Despite merger and acquisition rumors popping up all around the cable and satellite industry, Comcast (CMCSK) shares have not moved higher. This makes sense since Comcast is by far the biggest company in U.S. pay TV industry, with 25 million subscribers. Charter Communications, now 25% owned by cable industry pioneer John Malone's Liberty Media (LMCA), has just 4 million subscribers. Charter is hoping to buy Time Warner Cable, the second largest cable company with 10 million subscribers.
The combination of Malone's return and his bullish outlook for cable broadband and the possibility of acquisitions at premium prices suggest the value of a cable subscriber has moved up considerably. While Comcast will not be sold and is unlikely to buy other cable systems, all the activity in the industry does give a boost to the value of its subscribers and, in turn, its stock price. Add in early signs of turnaround at Comcast-owned NBC, steady growth in NBC Universal cable networks and theme parks, continued mid-single-digit growth in Comcast's core cable TV and broadband business, and Comcast shares look as if they have at least 20% upside.
Comcast generates about 80% of its operating cash flow from cable and 20% from NBC Universal. Other pure play cable stocks are trading at eight to nine times EBITDA in the current rumor-friendly environment. Assets similar to NBC Universal's stable of cable TV networks and theme parks trade at more than 10 times EBITDA. However, at $38, Comcast shares trade at less than 6.5 times EBITDA. Again, Comcast assets should not be valued at acquisition-inflated premiums, but somewhat higher valuations seem warranted. At a blended multiple of 8 times 2014 EBITDA, Comcast would trade at $60, a full 50% above the price Northlake clients bought in June. At seven times EBITDA, Comcast would trade just over $50, still 30% above Northlake's recent purchase.
One final support for higher prices for Comcast shares is the company's excellent balance sheet and free cash flow. Comcast is projected to end 2013 with debt at just a little over two times EBITDA. This is a very healthy balance sheet indicative of investment-grade ratings. Free cash flow should be comfortably over $3 per share in 2013, giving the shares a free cash flow yield of over 8%. Comcast is using its free cash flow to aggressively buy its own shares and pay a healthy dividend. Shares outstanding are falling by over 2% per year, providing further support for forward valuation of Comcast shares. Modest dividend increases can also be expected each year on top of the present current yield of almost 2%.
Disclosure: CMCSK is widely owned by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov. CMCSK is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focusing on media, entertainment, leisure, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia's investment management company, and has personal monies invested in the Entermedia Funds.