Comcast (CMCSA)

Comcast has the largest base of subscribers with almost twice as many cable customers as its closest competitor, Time Warner Cable, Comcast thus has the largest base for growth through bundling.

Consumers are interested in bundling their services, and Comcast’s “Triple Play” bundling of cable, Internet, and phone service is one of the most attractive on the market, possibly leading to customers abandoning satellite for Comcast. Moreover, Customers are willing to pay more for premium service, so Comcast’s VoIP and high-priced broadband Internet will be more desirable over cheaper, slower services.

There have been numerous recent regulatory actions against the cable industry by the FCC, but none of these hurt Comcast's core business model. In fact, the increased regulatory interest is a sign that the cable industry as a whole is doing very well. There has been opposition in Congress to the FCC's actions and Comcast has sucessfully overturned FCC decisions in court in the past.

Comcast is trading at an extremely low valuation relative to its historical multiples, peers, and the broader market. Investor concerns have been varied over the past year:

• Basic subscriber losses
• Increased telco competition
• Increased competition from web-based substitutes
• Slowing broadband growth
• Increased regulatory activity
• Major wireless capital spend
• No dividend
• Slow pace of share repurchases

These concerns are valid but only minimally impact the free cash flow generation of this company, which is primarily driven by video pricing increases and reduced capital spending. The company has been clear that 2007 is the peak year for capital spending

Given the slowing (but still rapid) growth and increased risks faced by Comcast, a lower than historically observed multiple is warranted, but at close to 5.0x 2009 EBITDA, it is cheaper than all its cable peers and most S&P 500 companies, even those in declining industries (e.g. rural local exchange carriers). A much higher multiple is warranted for a company with over 20% EBITDA growth over the next 3 years, defensive characteristics, and positive fundamentals.

Comcast is going start paying a dividend and has announced a buyback of $7 Billion over the next 2 years in some encouraging, share holder friendly actions. Furthermore, many analysts have concurred that Comcast shares are undervalued and worth more. ^[1]

Another recent investor concern has been around the potential for Comcast to spend most of its free cash flow to build an expensive, low return wireless network; given that the company is not bidding the upcoming 700 MHz spectrum auction and Comcast's historical discipline, a non-accretive wireless build-out is unlikely.

Basic subscriber losses are real and will likely continue as competition rises, but for every basic subscriber Comcast loses to a Verizon Communications (VZ) or The DirecTV Group (DTV) , it gains 7-10 Comcast Digital Voice (CDV) customers. Furthermore, basic subscriber losses are generally customers at lower price points and the new CDV customers gained are far more sticky since they likely take a triple-play bundle. So far, telco competition has been pricing rationally (Verizon is acutally increasing prices for its FiOS TV service) and will likely stay that way given the high capital spend requirements of the required telco plant upgrade (telcos are the bigger loser in a price war because they are at a cost disadvantage relative to cable). Competition from substitute forms of entertainment has increased in recent years, but this has not slowed the US household appetite for television, which has be increasing over the past few years, despite all the new entertainment options. This is very positive, as it implies consumers place a high value on television and Comcast will be able to more effecitvely increase pricing.

Broadband growth has slowed, but the absolute number of new broadband subscribers has held relatively steady. Longer term, US broadband penetration will reach similar levels to other industrialized countries. Even if broadband growth is no longer a major catalyst, it will continue to grow and contribute to cash flow.