.

“This merger’s potential to foreclose competition and stifle innovation is significant and real” screeched representatives of the Consumer Federation of America and Free Press, both Washington, DC-based consumer advocacy groups. The groups charged a deal would allow Comcast to use control over programming to charge satellite and phone company competitors more, or even to deny them access to content. They warned of a “merger wave” that would limit competition and bring higher prices for consumers. Their message to the Federal Communications Commission (FCC): “Just say no.”

Those aren’t the last strident comments we’re likely to hear from opponents of the deal. And their rhetoric will be turning up the heat not only on the FCC but also Congress, where net neutrality is again emerging as a potential legislative issue.

At the very least, that means months of intense scrutiny from federal regulators for the deal and almost certainly a mass of conditions attached to the deal. FCC Commissioner Michael Copps--a longtime advocate of net neutrality and a voice in several punitive FCC ruling directed at Comcast in recent years--states the transaction “raises a multitude of important questions.”

And with Chairman Julius Genachowski leading a 3-to-2 Democrat majority, the commission is likely to use merger hearings as a reason to open up a whole host of issues, including potential rules prohibiting owners of networks from favoring their own content over that of rivals’.

The companies’ current forecast is that full regulatory review will take anywhere from nine to 12 months, meaning we can expect a final ruling about this time next year. That timetable, however, could be strung out further by Congress, where Senator Herb Kohl (D-WI) has promised “public hearings” on the bid.

Congress has no authority to block the bid on its own. But a particularly nasty proceeding--always a risk when the economy is weak and unemployment is high--would put further pressure on the FCC to delay or derail, or at the very least impose harsh conditions.

The US Justice Dept or the Federal Trade Commission will also have to rule on whether the deal damages competition. As is the case with most such deals, concerns are usually met with asset sales, which in many cases actually make the deal more profitable by paring back extraneous assets--such as owning redundant assets, i.e. in the same market.

The bar at the FCC, however, is considerably higher. Technically, to approve a deal the commission must be satisfied that a merger is in the public interest. During the Bush administration, the 3-to-2 Republican majority routinely ruled in favor of deals. But times have changed, and the 3-to-2 Democrat majority isn’t likely to be so easily swayed, at least not without some concessions on their pet issue of net neutrality.

Mergers are, of course, the ideal time for regulators to wring concessions from major industry players. In fact, given the FCC’s repeated failures in court to get what it wants in recent years, they’re the only reliable way they can make policy. That makes the ultimate approval of this deal a high-percentage bet.

The key question, however, isn’t whether the FCC will sign off on something. It’s whether or not what it tries to get will be acceptable to Comcast. The answer depends on how well the two sides negotiate, and we have no choice but to wait to see how this plays out.

Happily, the key issue with Comcast common stock and fixed income is that the company is playing from a very strong hand here. If it’s successful in winning a deal with acceptable conditions, it will not only have control over a wealth of content to leverage profitably. But it will also potentially resolve a wide range of issues with the Obama FCC, smoothing its way until there’s a new occupant at 1600 Pennsylvania Avenue.

If it fails, it will still be an extremely strong franchise generating $5 billion or so a year in free cash flow from which to expand its operations, buy back stock and debt and boost dividends further. And most important, the bar for success is set extremely low and easy to hurdle--always the key to robust market returns.