Comcast Transforming Itself With Two Distinct Businesses

|
Includes: CMCSA
by: Bharat Ahuja

With the joint venture (with GE) and eventual takeover of NBCU, Comcast (NASDAQ:CMCSA) is transforming itself into a company with two distinct businesses.

Number one is the cable services business that includes 51 million homes passed with ~ 24 million video customers, ~16 million internet customers and ~7.5 million voice customers. This part can be thought of as a stable, utility-like business that has developed a moat around itself with its size and scale. The cable business has three moving parts - video, internet and voice service. Despite strong competition in the video business from the DBS operators such as DirecTV (NYSE:DTV) and Dish (NASDAQ:DISH), Comcast has been growing its over-all subscribers (or revenue generating units - RGUs) and importantly, it has been growing its cable business revenue and operating cash flow in mid-single digits. The contributing factors have been the success of triple-play as more customers have signed up for multiple services and also the growth experienced in the commercial services cable business (primarily comprising of small/medium business customers). Cable business has a current annual run-rate of 34 billion in revenue, 13.6 billion in operating cash flow or EBITDA and free cash flow of ~ 4.5 billion.

Note that Comcast has stated intent of returning a substantial portion of free cash flow to the shareholders in terms of stock buybacks and dividend. Current dividend yield on class A special shares is 2.2%.

Number two is the content business. With Comcast's legacy cable channels such as E!, Golf, Versus and NBCU contributed cable channels such as CNBC, MSNBC, USA, Syfy, this business also has sufficient scale and brand awareness. For example, USA holds the #1 spot in prime-time rating, CNBC is the premier business channel. Also, NBCU broadcast assets include channel NBC which reaches 100% of US households. These channels have strong brand recognition and viewership which bring with it strong affiliate fees and advertising revenues. As a side note, both affiliate fees and advertising revenues have shown strong growth of 12% and 7% respectively in the last 5 years. Part two also includes the Universal film studio/library and Universal theme parks. In terms of operating cash flow, part two is about 80% cable channels, 10% broadcast channels with the film studio and theme parks making up the remainder. This business is expected to have a current annual run rate of about 18 billion in revenue, 3-3.4 billion in operating cash flow and 1.4 billion in free cash flow.

Note that Comcast currently has 51% controlling stake in the business described as part 2. The joint-venture is expected to buy out GE's remaining 49% stake after the 3.5 year anniversary of closing and over a maximum of 7 years period using internally generated cash flow. For this reason, this cashflow will not be available to the Comcast parent until the buyout is complete.

Valuation:

With 2010 estimated free cash flow of 5.2 billion and 2.8 billion shares outstanding, Comcast yields 1.86 dollars per share of free cash flow. Given the predictability of its cable business, low leveraged capital structure (2.5 debt/OCF ratio) and strong brand assets in the content business, Comcast may be valued at 12-13 times free cash flow yielding a 22 to 24 dollar stock. Currently, class A special shares CMCSK trade at ~17 dollars.

A few options that can result in much higher valuation -

1. Comcast has shown itself to be opportunistic in making acquisitions e.g. the acquisition of AT&T (NYSE:T) broadband and recently NBCU. In the same breath, it is also being opportunistic with aggressive stock buy-backs to increase shareholder returns. They bought back 2.3 billion of stock in 2006, 3.1 billion in 2007 and 2.8 billion in 2008 and 765 million in 2009. 2009 also saw debt reduction of 3.4 billion. With a large, strategic acquisition out of the way, a ~ 10% reduction in shares outstanding in the next few years is not out of question. Current plan is to buy back 3.3 billion in stock by 2012.

2. The content business should remain a strong performer with solid assets in entertainment, news and sports category. Affiliate fees have shown solid growth in recent years and should be expected to grow at least in the mid single digits. Advertising revenues are at a cyclical low and should rebound with the economy.

3. Strategic benefits of combining content and distribution may materialize. Distribution can help content by helping launch and grow cable channels. On the other hand, content can help enhance distribution by increasing Video on Demand and On Demand online choices. Thus, Content has potential to reduce subscriber churn, increase RGUs and increase ARPU.

So, the new Comcast is an over-all solid franchise that is also a value story. As market valuation converges to fair value, the value of the company should continue to grow with time. With the company's franchise power growing with time and management now focused on shareholder returns, shareholders should be compensated for their patience with solid rewards.

Disclosure: Long CMCSK