Former cable mogul John Malone seemed primed to once again become the king of cable after an audacious bid in January to merger his Charter Communications (CHTR -2.15%) cable television company with larger competitor Time Warner Cable (NYSE: TWC). The deal would have nearly quadrupled Charter's video subscriber base and catapulted it into the no. 2 industry position behind kingpin Comcast (CMCSA 1.33%). Unfortunately, the bid piqued Comcast's own interest in a tie-up, leading to an agreement to acquire Time Warner Cable for roughly $45 billion in mid-February. So, fresh off its latest victory (assuming regulatory approval from the federal government), is Comcast a good bet?
What's the value?
Comcast's story keeps improving, thanks to smart deal making by the founding Roberts family who have transformed the former regional cable company into a leading media conglomerate. The company's blockbuster deal to buy a controlling stake in NBCUniversal from GE in 2011 was the lynchpin of its diversification strategy, ultimately creating a more balanced revenue base and adding positions in television broadcasting, films, and theme parks.
In its latest fiscal year, Comcast continued to generate solid financial results, reporting a 3.3% top-line gain that was aided by growth in its cable, film, and theme park units. The company benefited from a record box office haul for its slate of films, led by standout performers Despicable Me 2 and Les Miserables, which provided enhanced sales opportunities for its downstream home entertainment and merchandising units. The net result for Comcast was higher operating income, providing a greater amount of cash flow to invest in its growth initiatives, including an expansion of attractions and accommodations at its Universal Orlando theme park.
Of course, cable is still Comcast's bread and butter operation, generating the lion's share of its overall revenue and profit. The deal with Time Warner Cable adds approximately 11 million video subscribers to its existing base of more than 21 million subscribers, increasing its market share to an estimated 30% of the industry. The transaction should also improve Comcast's profitability in the cable business arena, allowing it to use its greater size to negotiate better deals with content providers, its largest cost center and the source of seemingly perennial margin pressure.
Benefiting all players
Naturally, the removal of a major competitor in the cable business should theoretically improve the fortunes of all of the major remaining players, including Charter. While the company lost out on Time Warner Cable to Comcast, it stands to potentially pick up some scraps from the deal, which will likely require system divestitures in order to win regulatory approval.
Like Comcast, Charter generated a solid top-line gain in its latest fiscal year, up 8.7%. This was thanks to higher average prices and a pickup in its total subscriber base, mostly due to its acquisition of cable systems from competitor Cablevision in July 2013. However, the company's profitability was hurt by the aforementioned perennial rise in content costs, as well as a double-digit increase in marketing costs. On the upside, though, Charter's operating cash flow yield continued to trend higher, providing an important base of funds to upgrade its network. This trend also gives it flexibility to pursue value-added acquisitions, like the potential purchase of system properties from a merged Comcast/Time Warner Cable.
The bottom line
Comcast's pending deal to buy Time Warner Cable certainly wasn't cheap, but the deal adds millions of customers in growing, high density markets like New York and Los Angeles. These are customers to whom the company can cross sell other products and services from throughout its vast ecosystem. Comcast should also be able to improve the operating margin of the acquired Time Warner Cable business by leveraging its existing base of back office operations and its investments in next generation customer premise equipment.
While a completed deal isn't a foregone conclusion, given anecdotal opposition to the pairing, the Feds have shown limited interest in blocking similar recent tie-ups in other industries, like car rentals and airlines. As such, I think that existing Time Warner shareholders should hold on to their shares and new investors should consider Comcast as a possible core position in the media space.
