Comcast Is Unable to Rationalize the Time Warner Cable Deal

The deal by Comcast Corp to purchase Time Warner Cable is hard to rationalize with the peaking stock prices and the struggling video customer business that the deal doesn't solve.

Jun 29, 2014 at 10:00AM

After years of strong stock gains for the cable operators, the deal to buy Time Warner Cable (NYSE:TWC) by Comcast Corp. (NASDAQ:CMCSA) raises a lot of eyebrows that the company is overpaying for the assets . In light of the news that AT&T (NYSE:T) is going to purchase satellite provider DirecTV (NASDAQ:DTV) in a $50 billion deal, investors need to consider whether these deals are top ticking the market.

The odd part of the equation is that the companies' stocks have surged the last couple of years, while their revenues are seeing limited growth. In fact, Time Warner Cable now trades at a historically high 21x trailing earnings. The company has squeezed out higher profits from existing operations, but how long can that last with revenue only growing roughly 4% each year? Based on the chart below and the limited revenue growth, now  doesn't appear the time to buy these stocks.


CMCSA data by YCharts

One thing to keep in mind is that huge stock gains attract competitors. The current environment for cable networks is incredibly competitive with challenges from Internet services and even consumers cutting the cord and going without a cable operator.

Deal details
Back in February, Comcast agreed to purchase Time Warner Cable in a deal that valued the company at approximately $45.2 billion. According to the press release, the transaction is valued at 6.7 times the company's operating cash flow and will generate operating efficiencies of around $1.5 billion. The amount is accretive to Comcast's free cash flow per share. The combined entity will own roughly 30 million managed subscribers after effecting a deal with Charter Communications to reduce the market share to 30% of total subscribers in the U.S.

A proposed benefit of the merger is creating  a national presence by merging the two cable operators. The below chart highlights the top areas where the two companies will have operations:

Screen Shot

The fallacy of this plan is that the market areas are all locally based. Any consumer will purchase television service based on whether Comcast or Time Warner Cable provides the better offering and corresponding price over the other service providers (including the primary satellite providers such as DirecTV.) If the company can use the proposed $1.5 billion in operating efficiencies to drive down prices and improve operations, the deal has a better chance of succeeding. 

Losing subscribers
Due to the competitive nature of the video subscriber market, it doesn't add up that Comcast wouldn't use its clout and size to move into a service that is distinctively national on its own. This deal doesn't change the trend of losing subscribers to national service providers such as DirecTV.

Time Warner Cable only generated revenue growth of 2% in the first quarter due to a loss of 34,000 residential video subscribers and a nearly 7% decline in revenue. Business services are seeing strong growth, especially from high-speed Internet that grew by nearly 20%.

On its own, Comcast is quick to point out that it has seen video customer growth for a second consecutive quarter (though the amount was only 24,000.) The big gains are coming from adding high-speed Internet customers, to the tune of 383,000 for the first quarter.

Bottom line
The deal is tough to rationalize, especially with Time Warner Cable trading at multi-year highs and the primary video customers in decline. While having a larger national presence is nice, the cable business is locally charged. The combined entity lacks services in key markets listed above that will prevent it from most exclusive national content deals. In the meantime, AT&T will collect a national television provider that covers all markets along with its wireless phone service. The deal makes Comcast larger, but not necessarily better.

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Mark Holder and Stone Fox Capital clients own shares of AT&T and DirecTV. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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