RealMoney Silver - Comcast Is Near Bottom

Comcast Is Near Bottom
By Steve Birenberg
RealMoney Contributor
10/29/2007 9:22 AM EDT

Comcast (CMCSA) shares remain under pressure since its earnings release last week, which Credit Suisse cutely labeled a "Comcastrophe."

The follow-up analyst commentary is a mixed bag of upgrades and downgrades -- downgrades focusing on the decelerating revenue and cash flow momentum and awful sentiment, and upgrades focused on the likelihood of several more years of double-digit growth and cheap valuation. Still, the recent price weakness presents a buying opportunity for investors who believe in the "quad-play" model.

To try to get a better handle on Comcast, I worked with my one of the best media minds I know, Ken Goldman, who manages a long/short media-focused hedge fund. He is a former Street analyst who has applied his knowledge very successfully on behalf of his money management clients.

We decided to compare Comcast with AT&T (T) and Verizon (VZ) across basic measures of growth and value.

Jim Cramer made a big deal about Comcast, admitting to economic sensitivity as a reason to be negative on cable shares. However, the real issue here is competition with the telcos and satellite companies. Economic sensitivity does seem to be affecting the takeup of the many products in the cable bundle. In addition, it is clear that cable received an artificial boost from the housing boom and is now suffering the reversal of that good fortune.

These impacts are marginal, however, compared with competitive issues that can move long-term revenue, EBITDA, capital spending, free cash flow and EPS estimates materially.

Ken and I are both long Comcast, and we are longtime cable believers. To be honest, we entered our analysis with the expectation that on a relative basis, Comcast would look attractive compared with AT&T and Verizon.

What we found, however, is that while Comcast's revenue and EBITDA growth should remain superior for at least a couple more years, the valuation disparity of the three stocks is minimal. If the predominant concern of investors is the battle for household spending on the quad-play bundle of TV, broadband and wireless and wireline telephony -- and I don't see any other way to look at these stocks on an intermediate- to long-term basis -- the market seems to be saying that Comcast's financial performance is most at risk from competition.

We attempted to keep it simple and focus on basic measures of growth and value. Here is a summary of what we learned:

Comcast Vs. AT&T and Verizon

Essentially, you are looking at companies with converging growth rates. Not surprisingly, valuation measures have also converged. Unfortunately for Comcast shareholders, the value convergence has come via a significant decline in Comcast shares while AT&T and Verizon shares have rallied.

Obviously, it is not as simple as this. On Wall Street, the rate of acceleration or deceleration in growth is often more important than comparative growth rates. Comcast is decelerating. Wall Street is worried the deceleration will be more rapid than even the recently lowered estimates imply.

On the other hand, Verizon and AT&T are stable or slightly accelerating. And Wall Street sees the acceleration, particularly telco entrance into TV and Verizon's FiOS network broadband, as coming at Comcast's expense.

Right now, this conventional wisdom works to the benefit of AT&T and Verizon shares and to the detriment of Comcast shares. I don't think that is really fair, however. Everyone seems to be overlooking that Comcast is taking telco telephony subscribers much faster and across virtually the entire country than telcos are gaining TV.

Verizon only overlaps Comcast in 5% of Comcast's footprint today, and no one sees the overlap as exceeding 30%-40% in the next several years. In addition, no one is giving Comcast any credit for the fact that the telephony subscribers they are adding will raise its operating margins. Finally, the magnitude of telephony gains (662,000 last quarter) dwarfs the basic cable subscriber losses (65,000 last quarter).

Another thing the market is apparently dismissing is that Comcast is getting ready to assault another telco monopoly: small and mid-sized businesses. These potential customers have never had a choice of telephone and Internet providers. This growth initiative for Comcast (and risk to AT&T and Verizon) should become more visible over the next 12 to 18 months. In fact, on its conference call, Comcast said that the business opportunity would produce material operating cash flow in 2008.

The bottom line is that competition between cable and telcos cuts both ways. That means all the negatives being piled on Comcast -- risk of losing customers, risk of slower-than-expected subscriber growth, risk that pricing for individual elements of the bundle or the bundle itself collapses, risk that capital spending will be higher than expected -- are also negatives for the telcos.

At a minimum, with Comcast shares trading at valuation parity with Verizon and AT&T, the bottom should be at hand. If Comcast faces the doomsday competitive scenario, so do AT&T and Verizon -- remember, Comcast has a fully-built-out advanced network, while Verizon and AT&T still have to spend tens of billions of dollars to upgrade their networks.

It doesn't make sense to be bullish on AT&T and Verizon and bearish on Comcast. Right now, the sentiment is overly tilted in those directions, because the bearishness on Comcast is too steep and the shares lack the dividend and management optimism currently provided by the telcos.

That is where the opportunity lies, and that is why $21 is no time to throw in the towel on Comcast. Just the opposite: It is time to step up to the plate -- especially if you buy the bull case on AT&T and Verizon.