Comcast: Elbowing Its Way Into The Streaming Wars

Summary

• Comcast derives the majority of its earnings from its cable and internet business.
• Although cord-cutting is accelerating, Comcast is positioning itself well to maintain its revenue and earnings.
• I have some concerns about Peacock, but it has the content to jump into the streaming conversation.
• Comcast is undervalued, and should outperform from these levels.

Thesis

Comcast (NYSE:NASDAQ:CMCSA) is a conglomerate that operates in one part very much like Disney (NYSE:DIS) or AT&T (NYSE:T) with its NBCUniversal and Sky segments, and in the other as a cable/internet utility similar to Charter Communications (NasdaqGS:CHTR). Much has been made of cord-cutting, but Comcast has managed to offset the effects with price increases and strong growth in its internet services. The prevailing sentiment seems to be bearish on Peacock, but I see the free ad-supported tier as a good way to get subscribers in the door considering how late to the game CMCSA is. Ultimately, the company controls a massive content library, which I assess to be behind only DIS and likely ViacomCBS (NYSE:VIAC), and the company's sports contracts and existing cable subscriber base leads me to believe the company will outperform on existing subscriber estimates. Although the company is not as attractively valued as VIAC, I believe that the risk is lower based on CMCSA's stable internet business, and CMCSA is likely to continue to beat the market. I am bullish and own shares, with a price target of ~$65 with a 3-5 year time horizon.

The Business

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As I discussed above, Comcast operates as both a cable television and internet utility, which I'm sure most of you know. Due to cable companies' proclivity for burdensome fees, contracts, and price hikes, they are not generally well-liked, and Comcast is no exception. I cut the cord years ago, and have never regretted it. I take that back. When I tried to figure out getting my antenna to work to watch football, I regretted it slightly, but ultimately I ended up just paying for one of the streaming cable services long enough to watch football and then canceled it again.

That being said, to me it is a foregone conclusion that the traditional cable television model is dying a slow death, and good riddance, in my opinion. It's projected that cable subscribers dropped 6% this year, back to 1995 levels. I don't foresee subscribership going to zero any time soon, so there will likely be some kind of level-off point. However, like I discussed in my article on VIAC, the major networks (NBC in this case) are still the only way for advertisers to reach a wide swath of the market in what is becoming an increasingly fragmented entertainment landscape. This has some inherent value in terms of driving ad spend, as do the major sports contracts these companies hold. What's interesting is that the services available to cord-cutters are starting to look more and more like traditional cable. A specific example is the YouTubeTV (NYSE:GOOGL) (GOOG) offering, which just hiked the price to $64.99 per month after adding VIAC content.

All that being said, I think that Wall Street understands the cord-cutting narrative and has priced it in. It is old news at this point, and Comcast has already shifted to adapt to it. The company has managed to fend off the existential threat with a few tactics. Effectively, the company lost 409,000 subscribers in the past quarter, but it hiked prices by 4.1% leading to flat revenue growth. Adding on to that, the company has added over a million subscribers in broadband internet every year for 14 straight years, and the first quarter net adds was the highest in 12 years at 477,000, or 27% YOY. The company boasts 29.1M residential and 2.4M business customer relationships at a penetration rate of 54% of areas that Comcast services. In an estimated 1/3 of those areas, Comcast is the only available provider of broadband, and the massive initial expenditure of the infrastructure provides Comcast with a well-entrenched competitive advantage.

Additionally, management has worked to improve the tech, which has seen strong engagement. The cable box, through Comcast X1, comes now with a self-install kit, reducing touch-points, and Comcast Flex is effectively a streaming device like a Roku (NYSE:ROKU) that is included with Xfinity Internet. Comcast also launched Xfinity Mobile in a deal piggy-backing off of Verizon's (NYSE:VZ) towers in 2017. The mobile virtual network operator (MVNO) has grown to 2 million subscribers and drives $1.5B in revenue as of the end of last year, which is pretty substantial growth considering it is an entirely non-core business for Comcast.

Much has been made of the 5G threat to broadband operators. I think that a ways down the road, it is difficult to predict where technology will go. However, from everything I have seen or read about 5G, it doesn't seem likely that it will be upending the home internet market any time soon, considering the difficulties inherent in spreading the 5G net (numbers of antennas for such a short-range transmission) and the massive data loads inherent in home internet when compared with mobile. I am not completely discounting the risk, but I think it's a reasonable one to monitor for when investing in Comcast.

Source

So far, I have really only discussed the cable and internet side of the business. It's important to remember that this accounts for 70% of the company's EBITDA, so when deciding to make an investment in Comcast, the rest of the business is somewhat secondary.

With that, the NBCUniversal segment has taken a beating this year. Between the Olympics getting postponed to 2021 when NBC just announced selling $1B worth of ads, the rest of sports getting postponed or cancelled, and of course the park closures for Universal Studios, it hasn't been a great year.

Theme park revenues dropped 31.9% and the pain might not be done, filmed revenue was down 22.5%, and cable networks revenues were relatively flat as advertising losses were mitigated by fewer costs related to amortized sports rights. Sky saw revenue drop 3.7%, and the company sees risks of customer attrition due to sports not being broadcast. For that reason, the company smartly stepped in to suspend customer subscriptions to allow Sky to control turning them back on once sports resume versus having customers cancel.

Speaking to what break-even looks like when reopening the theme parks, this is from the earnings call:

Mike Cavanagh, CFO and Senior EVP

It's something well short of typical. Seasonally through the year, we're operating at typical seasonal levels, which are, for the most part of the year, well below full capacity anyway. And so then versus typical, I would guess that we're breaking even and certainly when we get to sort of 50% of typical, which will be well below capacity on average. And I think another point would just be versus the number I gave for $500 million in second quarter loss if the parks are closed for the full quarter, as Jeff said, if they're closed longer, there's ability to flex and do more and change that long-term rate if we are staying closed. But on the other side of that, if we open and have lower attendance, at the lower end because our priority is going to be to make the parks safe, and so we're not going to push for attendance. But at pretty low levels of return attendance as things ramp up, we'll be in better shape than were the parks to be closed.

The company guided for a $500M loss if the parks stayed closed, but as I will discuss later in the article, Comcast has plenty of liquidity. I have no doubt that the parks will reopen, and that people will be chomping at the bit to get out and go to Universal Studios. The company is expected to open Super Nintendo World in its Japan location later this year, and an additional park in Orlando as well as a Beijing location next year. Surprisingly, it sounds like the Beijing location is set to open on-time and on-budget next year, which should be a boon for the company when looking at Disney's Shanghai location. I am also interested to see how Super Nintendo World works out, since I see Nintendo (OTCPK:NTDOY) as a best-in-class company at building and leveraging its characters. Super Nintendo World is delayed indefinitely, but it is nearly complete.

As for advertising, it's in everyone's best interest for the leagues to come together and figure out a safe way to get sports back on the air. I would be very surprised if the NFL wasn't back this fall, and the Tokyo Olympics is set to commence a year late, next summer. I think the CEO did a good job of summarizing the current position of the company in the call:

Brian Roberts, CEO[O]ur focus is the businesses we've got. We feel we're in a wonderful position. Again, as I think about the timetable, we know parks are going to reopen and we know sports is going to get back. So these are a temporary hit. And I think being home and watching sports, I think, is pretty safe. And that's going to return pretty quickly to a great business. And then I look at the majority of the company being broadband in people's homes and people who are spending more time in their homes, and that's not going to change quickly. And that's a great opportunity to develop new products and relationships and deepen those relationships. So as we've looked at it, as we talked as a team, I don't think we would trade positions with anybody. We like our company. We like our hand, and we are going to be focused on improving from here

Speaking of the CEO, he owns over $1B worth of Comcast stock, and his father founded the company. He has been the CEO since he was 31 in 1990, over which time Comcast has performed exceptionally well for shareholders. With the possible exception of Sky, he has exhibited acquisition discipline, and NBCUniversal is 3X more profitable today than it was when Comcast bought it nearly 10 years ago. One knock on management is how long it took for them to embrace streaming and to launch a service. Peacock is behind the times, and Comcast will likely pay for that, which I will discuss more below. However, I see management's interests aligned with shareholders overall, and Brian Roberts has every reason to see his family's legacy succeed.

The Future

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As I discussed in my last article, content is king these days. Streaming services will only garner subscriber dollars if they provide a compelling reason, which means that ultimately the number of subscription services is likely capped. I have seen projections that run the gamut in terms of what analysts believe customers will pay, or how many services they will juggle. My personal view is that it all comes down to content. AMZN's service is secondary to its main business, and doesn't require additional spend, which lowers the buy-in required for subscribers to view it. Apple (NYSE:AAPL) didn't really give subscribers sufficient reason to pay up, in my view, leaving it on the sidelines among the services. Netflix (NYSE:NFLX) launched on the back of licensed content, but is now investing heavily and has a significant library of its own as it starts to lose a lot of that licensed content. I don't think I'm going out on a limb by saying that I see NFLX as being core to most streamers' viewing habits for the foreseeable future.

That leaves VIAC, with its All Access offering, NBCUniversal with Peacock which launches July 15, and Disney with Disney+. My personal belief is that Disney holds the best content in the business, and Disney+ was launched into the best climate that could have existed for it, on the back of the runaway hit The Mandalorian. If it weren't for the fact that Disney also owns theme parks and ESPN, it's likely that the stock would have continued screaming up based on how quickly Disney+ jumped into the streaming wars. VIAC has perennially underinvested in All Access, which I hope to be rectified, and NBCUniversal has waited until now to launch its streaming service, possibly due to the fact that Comcast is a cable television company.

However, old shows like The Office and Parks and Recreation have been very popular when licensed to Netflix, where they will be leaving next January. Comcast also has shows like 30 Rock, SNL, Cheers, Frasier, Will and Grace, and all of the Dreamworks and Universal movies in its library. It has also licensed VIAC content to the Peacock service for its launch, as well as investing in several originals for the service. Here is a link to Peacock's YouTube channel, which has trailers for the service's original shows. It includes shows like a Battlestar Galactica reboot, Brave New World based on Aldous Huxley's book, Dr. Death, Girls 5Eva with Tina Fey, among others. I think that Peacock is set up well based on its content library when compared with its peers despite not having the Olympics this summer, although notable originals like Dr. Death and Battlestar Galactica will be delayed due to COVID. However, the pandemic flare-ups have kept portions of the country in some form of lockdown, which should provide a tailwind for viewership.

Adding on to that, Peacock is launching similarly to Hulu, where there are three tiers. The service will have a free, ad-supported tier with limited content to get subscribers in the door. Then, there is a $4.99 tier supported by ads, and a $9.99 ad-free tier. Existing Cox and Comcast cable customers get the ad-supported for free and the ad-free for $4.99, which is a huge installed base of customers to build up initial subscriber numbers to the service. Peacock was already launched to Comcast customers earlier this year, without the originals, presumably to gain valuable watch data and work out the kinks.

However, it's not all rosy. Peacock hasn't been worked out on Roku or Amazon Fire yet. This is a big deal, in my estimation, and it's based on the fact that Comcast wants the user data from its service instead of feeding it to Amazon and Roku. Amazon is a direct competitor in the space, so I'm not surprised that Comcast is at an impasse, but I am ultimately surprised that Peacock is being launched without the support of those two pieces of hardware, as it will definitely limit the subscriber penetration, and put a damper on initial numbers. I hope to see some kind of deal being worked out in the coming weeks, or the comparisons to Disney+ are going to be even more painful than they already were likely to be.

Ultimately, Peacock isn't going to make or break Comcast. I think that it has a good chance of elbowing its way into the streaming wars, and down the road it will likely be good that Comcast finally decided to make the move. The company is projecting 30-35M subscribers by 2024, which I think is undershooting the projections. At a projected $10 ARPU, the service could eventually start moving the needle for Comcast in a few years once it can break into profitability.

The Financials

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YCharts

Comcast definitely carries quite a bit of debt with a LT D/E of 1.3X. The company operates a lot like a utility in terms of its infrastructure and sustained cash flow, so $102B is serviceable for the company. I will look to see some further de-leveraging going forward. The company has over $15B in liquidity, and free cash flow covers the dividend at a little over 3X, and interest expense at ~2.5X. The company has grown its free cash flow over time, and exhibited consistent, long-term profitability, so I don't have any concerns about its current financial position. Comcast has hiked its dividend every year for 13 consecutive years at a double-digit rate, and it currently yields around 2.3% with a conservative payout ratio of 34%.

Looking at the short-term valuation graph, Comcast has bounced off its March lows, and earnings are projected for a dip in 2020. However, by 2022, earnings are projected to hit a new high.

Looking at the long-term valuation graph, Comcast has grown earnings steadily and quickly over the years, and total shareholder return has soundly trounced the S&P over the past 15 years, at 13.7% annualized, compared to the S&P at 7.5% (pulled from F.A.S.T. Graphs). The dividend yield is around average currently, and the company is trading well below its long-term average valuation, although this is skewed by the early 2000s.

Based on analyst estimates for earnings growth and a return to the company's average multiple over the last 10 years of ~17X earnings, an investment in Comcast today could return ~18% annualized. Valuations are finicky, so this is just a possible outcome, but it does show that Comcast is well-positioned in terms of its historical valuations to outperform going forward.

I think that Comcast is undervalued based on the conservative nature of its cable business. Additionally, news is likely to get better from here, and metrics will have a tailwind from parks reopening and sports returning. On top of that, I think that Peacock is reasonably well-positioned to elbow its way into the streaming conversation, although I would like to see it launched on Fire and Roku. Comcast is a buy for long-term investors. However, VIAC remains my top pick in the space, although risks are higher.

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Disclosure: I am/we are long CMCSA, VIAC, DIS, ROKU. 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.