In its latest move to prioritize and generate value for shareholders, the management team at Comcast (CMCSA) really showed AT&T (T) how to strike a deal. In its latest maneuver, the company struck a multi-faceted deal with The Walt Disney Company (DIS) whereby Comcast will unload itself of its stake in Hulu in time so that it can generate cash down the road for its shareholders. Though I am still adamant that the biggest winner here is Disney since it will end up with complete control over Hulu, the transaction struck up by Comcast is at least more in alignment with shareholders’ interests than AT&T’s was and it creates the opportunity for meaningful upside should everything go well.
A look at the transaction
With the launch of ESPN+ and the rise of Disney+, it’s no secret that Disney is bent on dominating the streaming space as much as possible. Adjusted for Hulu’s purchase of AT&T’s 9.5% in the company, the entertainment giant’s stake in Hulu, will climb to 66.7%, giving Disney control, effectively, over three streaming services, two niche and one broad in scope that already has mass appeal. During these early days of streaming, when companies are still trying to establish themselves and with only two major players (Netflix (NFLX) and Hulu), Disney has decided to dive all-in into this space, likely with the hopes that, in time, it can be the go-to player (in addition to Netflix) when people talk about the space.
To maximize its chances of achieving this coveted status, the management team has agreed to enter into an innovative put/call agreement with Hulu’s only remaining owner, Comcast, whereby, in the next few years, Disney is essentially guaranteed to acquire the company’s one-third stake in the firm. Unlike in the case of AT&T, where Disney bought up the company’s ownership for $1.43 billion in cash today (valuing Hulu at $15 billion), Comcast was able to negotiate something a little more interesting that should, in the long run, create added value for its own shareholders.
Effective immediately, Disney will assume full operational control over Hulu. As part of the agreement here, Comcast has been issued a put giving it the right to force Disney to buy its 33% ownership in Hulu at any point on or after January of 2024. Disney, meanwhile, has been issued a call giving it the right to acquire from Comcast the latter’s stock in Hulu at the same point in time (so either party can force a transaction). Unlike in the AT&T sale, which forced an assigned value at the moment of sale, come 2024 an independent expert will estimate the fair value of Hulu and Comcast will be paid its pro rata share of said value.
To protect its own interests, though, Comcast has also negotiated a floor on the valuation for the company of $27.5 billion, nearly double what AT&T’s valuation has assumed. So even if business goes south, Comcast will find itself insulated from any pain on that front. In all, the implied proceeds at the floor that Comcast will walk away with come out to just under $9.08 billion. Had AT&T worked out a similar deal, it would have been guaranteed a floor of $2.62 billion, but certain tradeoffs like opportunity costs and interest savings associated with debt reduction would need to be compared to see whether the wait for the guaranteed minimum would be worth it. That said, with Comcast’s debt/equity ratio today standing at 1.39, while its net leverage ratio is an elevated but not disastrous 3.50, the company doesn’t look to be struggling for cash, so waiting for its value to rise from $4.95 billion to at least $9.08 billion appears sensible.
There is another caveat here where Comcast could end up walking away with a smaller piece of the pie. You see, each year, the owners in Hulu must fund any cash shortfalls for the firm and Disney, earlier this year, said that 2019 should be the worst, with a shortfall of $1.5 billion on an operating basis. As part of the agreement, Comcast has been granted a reprieve from these obligations if it wants, but in exchange for not having to dole out its share of cash, equity of up to $1.5 billion per year will be issued by Hulu (likely to Disney) to cover any shortfalls. This, in turn, will lead to dilution on Comcast’s part. It is very important to mention here that any shortfalls for equity purposes will be limited to $1.5 billion per year, meaning that any losses in excess of that will have to be covered by debt issued by Hulu. Even if equity is issued each year moving forward, the agreement between the firms stipulates that Comcast’s ownership will not decline below the 21% threshold, guaranteeing it at least $5.78 billion come 2024.
The final component to this deal that was made public centers around Comcast and its content. According to the press release covering all of this, Comcast has agreed that its NBCUniversal content that’s currently on Hulu, as well as Hulu Live content and NBCUniversal channels on Hulu will remain in place until ‘late’ 2024. During this timeframe, it’s expected that Hulu will also be distributed still on Comcast’s Xfinity X1 platform. That said, it sounds like some content will be terminated in 3 years and that in 1 year Comcast will be able to put some of its Hulu-exclusive content onto its own OTT services, but in exchange for this the company will be forced to lower the fees it’s charging Hulu by (from a public perspective) an unspecified amount.
Though this is all a lot to digest, my general thought here is that this is a nice win-win for both firms, but particularly for Disney as it will get to have absolute control and ownership over Hulu a few years from now. Comcast, meanwhile, will get to benefit from the growth the platform generates over the next few years in the form of receiving a payout in the future that’s far larger than what it would likely see today (as evidenced by the AT&T sale).
Right now, investors in both Disney and Comcast should feel happy about this development, while investors in AT&T should probably be disappointed. Selling its Hulu stake period was a mistake, but if you need or want to sell, the kind of transaction negotiated by Comcast is the way to go. Though many will disagree with my assertion that Disney is the biggest winner, in the end I don’t see anybody walking away from this better than it will.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.