YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

Comcast in talks with NBC Universal

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Successfully run by the Roberts family, Comcast enjoys great scale – the largest U.S. cable TV operator with about 24 million subscribers in 39 states. Through their cable infrastructure, they also offer high-speed internet and telephone services, with about 15.3 million and 7 million customers, respectively. This triple-play offer is very valuable in not only adding to customer loyalty, but there is little added variable cost to these upgrades. Additionally, they own some cable stations such as E! entertainment, Style, Versus, and the Golf Channel; some websites including Fancast, DailyCandy, and movie-ticket service Fandango; and a majority ownership in some sports franchises, namely the hockey team Philadelphia Flyers, the basketball team Philadelphia 76ers, and two sports arenas in Philly.

Despite a slumping economy and stiff competition from telephone and satellite companies, Comcast has shown resilience with continuing revenue growth. We view Comcast more like a utility than a media company. Relative to large phone companies, they have a superior infrastructure and capital expenditures are slimming thus cash flow steadily increasing (currently about $4 billion). Through DOCSIS 3.0, they are in the process of converting more and more analog channels to hi-def channels and doubling internet speeds which will allow for more premium on-demand offerings to bring more revenue growth, while actually cutting capital spending.

However, Comcast has significantly lagged the market rally. In part, some fear cable TV & internet are dying businesses as consumers shift to free online viewing and as technology advances in wireless technology threaten the competitive advantage of cable speeds. While this may eventually come true, these risks seem afar off and in the meantime, Comcast is a solid and fairly predictable cash cow. The real near term concern is while markets become more saturated and upgrades (triple-play) begin to slow, growth becomes limited.

Thus, in comes NBC Universal (NBCU). There has been lots of talk lately about Comcast purchasing NBCU from General Electric. NBCU owns all sorts of assets. Obviously, they own the oldest TV broadcast network NBC (shows such as “Jay Leno,” “Seinfeld,” “Friends,” and “The Office”) and other networks such as Telemundo. This is a more economically sensitive business which, out of the big four networks, has been struggling the most in ratings. Like Comcast, they also own some cable channels such as CNBC, MSNBC, USA, Bravo, Oxygen, and the Weather Channel; and some websites including iVillage and Hulu.com. They own the Universal Pictures movie studio library, a business that is much like drilling for oil – sometimes there’s a hit, other times a flop. Finally, they own the Universal Studios theme parks – a capital intensive business of which we don’t have much interest.

In the deal under consideration, Comcast would take a 51% stake in a new private company by contributing some $5-7 billion in cash and some cable network assets. Vivendi, which currently owns 20% of NBCU, would be bought out by GE who would end up owning the remaining 49%. In the end, the deal will likely be valued around $30 billion.

The question is whether there is a fit or not – are there synergies, or will this be “de-worsification?” Secondarily, with the advent of online video, the future of the traditional media content business is beset by uncertainty. Online video, as well as Netflix and Redbox, have also threatened the movie and DVD business. The market loathes the idea as it crushed Comcast’s already depressed shares nearly another 10%. They have reacted negatively to this idea as it runs counter to the trends we’ve seen in the industry – for example, Time Warner spinning off its cable business and Viacom undoing its merger with CBS.

Nobody knows exactly how this would all play out – but we believe the net effect of vertically integrating the content business with the distribution channel will likely have a neutral impact. Comcast would avoid paying fees to NBCU’s cable channels which would help offset the networks increasing costs and declining ad spending that is now shifting towards cable channels. Even still, Comcast’s core cable distribution pipeline business will generate about three quarters of its operating profit. Our biggest concern is that they avoid the all too common mistake of overpaying. This deal also puts a large question mark around Vivendi’s exit price as this situation would give them bargaining power, not to mention possible obstacles stemming from legal issues with regulators. One huge positive is Comcast plans on using their assets rather than their undervalued stock as currency, nor will they need to raise absorbent amounts of debt and take a hit to their credit rating. Admittedly, we would prefer to see Comcast use its cash flow to buy back shares. But regardless of how this deal pans out, at 11 times cash flow, we find Comcast shares attractive at this price.

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Brian Yacktman | October 07, 2009 | Permalink

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