Description

Current Price: $58

Target Case Price: $85 in 12 months

Downside Case Price: $52

Market Cap: $147B

Liquidity: $815MM per day or 14.5MM shares

Thesis

CMCSA is a lightly regulated emerging monopoly, selling a non-cyclical product, presently growing EBITDA 5-8% per year, trading 15x 2015 adjusted FCF without a deal and 13.5x PF 2015 FCF with a TWC deal. In the near term (6-12 month), I do not anticipate acceleration in CMCSA’s current trends, particularly during the FCC/DOJ review of TWC/CHTR deal. However, longer term, as demand for higher speed/volume internet access increases, CMCSA’s structural advantages versus satellite, wireless, and wireline will become more and more dominant, leaving CMCSA with a monopoly position across 70% of its portfolio and a duopoly in the 30% where a credible fiber competitor exists/will exist. As CMCSA’s cost base is largely fixed, price increases and increased market penetration will yield revenue and EBITDA growth well in excess of Street estimates. Further, CMCSA has growth opportunities in Wi-Fi mesh networks, business services, NBCU, home security, etc. Given the minimal cyclicality and predictability of current trends plus eventual higher growth, I feel at least an 18x FCF multiple is warranted.

Less formally, I think the market is underestimating odds of TWC deal, underestimating pricing and household penetration rates, and still views cable companies as the cash sucking, overbuilders they were in the previous decades instead of what they are today… consumer staples with monopoly pricing power that will only get stronger.

Of the “close to sure bets” in the world, I think Americans wanting higher speed access is one of them and CMCSA/cable best positioned to take advantage of that.

Valuation

• Target Case – TWC Deal – Assuming a normalized 13% capex/sales ratio for cable business and 2% for NBCU, I reach $4.00 in PF 2015 FCF, which grows to $5 in 2017. Applying 18x 2017 FCF, discounting back one year at 10%, and giving $4/share in value to “other” assets (Greatland Spinco, CHTR stake), I reach a value of $85.

o I am sure the terms of the CMCSA/TWC/CHTR deal will inevitably be reworked. No one gives the regulators their best offer first. However, the math of “around $5 in 2017 FCF” should stand.

• Target Case – No Deal – If regulators completely block the deal, CMCSA should earn $3.80 in 2015 FCF and $4.20 next year. 18x yields $68.

• Downside Case – With no deal and  CMCSA’s EBITDA growth slows towards 2-3%, 2015 FCF could be $3.50 and 2016 $3.75. 15x 2015 and 13.5x 2016 yields $52.

o This corresponds with the bottom of CMCSA’s trading range.

Risks

• Regulatory Changes – The FCC has recently changed the regulations regulating US cable to give the FCC more authority over cable. While a burden, so far the FCC is only attempting to enforce the same net neutrality rules that governed the industry until Jan 2014, which include no price controls.. However, over the long term and CMCSA’s monopoly becomes clearer, it is possible the FCC steps up oversight.

o I’d point out that the scenario where CMCSA flexes its pricing power muscles to the point of FCC intervention implies a much higher earnings base than CMCSA currently…

• New Technologies – The primary driver of CMCSA/cable’s competitive positioning is that it is the best way to deliver data to homes. While remote at present, the emergence of a better technology is always a threat.

• Fiber Buildouts – If someone builds out a competitive fiber offering (Verizon, AT&T, Google, municipalities, etc.), cable’s monopoly would become a duopoly as fiber and cable are essentially the same. However, this is extremely costly, which is why I doubt a serious national fiber rollout ever occurs. 

o I estimate a $40-$60B cost to build out fiber across CMCSA’s monopoly markets, or about half the EV of CMCSA excluding NBCU

Data Transport

Fundamentally, CMCSA is a transportation business – data transport. What drives a transportation business is demand is end market demand for the goods it transports and the supply of comparable quality transit options, adjusted for price elasticity. Since residential internet access emerged in the 1980s and 1990s, demand for data speed (or more accurately volume) has increased every year at an often exponential pace. While browsing, streaming, and of course cable TV are the major drivers of current demand, advances in cloud computing, VPN, the Internet of Things, etc. will only increase demand for high quality, high speed internet access. Importantly, this demand is largely non-cyclical and “mission critical” for consumers. Internet access is a “must have” for those accustomed to using it; lose your job, you probably use at home internet more than you did with one. At home entertainment, cable, Netflix, or otherwise, is the best value proposition around; there’s a reason 99% of homes have at least on television, passing the household penetration of microwaves, stoves, dishwashers, washing machines, and coffee makers.

On the supply side, there are currently four mass market methods of data supply – cable, copper telephone lines, satellite, and wireless.  Satellite and wireless at present are completely un price competitive for large volume consumption. For example, watching 2-3 hours a day of streaming HD video would cost approximately $5,000 a month on current pricing, versus $50-$70 for cable. Without a step change in technology, it is doubtful satellite or wireless will reach price competitiveness. Copper telephone lines can be used for DSL, which at sub 5mbps download speeds can be provide roughly the same internet service as cable. However, 1) even getting to 5mbps requires expensive upgrades that telephone companies are reluctant to do and 2) copper wiring really can't go >5mbps in most areas. The telephone companies basically need to build out an entire fiber network, which is extremely costly. That's why you see the large telephone companies, T and VZ, dumping their existing copper wireline businesses at 3.7x EBITDA to roll up phone companies, FTR CTL WIN, who don't even have the cash to theoretically build out fiber. Hence, if you believe most homes will want >5mbps internet access – or more bluntly, to watch streaming HD on one TV – you believe CMCSA will have a monopoly position without a step change in technology that at present does not exist.

The one obvious exception to this “data transport” theory is satellite TV, which is comparable to cable TV. However, satellite is incapable of offering competitive internet or phone, has a lower quality VOD offering (requires broadband internet anyways), and can be affected by weather, resulting in an overall lower quality product. Over time, I expect satellite to continue bleeding share in TV, but the cable TV side of CMCSA business is lower quality (though still pretty decent) than internet.

High Speed Internet Penetration

One key driver of differentiation of my view versus the Street is penetration of homes passed. Essentially, CMCSA and other cable companies roll cable to all homes in a neighborhood, and each additional one that signs up is extremely high margin - say 85% excluding set top box costs. At present, high speed internet is taken by ~40% of homes passed. Most sell side models expect penetration to tick up to mid-40s by say 2020 with margins ticking up slightly, if they model out that far. While I don’t have an exceptionally strong view on pace, 1) that seems too slow, 2) I expect margins to improve substantially overtime as penetration increases (and DSL becomes less and less competitive), and 3) I fully expect high speed internet to eventually be ubiquitous in areas where it is available. A 70-80% penetration rate, depending upon pricing, is not crazy. Many European countries are there at present. While the price of high speed internet access, and not wanting to see price controls, may limit where CMCSA takes penetration, I fully expect a broadband internet connect connection to be as ubiquitous as a phone line over time. Do we really think only 43% of Americans will be watching Netflix or HBO in HD quality streaming a decade from now?

Regulatory

No discussion of cable these days would be complete without mentioning the new Title II rules from the FCC. Essentially, the FCC has voted to give itself more power to regulate cable (gotta love the ability to vote yourself into power). The big fear is that one day the FCC will look to set prices for cable. However, again “at present”, absolutely no one in a position to matter is calling for that. What has happened is that after political posturing and grandstanding, we have enacted a huge regulatory change to result in exactly the same rules that governed cable prior to January 2014. That's why the stocks have rallied since then. Over time, I fully expect the FCC to move towards price controls as cable will be a monopoly. It's just that I think it's 10-20 years out and that CMCSA will compound at a 20-30% pace until then.

Cable Fears Overblown

Another common fear is that the shift from linear TV to streaming OTT products will destroy CMCSA’s cable TV business. I have three thoughts. First, OTT streaming products, particularly in HD quality of better, require a broadband internet connection. If cord cutting does emerge, it quickly ensures cable’s monopoly/duopoly on internet. Second, to make up for lost revenues on the TV business, cable companies will look to charge higher volume customers, much like wireless companies do. Third, the bundled TV package is actually a huge value proposition to customers. The average American watches 4-5 hours of TV per day. Assuming a family of four and a $50 opening price point, that works out to 8.3 cents an hour to get cable TV. There's really no better value option for consumers, which is why you've seen the streaming OTT services grow with much cord cutting. Further, the Xfinity App is actually a better product than NFLX or Amazon Prime. If CMCSA and other cable businesses had gotten a quality app to market in 2009 instead of 2013, NFLX would be “that out of business DVD company.”

TWC/CHTR

As this has been written about extensively elsewhere, I will keep this brief. I put the odds of a deal at >70%. The recent news about CHTR looking to buy Brighthouse, which has a shared ownership/operations with TWC, is a bullish sign for the deal completing. It could be part of the concessions the government demands. Legally, there's very little reason to block the deal. CMCSA and TWC really have no overlap and keeping them separate will have little impact on customers. In fact, greater scale gives CMCSA leverage to push back on networks, which could drive lower prices. Politically, it's become a circus. I'll leave it at that.

Most importantly, CMCSA is cheap even if deal doesn't go through.

Other Growth Opportunities

CMCSA owns a huge network across it's markets with growing importance as more data is demanded. There are numerous potential ways to increase that networks monetization. Home security is basically a motion sensor connected to the internet with a call center. CMCSA can build out fiber to business centers and high rises and target SMB and enterprise customers. They have built out a wifi network in major cities and could provide a cell phone service using their the network. They can build fiber out to cell towers and provide back haul for carriers. While the bulk of CMCSAs growth comes from internet and TV, there are dozens of interesting growth opportunities to further monetize CMCSA’s existing network.

Catalyst

Finalizing TWC deal. Earnings beats.