Comcast stock, even near a record high, continues to trade at a discount to the combined value of each of its businesses—Xfinity, NBCUniversal, and Sky, according to one observer.
In a report this week, Wells Fargo analyst Steven Cahall argued that the conglomerate structure will continue to weigh on Comcast’s (ticker: CMCSA) valuation, and that shareholders would be better served by a breakup of the company. He refered to Comcast having Xfinity, NBCUniversal, and Sky all under one roof as “Diworsication.”
Cahall initiated coverage of Comcast stock at the equivalent of Sell, with a $48 price target. Shares are down 2.2% to $56.76 in afternoon trading Wednesday, giving Comcast a market value of about $265 billion.
Comcast stock has returned 19% after dividends annually over the past three years, versus a 15% average return for the S&P 500. Stocks of pure-play cable companies such as Charter Communications (CHTR) or Altice USA (ATUS) have done even better, however. Both have returned about 23% a year over the past three years.
Comcast “trades more like a Media company (or at least it can trade like a Media company) post the acquisition of Sky [in 2018],” Cahall wrote. “It trades less like Cable given lower leverage and capital returns. Comcast is leaving incremental shareholder value on the table due to Media exposure as cable and broadband peers have increased earnings and have been rerated higher over the past decade.”
Charter—which sells its cable service under the Spectrum brand—and Altice—whose cable business bears the Optimum brand—have been major beneficiaries of Americans’ growing reliance on their home internet connections, as has Comcast’s Xfinity. Both have been aggressive in buying back their own stock over the years, reducing the number of shares outstanding, and boosting earnings per share. Both have been happy operating with a higher ratio of debt to earnings, or leverage, to provide additional buyback firepower rather than paying down debt faster—meaning more free cash flow goes to shareholder returns.
Comcast stock trades at 20 times this year’s estimated EPS, versus 31.5 times for Charter. Comcast’s ratio of net debt to Ebitda—earnings before interest, taxes, depreciation, and amortization—stands at about 3.3 times, while Charter’s is about 4.6.
Cable is an asset-heavy industry, and there are a lot of properties that companies can offer as collateral for loans. Plus, it’s a recurring-revenue subscription business, with greater visibility into future revenues than a more cyclical media business like NBCUniversal. That greater certainty of cash flows also makes investors more comfortable with higher leverage.
Essentially, Cahall argues that the higher leverages of Charter and Altice produce a more-efficient capital structure that helps to boost returns for equity holders, and that Comcast’s combined media-and-cable portfolio keeps it from matching that approach. Each business has its own needs and trends, and their trajectories don’t necessarily match.
“While CMCSA may be a collection of good businesses, we don’t think it’s a good stock in its current form,” he wrote. “Cable and Media have very different requirements, with the former benefitting from decelerating capital intensity, which lends itself to the sort of leveraged equity returns practiced by pure-play cable peers. In contrast, the media industry is entering a multiyear period of accelerating investments as the pivot to streaming requires ever more content and subscriber acquisitions costs, with the intensity of spending only matched by the accelerating pace of linear pressures.”
NBCUniversal’s Peacock streaming service is playing in a market with several deep-pocketed competitors including Netflix (NFLX), Walt Disney (DIS), and AT&T (T), which similarly owns both telecom and media businesses. The entire industry is in a heavy investment phase, with billions of dollars in new content planned to attract subscribers.
That Peacock spending need will further keep Comcast from matching its cable rivals’ ability to direct cash flow toward buybacks, Cahall argues. Comcast stock has a dividend yield of 1.7% annually.
“CMCSA is trying to strike a balance between what cable companies promise (capital returns) and how media companies pivot (big content investments),” he wrote. “We see limited rationale for keeping the two major pieces together as investors can construct their own CMCSA-like portfolios (e.g., CHTR + DIS).”
Cahall proposes three possible avenues for splitting NBCUniversal and Sky from Xfinity, which can then be operated with a higher leverage, and return more cash to investors, garnering a higher valuation multiple. One way is to sell the media businesses to another company, which would come with a hefty tax bill but bring in plenty of cash. Another way would be a tax-free spin off of the media assets to current Comcast shareholders.
The third would be a merger of NBCUniversal/Sky with another media company. Cahall suggests AT&T’s WarnerMedia, pointing to the greater investment scale in streaming, the opportunity for cost savings, and the consumer appeal of a theoretical bundle of HBO Max and Peacock.
Wells Fargo’s Cahall is the only Wall Street analyst with a Sell rating on Comcast stock. According to FactSet, nearly 80% of analysts who cover the shares have a Buy or equivalent rating. Their average price target is $60.14, about 6% above recent levels.
Barron’s recommended buying Comcast stock late last year, noting that the company appears undervalued on a sum-of-the-parts basis. The stock has returned 12% since then, about five percentage points ahead of the S&P 500.
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