Comcast is the largest cable company in the United States . They operate in two segments, Cable and Programming. Within the Cable segment they provide video services, high-speed internet, and phone service. In their Programming segment they operate national network channels such as: E!, Style, and The Golf Channel.
Until 2006, Comcast’s shares were priced as though their business would commence a decline similar to the newspaper industry. Comcast’s Class A Special (Ticker: CMCSK) share price, which sells at a modest discount to the Class A shares (Ticker: CMCSA) due to their lack of voting rights, subsequently rose 63% in 2006 after languishing for six years. Despite the dramatic increase it remains an undervalued company with high returns on invested capital.
Comcast has a terrific management team with true owner operators. Ralph Roberts built Comcast from a 1,200 subscriber cable television system he purchased in 1965 located in Tupelo , Mississippi into the juggernaut it is today. Mr. Roberts accomplished this feat by rolling up local cable operators. His son Brian Roberts took the position of president in 1990, then Chairman and CEO in 1998. The Roberts’ own 100% of the Class B shares which control 33.3% of the voting power of the company, and 2.0% of the Class A special shares. Although they remain heavily criticized for their lavish pay packages, investors cannot argue with their savvy in the cable business.
Stephen Burke joined Comcast as the Chief Operating Officer in 1998 from Disney. His dad was the right hand man of Tom Murphy at Cap Cities ABC. The team of Mr. Murphy and Mr. Burke has won consistent praise from Warren Buffett. When asked about the relationship in a 2007 New York Times article Mr. Burke said, “I watched my dad for 30 years work with Tom, I know they had a wonderful time and a wonderful relationship, and Brian (Roberts) is the same way.”
In the same article in the Sunday New York Times Mr. Burke referred to the Cable segment as a “layer cake.” The bottom layer of the cake is the video services segment, where earnings are growing at 6% per annum. The video portion of Comcast is growing at 6% through buying smaller cable systems and through the pricing power they enjoy by being able to increase prices to their subscribers. The video division has 25% of the total 96.8 million households in the U.S subscribing to Comcast’s cable and other services. Comcast enjoys a competitive advantage in purchasing programming and equipment at a discount since it counts one quarter of the subscribers in the United States as customers. Their programming costs are nearly half of the second largest cable companies, Time Warner.
Imagine any television network not having access to 25% of the U.S. households; not only does Comcast enjoy a 25% market share but most of the subscribers reside in the top twenty five markets in the United States . ESPN currently receives over $2 per subscriber, which equals over $600 million dollars per year from Comcast’s video subscribers. ESPN would have a difficult time making up these revenues from video over the internet. As well, local governments receive franchise fees as high as 5% of gross video revenues.
The second layer is their high-speed internet service which has 12.1 million subscribers. They truly only have one competitor in this sector, the phone companies DSL service. In this sector price competition with the phone companies has kept Comcast from enjoying pricing power over their subscribers. They offer their customers state of the art broadband. They also own Comcast.net, which ranked among the top ten sites in internet search traffic and The Fan, which ranked in the top 15 providers of video on the internet.
The new, third layer is their phone service, Comcast Digital Voice, with three million subscribers. This is up from 200,000 subscribers at the end of 2005. The new layer of their phone services has been the latest key to their growth. They have been able to offer their subscriber’s all three services for a starting price of $99, a full 75% of new subscribers are signing up for all three services. At the end of the 2007 first quarter, more than 7% of Comcast’s subscribers had signed up for its phone service, up from less than 1% in 2005. Comcast forecasts to have over 20-25% of their subscribers signed up for Comcast Digital Voice by 2009.
The fourth layer of the cake is advertising. As part of Comcast’s agreements with programming networks they receive an allocation of scheduled advertising time to sell to local, regional and national advertisers. Revenues from the advertising division totaled $1.5 billion in 2006, up 21% from 2005 due to strong political advertising and the addition of newly acquired cable systems.
Each layer has different growth rates and in order to grow total revenues in the double digit range Comcast needs to add a new layer from time to time. One potential option is their much loved video on demand service, which today is free to Comcast customers but one day may be their fifth layer. Comcast is also trying to grow their services to small businesses where their customer base is very small. This could provide another revenue stream that is not currently present. The infrastructure is already in place and all they have to do is light up the dark fiber or add on to different nodes of their existing network to generate significant revenue increases.
Comcast, through SpectrumCo, LLC a consortium of investors purchased a basket of wireless spectrum licenses in 2006 for $2.4 billion dollars of which Comcast chipped in $1.3 billion. This purchase is a hedge against the proliferation of wireless. These licenses are predominantly in major markets and would provide them the option of adding wireless services to their platform.
Valuation
While Comcast’s shares are not as cheap as they were a year ago they remain undervalued. The main idea with Comcast is not how much an investor can make but how little they can lose. The cash flows of Comcast are incredibly stable and are being returned to shareholders in the form of share repurchases. Comcast generates returns on invested capital of 30%. Therefore, every shareholder dollar retained and reinvested will create $0.30 in earnings power the following year. Comcast also has repurchased $6.5 billion worth of their common stock or more than 10% of their shares outstanding in the past three and one quarter years.
Comcast has 24.2 million subscribers which generate monthly revenues of $96 per subscriber. They can grow their total revenues per subscriber by adding additional subscribers, increasing the number, and of services each subscriber takes. Comcast grew the average revenue per subscriber from $77 a month in 2003 to $95 in 2006, or 7.2% per year. If Comcast can grow the revenue per subscriber at 5% per annum while increasing the total number of subscribers to 26 million, or 2.4% per annum, by 2009 they would generate revenues of $34.8 billion. Adding the current $1.5 billion of revenues generated by advertising makes $36.3 billion of revenues for the Cable segment.
Comcast will need to make capital expenditures to update and maintain their cable systems each year. Comcast spent $4.4 billion dollars on capital expenditures in 2006. This is where the value is hidden at Comcast. Normally, depreciation and amortization match up to capital expenditures over time however, Comcast’s $31.9 billion of cable transmission and distribution facilities required only 25% of the total capital expenditures spent in 2006 to maintain the current assets. Approximately 75% of total capital expenditures in 2006 were variable and associated with demand for new services. Taking Comcast’s 2006 capital expenditures and increasing them by 12% per annum until 2009 leaves us with capital expenditures of $4.93 billion. Assuming Comcast will need 35% of this for maintenance capital expenditures we arrive at a maintenance capital expenditure figure of $1.7 billion.
Comcast should be able to achieve operating margins of 40%. If we multiply this operating margin by the estimate 20009 revenues of $36.3 billion, we arrive at an estimated operating income of $14.5 billion. If we then subtract the $1.7 billion needed for capital expenditures we arrive at $12.8 billion. Multiplying the $12.8 billion by the inverse of the combined federal and state tax rate (60%) leaves us with $7.7 billion. Applying a market multiple of 18 to Comcast’s estimated net owner earnings leaves us with a 2009 value of $138.6 billion for the Cable segment of Comcast.
Comcast’s other segment is their Programming division. The programming division generated operating income before depreciation and amortization of $241 million. We could simply slap a multiple on that number to come up with a value, but I believe there is more value there than that. Comcast paid $1.2 billion for 39.5% of E! in 2006. This is the equivalent of $3 billion for all of E!, which they own. Dividing the $3 billion by E!’s 81 million subscribers, yields a value of $37 per subscriber. If we ascribe a reduced value of $20 per subscriber to The Golf Channel and Style that yields another $2 billion in value for those two networks. If we ascribe a further reduced $5 in value per subscriber to their other three networks we come up with a value of $640 million. This does not include five other channels where Comcast owns 20-55% of the equity, the Philadelphia Flyers, the Philadelphia 76ers, and the Spectacor Complex. Totaling these up, we arrive at value for the Programming division of $5.6 billion. There also remains some optional value in Comcast starting a network channel and adding it to their large subscriber base. The cost is extremely low and the payoff is huge. Comcast invested $380 million in QVC and sold it for $7.9 billion therefore they have shown some abilities in this area.
Comcast has net debt of $27.2 billion and investments totaling $6.1 billion. Adding the investments, Programming segments value, and the Cable segments value gives us $150.3 billion. Subtracting the net debt gives us a value of $123.1 billion for the whole company. Then we subtract another $3 billion for options granted and outstanding giving a value of $120.1 billion for the entire company.
Comcast has been plowing their prodigious cash flows into share repurchases. Assuming this continues, they will repurchase 2% of their shares outstanding and will be left with 3 billion shares in 2009. This yields us a value per share of $41 per Comcast Class A Special share. On Friday June 29, 2007 their Class A Special shares closed at $27.96 which if purchased at that price would yield a return of 13.5% per annum for the next three years. This valuation leaves us with the free upside of further share repurchases, monetization of their investments which may be undervalued, monetization of their wireless spectrum, and the free option of adding more layers such as charging subscribers for video on demand or other new platforms which are created.
There are many other ways to look at the valuation. Comcast’s current free cash flow yield is nearly 6% and is estimated to grow at 12% per annum for the next three years. Alternatively one could take current operating income before depreciation and amortization and grow this at a double digit rate until 2009, the guidance Comcast’s management gives; and then subtract the maintenance capital expenditures. This figure ends up very similar to the estimate above; as well a discounted cash flow which gives a similar result. The triangulation of these four valuations gives an added level of comfort. They key to Comcast’s value lies in their gap in required spending to maintain their systems versus the depreciation and amortization that is expensed on their income statement.
Risks
Comcast’s cash flows are stable, but risks still remain. Comcast has three main risks. They could make a poor reinvestment decision with their cash flows by making a irrational major acquisition. They could become involved in a price war with the telecom or satellite companies. I view the largest risk as Comcast being required to make a major system upgrade, eating up a ton of their cash flows. As well, insiders have sold some shares in recent months.
Full Disclosure: Lindmark Capital Fund, LP owns shares of Comcast as of this writing and is not responsible to update this article. Under no circumstances does this article represent a recommendation to buy or sell stocks .
Until 2006, Comcast’s shares were priced as though their business would commence a decline similar to the newspaper industry. Comcast’s Class A Special (Ticker: CMCSK) share price, which sells at a modest discount to the Class A shares (Ticker: CMCSA) due to their lack of voting rights, subsequently rose 63% in 2006 after languishing for six years. Despite the dramatic increase it remains an undervalued company with high returns on invested capital.
Comcast has a terrific management team with true owner operators. Ralph Roberts built Comcast from a 1,200 subscriber cable television system he purchased in 1965 located in Tupelo , Mississippi into the juggernaut it is today. Mr. Roberts accomplished this feat by rolling up local cable operators. His son Brian Roberts took the position of president in 1990, then Chairman and CEO in 1998. The Roberts’ own 100% of the Class B shares which control 33.3% of the voting power of the company, and 2.0% of the Class A special shares. Although they remain heavily criticized for their lavish pay packages, investors cannot argue with their savvy in the cable business.
Stephen Burke joined Comcast as the Chief Operating Officer in 1998 from Disney. His dad was the right hand man of Tom Murphy at Cap Cities ABC. The team of Mr. Murphy and Mr. Burke has won consistent praise from Warren Buffett. When asked about the relationship in a 2007 New York Times article Mr. Burke said, “I watched my dad for 30 years work with Tom, I know they had a wonderful time and a wonderful relationship, and Brian (Roberts) is the same way.”
In the same article in the Sunday New York Times Mr. Burke referred to the Cable segment as a “layer cake.” The bottom layer of the cake is the video services segment, where earnings are growing at 6% per annum. The video portion of Comcast is growing at 6% through buying smaller cable systems and through the pricing power they enjoy by being able to increase prices to their subscribers. The video division has 25% of the total 96.8 million households in the U.S subscribing to Comcast’s cable and other services. Comcast enjoys a competitive advantage in purchasing programming and equipment at a discount since it counts one quarter of the subscribers in the United States as customers. Their programming costs are nearly half of the second largest cable companies, Time Warner.
Imagine any television network not having access to 25% of the U.S. households; not only does Comcast enjoy a 25% market share but most of the subscribers reside in the top twenty five markets in the United States . ESPN currently receives over $2 per subscriber, which equals over $600 million dollars per year from Comcast’s video subscribers. ESPN would have a difficult time making up these revenues from video over the internet. As well, local governments receive franchise fees as high as 5% of gross video revenues.
The second layer is their high-speed internet service which has 12.1 million subscribers. They truly only have one competitor in this sector, the phone companies DSL service. In this sector price competition with the phone companies has kept Comcast from enjoying pricing power over their subscribers. They offer their customers state of the art broadband. They also own Comcast.net, which ranked among the top ten sites in internet search traffic and The Fan, which ranked in the top 15 providers of video on the internet.
The new, third layer is their phone service, Comcast Digital Voice, with three million subscribers. This is up from 200,000 subscribers at the end of 2005. The new layer of their phone services has been the latest key to their growth. They have been able to offer their subscriber’s all three services for a starting price of $99, a full 75% of new subscribers are signing up for all three services. At the end of the 2007 first quarter, more than 7% of Comcast’s subscribers had signed up for its phone service, up from less than 1% in 2005. Comcast forecasts to have over 20-25% of their subscribers signed up for Comcast Digital Voice by 2009.
The fourth layer of the cake is advertising. As part of Comcast’s agreements with programming networks they receive an allocation of scheduled advertising time to sell to local, regional and national advertisers. Revenues from the advertising division totaled $1.5 billion in 2006, up 21% from 2005 due to strong political advertising and the addition of newly acquired cable systems.
Each layer has different growth rates and in order to grow total revenues in the double digit range Comcast needs to add a new layer from time to time. One potential option is their much loved video on demand service, which today is free to Comcast customers but one day may be their fifth layer. Comcast is also trying to grow their services to small businesses where their customer base is very small. This could provide another revenue stream that is not currently present. The infrastructure is already in place and all they have to do is light up the dark fiber or add on to different nodes of their existing network to generate significant revenue increases.
Comcast, through SpectrumCo, LLC a consortium of investors purchased a basket of wireless spectrum licenses in 2006 for $2.4 billion dollars of which Comcast chipped in $1.3 billion. This purchase is a hedge against the proliferation of wireless. These licenses are predominantly in major markets and would provide them the option of adding wireless services to their platform.
Valuation
While Comcast’s shares are not as cheap as they were a year ago they remain undervalued. The main idea with Comcast is not how much an investor can make but how little they can lose. The cash flows of Comcast are incredibly stable and are being returned to shareholders in the form of share repurchases. Comcast generates returns on invested capital of 30%. Therefore, every shareholder dollar retained and reinvested will create $0.30 in earnings power the following year. Comcast also has repurchased $6.5 billion worth of their common stock or more than 10% of their shares outstanding in the past three and one quarter years.
Comcast has 24.2 million subscribers which generate monthly revenues of $96 per subscriber. They can grow their total revenues per subscriber by adding additional subscribers, increasing the number, and of services each subscriber takes. Comcast grew the average revenue per subscriber from $77 a month in 2003 to $95 in 2006, or 7.2% per year. If Comcast can grow the revenue per subscriber at 5% per annum while increasing the total number of subscribers to 26 million, or 2.4% per annum, by 2009 they would generate revenues of $34.8 billion. Adding the current $1.5 billion of revenues generated by advertising makes $36.3 billion of revenues for the Cable segment.
Comcast will need to make capital expenditures to update and maintain their cable systems each year. Comcast spent $4.4 billion dollars on capital expenditures in 2006. This is where the value is hidden at Comcast. Normally, depreciation and amortization match up to capital expenditures over time however, Comcast’s $31.9 billion of cable transmission and distribution facilities required only 25% of the total capital expenditures spent in 2006 to maintain the current assets. Approximately 75% of total capital expenditures in 2006 were variable and associated with demand for new services. Taking Comcast’s 2006 capital expenditures and increasing them by 12% per annum until 2009 leaves us with capital expenditures of $4.93 billion. Assuming Comcast will need 35% of this for maintenance capital expenditures we arrive at a maintenance capital expenditure figure of $1.7 billion.
Comcast should be able to achieve operating margins of 40%. If we multiply this operating margin by the estimate 20009 revenues of $36.3 billion, we arrive at an estimated operating income of $14.5 billion. If we then subtract the $1.7 billion needed for capital expenditures we arrive at $12.8 billion. Multiplying the $12.8 billion by the inverse of the combined federal and state tax rate (60%) leaves us with $7.7 billion. Applying a market multiple of 18 to Comcast’s estimated net owner earnings leaves us with a 2009 value of $138.6 billion for the Cable segment of Comcast.
Comcast’s other segment is their Programming division. The programming division generated operating income before depreciation and amortization of $241 million. We could simply slap a multiple on that number to come up with a value, but I believe there is more value there than that. Comcast paid $1.2 billion for 39.5% of E! in 2006. This is the equivalent of $3 billion for all of E!, which they own. Dividing the $3 billion by E!’s 81 million subscribers, yields a value of $37 per subscriber. If we ascribe a reduced value of $20 per subscriber to The Golf Channel and Style that yields another $2 billion in value for those two networks. If we ascribe a further reduced $5 in value per subscriber to their other three networks we come up with a value of $640 million. This does not include five other channels where Comcast owns 20-55% of the equity, the Philadelphia Flyers, the Philadelphia 76ers, and the Spectacor Complex. Totaling these up, we arrive at value for the Programming division of $5.6 billion. There also remains some optional value in Comcast starting a network channel and adding it to their large subscriber base. The cost is extremely low and the payoff is huge. Comcast invested $380 million in QVC and sold it for $7.9 billion therefore they have shown some abilities in this area.
Comcast has net debt of $27.2 billion and investments totaling $6.1 billion. Adding the investments, Programming segments value, and the Cable segments value gives us $150.3 billion. Subtracting the net debt gives us a value of $123.1 billion for the whole company. Then we subtract another $3 billion for options granted and outstanding giving a value of $120.1 billion for the entire company.
Comcast has been plowing their prodigious cash flows into share repurchases. Assuming this continues, they will repurchase 2% of their shares outstanding and will be left with 3 billion shares in 2009. This yields us a value per share of $41 per Comcast Class A Special share. On Friday June 29, 2007 their Class A Special shares closed at $27.96 which if purchased at that price would yield a return of 13.5% per annum for the next three years. This valuation leaves us with the free upside of further share repurchases, monetization of their investments which may be undervalued, monetization of their wireless spectrum, and the free option of adding more layers such as charging subscribers for video on demand or other new platforms which are created.
There are many other ways to look at the valuation. Comcast’s current free cash flow yield is nearly 6% and is estimated to grow at 12% per annum for the next three years. Alternatively one could take current operating income before depreciation and amortization and grow this at a double digit rate until 2009, the guidance Comcast’s management gives; and then subtract the maintenance capital expenditures. This figure ends up very similar to the estimate above; as well a discounted cash flow which gives a similar result. The triangulation of these four valuations gives an added level of comfort. They key to Comcast’s value lies in their gap in required spending to maintain their systems versus the depreciation and amortization that is expensed on their income statement.
Risks
Comcast’s cash flows are stable, but risks still remain. Comcast has three main risks. They could make a poor reinvestment decision with their cash flows by making a irrational major acquisition. They could become involved in a price war with the telecom or satellite companies. I view the largest risk as Comcast being required to make a major system upgrade, eating up a ton of their cash flows. As well, insiders have sold some shares in recent months.
Full Disclosure: Lindmark Capital Fund, LP owns shares of Comcast as of this writing and is not responsible to update this article. Under no circumstances does this article represent a recommendation to buy or sell stocks .
