Ignore Comcast At Your Own Risk

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About: Comcast Corporation (CMCSA)
by: Michael Henage
Summary

Did Comcast overpay for Sky? Only time will tell, yet we can make some comparisons to get an idea.

The headlines are the drumbeat that suggest cable companies are going the way of the dinosaur, the facts tell a different story.

Comcast is taking steps to expand and grow the Universal part of NBCUniversal.

Sometimes investing means ignoring popular (or in this case unpopular) opinion and going with the facts. There is a company that appears relatively cheap on a valuation basis. The same company has a strong lineup of revenue producing properties coming this year. Our mystery company grew one of its most important lines of business by nearly 10% annually in the last quarter. Investors who are looking for income get a yield north of 2%, and analysts expect strong earnings growth over the next several years. Last, this company just made a significant acquisition that could help drive earnings and cash flow over the next few years. There is just one problem facing the stock… the name Comcast (NASDAQ: CMCSA). So many investors ignore this name based on the company’s reputation, yet this spells significant opportunity for those willing to invest based on the facts.

Paying a Sky high value?

One of the worries that kept Comcast’s stock range bound over the last year, is many investors are wondering if the company paid too much for Sky. It’s nearly impossible to answer this question until several years down the road. Since Sky operates primarily overseas, some may not be familiar with the company. To say that Sky is diversified is an understatement. The best way to describe Sky is a combination of ESPN, a huge cable network, DirecTV NOW, and more, under one company umbrella.

To get an idea of what Sky’s worth to Comcast might be, it seems to make sense to look at some similar divisions at other companies. If we look at ESPN’s value to Walt Disney (NYSE: DIS), last quarter the Cable Networks division generated $4.1 billion in revenue. If we look at this unit’s revenue as a percentage of Disney’s overall revenue, it represented nearly 29% of the total. Applying the same percentage to Disney’s market cap means this division is worth an assumed $48 billion to investors.

If we apply the same technique to CBS Corporation (NYSE: CBS), we get a very different result than with Disney. CBS’ Entertainment division is by far the company’s largest at 66% of revenue. Entertainment generated $2.1 billion in revenue last quarter, yet this equated to an assumed market value of just over $12 billion.

If we look inside of Comcast and the company’s Cable Networks division, we get a result that lands somewhere in the middle of Disney and CBS. Cable Networks generated $2.9 billion in revenue last quarter or about 11% of overall revenue. At the present time, 11% of Comcast’s market cap would work out to roughly $18 billion.

Using Sky’s revenue production from last year, the company would have contributed about $4.1 billion in revenue for Comcast last quarter. If we add this amount to Comcast’s most recent results, this would work out to about 15.6% of the total company’s quarterly revenue. Using this same percentage of market cap as in the prior examples, Sky would be worth about $25 billion in market cap to Comcast.

One worry about this acquisition that has gotten a lot of press, is the increase in Comcast's debt load. A quick look at Comcast's balance sheet and cash flow should easily put this concern to rest. First, an increase in debt primarily manifests itself in additional interest cost. Last quarter, Comcast paid $830 million in quarterly interest while carrying net long-term debt of $62 billion. Doing a quick calculation, this means Comcast is paying an average of 5.3% on its debt load.

If we assume Comcast pays about the same interest cost on its roughly $39 billion in Sky debt, this would add about $2 billion in additional annual interest cost. If we divide this interest cost by quarter, Comcast needs to be able to service about $516 million of additional interest for a total of $1.3 billion. Investors who worry about Comcast's ability to handle this additional debt can relax.

Over the last nine months, Comcast generated an average of $3.4 billion in quarterly core free cash flow. During this same time frame, Comcast paid about $700 million in quarterly dividends. Even with no contribution from Sky, if we include the additional interest cost, Comcast would have generated more than $2.1 billion in quarterly free cash flow beyond dividends. Given this calculation is without cash flow from Sky, Comcast appears to more than capable to handle this acquisition cost.

Given that Comcast paid $39.4 billion for Sky, on the surface it seems the acquisition cost might be somewhat high. However, Sky seems to be unique property that doesn’t give investors a perfect comparison to any one business. Sky’s CEO Jeremy Darroch made it very clear that Sky still has significant growth potential. He pointed out that Sky has grown revenue, “by 11% compound” over the last few years. Sky’s CEO also said that during this same time frame, the company grew cash flows by 7% annually. In addition, “we have access to potentially 118 million addressable households,” yet at this point Sky’s penetration rate is 34%. If Comcast paid a premium for Sky, it seems investors can have confidence that Sky will add to Comcast’s top and bottom line.

Comcast is growing despite what you’ve heard

Investors hear so many times that the cable business is dying that it almost seems like a waste of time to dispute the fact. However, if we look at the numbers that Comcast is reporting, the cable business isn’t as bad as everyone would expect. There is little debate that traditional video subscribers are declining. What isn’t discussed is that video isn’t all there is to this business.

It’s instructive to compare Comcast to one of its peers in the high-speed Internet business. AT&T (NYSE: T) is a diversified company, yet the company has millions upon millions of broadband customers. In the last quarter, AT&T’s high-speed Internet business generated $2 billion in revenue, which was a 6.7% annual increase versus last year. However, if we look at the core growth in this business, AT&T’s broadband connections of 15.8 million increased by just 0.2% annually.

By comparison, Comcast’s high-speed Internet business generated over $4.3 billion in revenue last quarter, which was an increase of just under 10% annually. Growing high-speed Internet at a faster rate than its peer, and on a base of revenue that is more than double AT&T, isn’t a small feat. What’s more impressive, is Comcast is doing this not only by attracting higher priced business, but also by growing customers significantly as well. In the last quarter, Comcast grew residential customers by over 5% annually to nearly 25 million. This is just a continuation on the theme of a faster growth rate on a much higher base relative to AT&T.

Despite the headlines that suggest cable companies are going the way of the dinosaur, Comcast’s core high-speed Internet business is doing quite well. Investors who read only the headlines are missing what seems to be solid opportunity.

A Universal reason

A final yet important reason to consider buying Comcast is the Universal part of NBCUniversal. Universal Studios generated $3.3 billion in revenue last quarter between Filmed Entertainment and Theme Parks. On the Films side of the business, 2019 seems to be set up as a strong year. The company has How to Train Your Dragon: The Hidden World, The Voyage of Dr. Dolittle, The Secret Life of Pets 2, and Hobbs and Shaw coming this year just to name a few. During 2018, the studio had a big hit in Jurassic World: Fallen Kingdom, yet the comparisons look favorable for this year.

If we look at the Parks side of the business, this division reported revenue declined by 1.4% annually. However, Comcast has several ideas on how to improve results over the next few years.

First, the company plans to expand The Wizarding World of Harry Potter by adding a new ride. The rumor is this ride could be based on the Fantastic Beasts part of the franchise and it could be announced as soon as this year. New rides at theme parks usually garner attention and new attendance, which of course helps with revenue growth.

Second, Comcast also expects to expand the Harry Potter section of the park another way by building the iconic Ministry of Magic. Fans of the Harry Potter world would flock to see such an attraction. Though the rumor suggests building may not begin until late 2019, investors normally see a pop on the announcement of a park expansion, then another pop as better revenues are realized.

Last, Comcast expects to expand Universal Studios further with another attraction. Though there aren’t firm details on what the attraction will be, the company has said it will house, “a high-energy Universal franchise that’s set to open in 2019.” Needless to say, it sounds like the company has enough to do with the Harry Potter attractions, but something tied to Jurassic World, The Secret Life of Pets, or another recent film would seem to make sense.

New attractions mean a risk to Comcast, as building out the theme park costs money. The company’s acquisition of Sky already puts a strain on the company’s finances. Pouring money into Theme Parks adds another risk to the equation. That being said, if these investments improve NBCUniversal’s results, stockholders will be more than willing to hold on for the ride.

The bottom line

Comcast is a company with a negative reputation because of issues with customer service and monopolistic tendencies. If investors only look at the past, they will miss an opportunity in the present.

Comcast’s deal for Sky certainly represents billions of dollars in risk, yet this unique property seems like it may be worth the cost. Sky is growing revenue and cash flow in a part of the world that Comcast essentially has no overlapping business. Despite the headlines suggesting the death of cable companies, the company’s high-speed Internet business is growing in both customers and revenue.

Universal Studios represented about 15% of Comcast’s overall revenue in the last quarter. While this business may not seem significant enough to excite investors, the company is making investments to build for future growth. Investors who only think of Comcast as the traditional cable company are missing the bigger picture.

A company expected to grow EPS by over 18% per annum over the next five years should get growth investors attention. Income investors looking at a yield of over 2% that is increased annually should be interested. When you add these numbers to a stock that trades for under 13 times this year’s earnings projections, the value seems obvious. What’s holding the shares back is the company name. Over time, the old assumptions about Comcast will fade away while strong fundamentals should drive the stock price. Investors should ignore Comcast at their own risk.

Disclosure: I am/we are long CMCSA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.