June 15, 1999

Comcast for Dad
by Louis Corrigan (TMFSeymor@aol.com)

Trading at $33 5/8 as of June 14, 1999

All Dads want to speed around fool.com, right? Well, being wired for speed increasingly means Internet access via cable modem or the local telephone company.

Cable companies, working in partnership with the new Excite@Home (Nasdaq: ATHM), have the head start in rolling out such "broadband" service. Cable is also going digital in general, increasing its channel offerings and clarity to better compete against satellite providers like Hughes Electronics' (NYSE: GMH) DirecTV. And thanks partly to AT&T's (NYSE: T) acquisition of Tele-Communications Inc. and pending deal for MediaOne (NYSE: UMG), local and long-distance telephone services should become a standard offering for all cable operators in the next few years.

Thus, all the good stuff that requires a wire into the home -- TV, Internet, telephone, and shopping -- will soon be available via cable. That's why cable customers have become more valuable: They're expected to buy more services. True, cable operators will have to spend heavily to upgrade their lines, but investments in infrastructure will get spread out over higher revenues, ultimately leading to heftier profit margins.

Of course, this isn't a secret. AT&T's bid for MediaOne is part of an industry consolidation that's caused all cable companies to trade at a premium: $3,600 to $4,600 per subscriber versus just $3,000 not long ago. The premium depends on variables like how much of the system is upgraded for digital services and how good the subscriber clustering is. Companies have also been selling at the high end of the typical valuation range of 14x to 18x operating cash flow (earnings before interest, taxes, depreciation, and amortization). Cable investors focus on cash flows rather than earnings partly because this capital-intensive, merger-happy business creates lots of non-cash charges that make EPS a poor metric.

Still, cable stocks have dipped from their highs due to an Oregon court decision that investors fear might lead to cable companies being forced to lease access to any Internet service provider (ISP) that wants to offer broadband over cable. If that actually happens (it may not), cable operators' exclusive (and lucrative) relationships with @Home would have to be renegotiated. This is a complicated issue, but independent cable operators should come out pretty well now matter how it turns out. Cable companies might even see an acceleration in their Internet access revenues if America Online (NYSE: AOL) were permitted to offer its customers broadband via cable. Even at wholesale prices, cable systems would enjoy a profitable new revenue stream that ties consumers even more closely to cable service.

Why Comcast (NYSE: CMCSK)? Though it lost the war for MediaOne, it will pocket a $1.5 billion walk-away fee. It also will acquire 750,000 customers from AT&T for $3-$3.5 billion and get a three-year option to acquire another 1-1.4 million subscribers for $4.8-$6.7 billion in Comcast stock. So Comcast made out well, positioning itself as the third-largest cable operator in the country, behind AT&T and Time Warner (NYSE: TWX), with control over some 8.3 million cable subs, including Jones Intercable (Nasdaq: JOINA) and other systems. Plus, a recent customer swap with Adelphia Communications (Nasdaq: ADLAC) has enhanced its already high-density Mid-Atlantic super-cluster.

Comcast's revenues soared at a 47.4% compound annual growth rate (CAGR) between 1994 and 1998 while cash flow increased at a 34.3% rate. That's a bit misleading, though, since the company has been shuffling assets. Still, on a pro forma basis, FY98 revenues increased 12.4% and operating cash flow rose 13.2%. On a pro forma basis, Comcast's first quarter FY99 revenues increased 14.2% and operating cash flow jumped 21.2%.

For the first quarter of FY99, Comcast's cable revenues rose 11.7% to $604.8 million and operating cash flow increased 12.5% to $280.5 million. Margins are tops in the industry, edging up to 46.4% from 46% in the first quarter of FY98. Although subscriber growth for basic cable ran just below the industry average of 1.5% last quarter, Comcast has been rolling out digital cable, doubling subscribers to 160,000 between December 31 and May 10. Digital services were available to just 30% of its cable customers at the beginning of the year, but over 60% today.

The company has been slow to enter the local telephony business, but it's now guaranteed a good deal with AT&T. It has also prepared its systems for broadband, with some 1.93 million of its 4.55 million wholly owned subscriber homes now "modem-ready," up 79.3% from a year ago. Over 71,600 customers use Comcast@Home for high-speed Internet access.

Comcast's cable business is operating at a current run-rate (Q1 results x 4) of $2.42 billion in revenues and $1.12 billion in operating cash flow. At 18x cash flow, it's worth $20.2 billion. To double-check this on a subscriber basis, multiply Comcast's 4.55 million wholly owned cable subscribers at the end of March x $4,500 to get $20.5 billion.

Comcast also operates other businesses. Its 57%-owned QVC home shopping network is particularly interesting given that it reaches 70 million homes in the U.S. and Europe. QVC's Q1 revenues spiked 19.3% to $649.6 million while operating cash flow soared 37.6% to $130.9 million. Margins shot up to 20.2% versus 17.5% a year ago. In his bid for Lycos (Nasdaq: LCOS), Barry Diller of USA Networks (Nasdaq: USAI) tried to convince Internet speculators that a home shopping network's fulfillment infrastructure, reach, brand, and cash flow have great value for e-commerce. It didn't work, but I'm a believer.

Because retail is seasonal, we'll take QVC's trailing 12-month results of $2.5 billion in revenue and $470 million in operating cash flow. Using a multiple of 12x to 20x cash flow, QVC is worth up to $9.4 billion, with Comcast's stake worth perhaps $5.4 billion.

Add in an estimated $2.9 billion for Comcast's other properties (like stakes in the Philadelphia 76ers, E! Entertainment, and Jones cable), and the business would be worth $28.8 billion. Multiply Comcast's 815 million fully diluted shares by a $36 1/2 share price, and you get a market cap of $29.75 billion. But the company also has $1.5 billion in cash net of debt, which you subtract from the market cap to get an enterprise value of $28.25 billion. Adjust for the cash from the MediaOne breakup, and the market is now valuing Comcast at just $26.75 billion.

I'm using high-side assumptions, though. Clearly, the stock isn't inexpensive by the going metrics. Still, Comcast is a well-positioned, financially strong cable operator that should make a solid investment in the broadband future. Buying at $36 1/2 should give you a modest market-beating return over the long term. Since April, though, it's traded between $29 to $42 and could dip back toward $30 due to fears over the Oregon ruling. At that level or below, it would become even more interesting.

Comcast Company Information:
Trades on NYSE under symbol CMCSK
Comcast's website: www.comcast.com
Current Quote
Comcast's Chart

Other Related Links:
Comcast Message Board
Comcast: A Deal for Its Share of the Future -- 3/22/99
AT&T, Comcast Sign Deal -- 5/5/99
Lycos Held Hostage by Speculators -- 5/19/99
Industry Snapshot on Cable Companies -- $7 in FoolMart

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* A Stock for Dad represents the opinion of one Fool and in no way should be taken as the opinion of either The Motley Fool, Inc., the company in question, or representative of anyone or anything else other than that specific Fool's thoughts.