On April 28, news broke that Comcast (NASDAQ:CMCSA) and Charter Communications (NASDAQ:CHTR) agreed to a deal in which the former would divest a substantial number of its customers to the latter in a transaction valued at $7.3 billion. This initiative by Comcast serves as an attempt to both increase its cash and appease regulators who are reviewing its proposed purchase of Time Warner Cable (NYSE:TWC) in a deal initially valued at $45.2 billion. With such significant news for both companies coming out of the woodwork, who looks set to benefit the most, and who, if anybody, will be left holding the bag?
Comcast has a strong reason to get rid of these subscribers
At the time of its merger announcement, Comcast had around 19 million managed subscribers to its name. In an attempt to grow its business, the company decided to buy Time Warner Cable. By doing so, management could increase its managed subscriber base by around 58% to 30 million. Using Time Warner's initial valuation, Comcast was effectively paying around $4,100 per subscriber.
On top of increasing its customer base, the company's revenue (using 2013's numbers) would rise 34% from $64.7 billion to $86.8 billion, while its net income would increase 29% from $6.8 billion to $8.8 billion. When you add to this the $1.5 billion in operating cost reductions management believes would accrue to the combined company, the business's profitability could hit around $9.8 billion.
While all of this sounds very attractive, the fact that Comcast's deal would increase its U.S. market share of managed subscribers above 30% has regulators concerned that the combined business may have enough power to create a significant monopoly-like advantage over its peers.
To address this concern, the business began engaging in talks with Charter, one of its largest competitors. If a sale of 3 million or more customers could be arranged, Comcast's market share of managed subscribers would decrease below that 30% threshold that management believes is vital to receive the approval of regulators.
Charter could benefit greatly from the deal, but it will leave a bitter taste in management's mouths
Through a direct sale of 1.4 million subscribers from Time Warner Cable and 1.6 million from Comcast, as well as through acquiring 33% of a spinoff planned by Comcast that will hold 2.5 million customers, Charter will be able to grow significantly in size. Through this deal, it will become the second-largest cable operator in the United States with approximately 5.7 million customers.
This will ultimately help Charter, which has seen its revenue rise just 16% over the past four years while experiencing continuous net losses, while Comcast's top line and bottom lines have risen 70% and 88% over the same timeframe, respectively. However, it's likely to leave an unsavory taste in the company's mouth. On Jan. 13, the company announced that it was interested in merging with Time Warner Cable, but its larger rival rebuffed the deal as inadequate. Comcast then swooped in and stole Charter's prey.
Now, it seems, the company is essentially taking what investors might call the leftovers. Yes, the business will receive a larger customer base, about 1 million of whom are tied to the success of Comcast through the spinoff, but it's just a fraction of what management hoped to get through its proposed acquisition of Time Warner Cable.
Based on the data provided, it looks like the divestiture of 3.9 million subscribers will help Comcast by generating additional cash and making it easier to smooth things over with regulators with the hopes of closing its Time Warner Cable deal. Additionally, the transaction will create for Charter a larger base that it can use to generate higher revenue and, hopefully, some much-needed profits. In essence, both businesses appear to win from this transaction, but the fact that Comcast is getting rid of assets it feels it can do without suggests that Charter's new customers may not be high quality, leaving the potential for underperformance down the road.
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