Comcast Corp. (CMCSA, Financial) announced it would be buying Time Warner Cable (TWC) in February, making it a mammoth cable company, reaching over 84 million homes, or 70% of the U.S. population. However, the all-stock transaction for $159 per share could be in danger, as the firm’s share price has dropped nearly 10% since the announcement (stock is currently at $49.93). Thus, the original deal offered to Time Warner would now read $144 per share and this could re-open negotiations with other companies like Liberty Media Corp. (LMCA)’s Charter. Nonetheless, investment gurus like Caxton Associates (Trades, Portfolio) and Larry Robins seem confident that Comcast will perform well, even without the merger, leading them to purchase the firm’s stock in the past quarter.
As the cable business grows, so do profits
Comcast’s fully transitioned merger with NBC Universal, now NBCU, in 2013 was a bold move and helped establish the cable operator as the largest player in the pay TV industry, with a reach of over 54 million households. And while the core cable business is the company’s main growth catalyst, generating two thirds of revenue and 80% of EBIDTA, its scale advantage and networks have benefitted the triple play system offer (TV, Internet, and phone service), which has been consistently stealing customers from rivals like AT&T Inc. (T, Financial) and Verizon Communications Inc. (VZ, Financial). Nonetheless, I believe that Comcast’s content-creation business, via NBCU, will continue to be the most profitable segment, thanks to its dual revenue stream of affiliate and advertising fees. Apart from benefiting from long term deals with CBS Corporation (CBS, Financial) and Walt Disney Company (DIS, Financial), NBCU has been augmenting its presence in sports programming, and looking forward, investors can expect to see more profitable content franchises grow.
Also, the stable revenue stream should allow the firm to continue investing in content, as well as product innovation to offset losses from consumer shifts towards video streaming options like Netflix, Inc. (NFLX, Financial). Comcast’s capital spending is due to spike from 2013’s $5.4 billion to $6.2 billion for the current fiscal year, as it develops additional platforms like the online site and iPad application. But this week’s launch of the cloud-based DVR service in Philadelphia, New Jersey, and Delaware, combined with the X1 platform, will expand the streaming of live television channels to mobile devices inside the home. With the nationwide launch expected through 2014, I believe this additional option will surely help retain customers despite increasing competition. Also, the merger with Time Warner Cable will contribute to cost savings, while significantly increasing Comcast’s scale.
Valuation
Although television customer losses will decrease at a moderate pace, while Comcast readjusts to changing consumer preferences, the company’s revenue will continue to increase from the current 21.7% growth rate, consequence of growth in the triple pay service business. Furthermore, the higher-margin data service segment should help maintain the current 20.9% operating margin looking forward, with EBITDA consistently increasing from 2013’s 25.7% growth rate. The company’s current return on invested capital of 13.5% is also an attractive feature, and investors can expect this figure to increase even more once the merger with Time Warner is completed.
While Comcast’s debt load has intensified over the past few years, growing from $29 billion in 2011 to a current $44.6 billion, I believe the firm’s strong revenue growth and scale increase will steer it clear from any major trouble in the long term future. And while the company’s stock is trading at a price premium of 19% relative to the industry average of 16.7x, I think investors will strongly benefit from placing their bets on this cable giant.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.
