Comcast: A Recession “Proof” Compounder

Comcast logo

Introduction and summary:

Comcast (tickercode: CMCSA) is the world’s second biggest telecom company and headquartered in Philadelphia, USA. The company was founded by Ralph Roberts in 1963 and has largely grown via M&A.

I’m long Comcast since late summer 2018 and consider this a long-term holding that will compound for years to come. My main reason for buying was twofold:

  • Comcast’s acquisition of News Corp made the earnings multiple contract to around 12, pretty low for a quality company.
  • I wanted to invest alongside a good owner-operator: The Roberts family. Management has a fair skin in the game hence aligning interests with outside investors. The Roberts family has a proven track-record in making good acquisitions, a very difficult field to navigate successfully, and has created significant wealth for the shareholders.

Despite its market cap of 200 billion USD, I expect Comcast to grow for years to come and outperform the market. I invest as a business-owner and my investment horizon is infinite, unless something makes me change my mind.

The Business:

Comcast has a very diverse revenue mix. From being solely a cable-TV operator in 1987, it has evolved into a conglomerate with a lot of different profitable businesses. Most of the businesses are somewhat related and can be used in cross-selling between the segments: Comcast is vertically integrated.

The business consists mainly of three parts – Cable, NBC and SKY – but is divided into six segments, perhaps a little messy:

  • Cable communications: high speed internet, video, voice, security and automation.
  • Cable Networks (NBC): Cable networks that provide entertainment, news, sports etc.
  • Broadcast Television (NBC): NBC and Telemundo plus local TV-stations.
  • Filmed Entertainment: Mainly Universal Pictures (NBC) and DreamWorks.
  • Theme Parks (NBC): Three entertainment parks in Orlando, Hollywood and Osaka, Japan. A fourth is under construction in Beijing, China.
  • Sky (acquired in 2018): A UK based media conglomerate that operates as a “Mini-Comcast” on its own, minus Theme Parks and Filmed Entertainment. Sky is best known for its live coverage of sport events (football/soccer).

The cable business is still the biggest segment both in terms of revenue and profits:

Comcast revenue and EBITDA among the segments. Source: Annual report 2019.

Today, approximately 45% of the homes in Comcast’s range subscribe to their broadband service. This is up from 35% in 2012.

The Industry:

The telecom industry does not have a high standing among customers. The most likely reason being the market resembles a monopoly/duopoly. Unlike most markets in Europe/EU, where the markets are strictly regulated, no US operator gets access to a competitor’s network. If an area has more than three operators, business will suffer and thus I believe there is a “gentleman’s agreement” to not build a network on the competitor’s turf. According to the ACSI, more than half of all Americans have only one choice for ISP.

The two maps below show the small overlap between Comcast and Charter Communications:

Comcast broadband coverage. Source: Annual report 2018.

Compare this to Charter Communications’ network (Charter serves 26 million residential customers and 2 million small and medium businesses, slightly less than Comcast):

Charter Communication’s broadband coverage. Source: Annual report 2018.

Is it likely that the US regulator opens up the networks like they have done in Europe and the EU? I believe this is unlikely because it’s “unamerican” and there are no precedents for this. This means the telecom business is a much better business in the US than in EU.

The theme park segment is likely to rise in importance in the coming years. A site in Beijing is under construction and expected to open in 2021, an expansion of Orlando is ongoing (Epic Universe – expected finished in 2023) and an expansion in Japan (Nintendo) opening in the summer of 2020 as part of the Olympic Games. It’s not unreasonable to expect a doubling of the revenue in about five to six years. However, the brand is less dominant as Disney’s: Disney is still much bigger than Universal with 157 vs 50 million visitors a year (2018 numbers).

Performance:

Since the start of 1993 Comcast has returned 13.3% annually. Over the last ten and five years CAGR was 21% and 11.1%:

Comcast’s share price and rolling five-year returns. Left axis is share price, logarithmic scale, and right axis is rolling five-year CAGR. Source: Yahoo!finance and my own calculations.

Comcast mentions AT&T, Disney, Verizon, Charter Communications, DISH Network, Centurylink, CBS and Viacom as their peers. In my opinion Disney and AT&T are the most relevant.

The graph below shows the relative performance since 1993 for some of these stocks:

Comcast vs. AT&T, S&P 500, Disney and Verizon. 10 000 invested at the beginning of 1993. Blue line is Comcast, yellow is SPY and light blue is Disney. Charter Communications has performed better than Comcast since 2009 (not included in the chart). Source: Yahoo!finance and my own calculations.

The reason for the outperformance is of course superb operational performance:

Comcast’s EPS history. 2017 is an outlier due to the tax reform. Red bars are adjusted earnings. Source: Annual reports.

About 12% of the revenue ends up as free cash flow, even though CAPEX is quite high at 13% of revenue. Worth noting is that CAPEX usually is a tad higher than depreciation, indicating a healthy investment to generate future revenue and earnings. (Depreciation can be used as a proxy for the cost of maintaining the business as status quo).

Management

Family-controlled and/or owner-managed companies have performed better than the main indices, something I have covered in this article.

Three keywords about Comcast is skin in the game, long-term orientation and the Roberts family. Ralph Roberts was the founder and CEO up until 1990 when he surprisingly handed over the leadership to his 30 year-old son, Brian. The second generation CEO has taken the company to a new level and completely transformed it successfully from a cable operator to a vertically integrated telecom/entertainment company. Brian Roberts knew broadband would be important (he bought AT&T Broadband in 2001), he knew content would be important (NBC Universal, 2009/2011/2013 and DreamWorks, 2016) and he realized theme parks have huge barriers to entry (Universal Studios). At the start of 2013 Comcast decided to buy the remaining 49% of NBC (accelerated by several years) because of their confidence in the business. This has turned out to be very smart as NBC has witnessed a huge increase in both turnover and profitability. Big acquisitions are difficult to implement, and most executives fail at this task, but Brian Roberts seems to excel. However, the jury is still out on the expensive Sky acquisition which had a 13x EBITDA multiple.

Worth mentioning is that Comcast tried to take over Disney in a hostile bid in 2004. The bid failed, but if Comcast succeeded it most likely would have turned out to be a fantastic acquisition.

By investing in Comcast you invest alongside a management team that up until now has an excellent track record in both daily operations and M&A. I think it’s fair to say that Comcast is a family run (and controlled) business, even though the direct ownership is small. Brian Roberts owns 35.6 million a-shares (0.77%), while all directors and executives own 1.1% of the a-shares in total. However, Brian Roberts owns 100% of the B-shares which gives him non-dilutable 33.3% voting power, in effect complete control of the company.  Worth noting is that a-shares (CMCSA) can’t vote in the election of directors or otherwise, except where required by law.

Capital Allocation:

The acquisition of Sky in 2018 increased the debt significantly (currently at 2.8x EBITDA and 1.2x shareholder’s equity) and management has made paying back debt a top priority and temporarily halted the buybacks which will resume later. This means paying the dividend was made a priority over buybacks, which I consider somewhat disappointing. There are three reasons for that:

  • I believe Comcast currently offers good value, thus making buybacks effective.
  • Buybacks are more flexible than dividends because an owner can decide if he wants to sell parts of his increased ownership (or not).
  • Buybacks are tax-free, while a dividend is not if held in a taxable account.

The dividend is currently at 0.92 per year, which equals 2% yield. The payout ratio is about 30% and we can expect dividend growth in the coming years.

Advantages:

Based on Comcast itself and the industry, I believe Comcast has some attractive features:

  • Near monopoly business in Cable Communications. Comcast’s internet connections work as a tollbooth business: Customers need it, and many have no other choice than Comcast.
  • To compete requires a lot of capital, which means Comcast is unlikely to lose their “monopoly” status.
  • Comcast’s and Disney’s theme parks account for all nine of the most visited theme parks in the US, and 15 of 16 globally. This makes them very hard to compete with, and both companies have synergies with their filmed entertainment segment. Theme parks have tremendous pricing power. Disney recently increased the entrance fee for their parks to about 200 USD. The entrance fee has risen way above the inflation rate since the 1950s.
  • Management has an outstanding record with acquisitions and internal growth.
  • In order for 5G to work, telecoms need support. Comcast and other providers with physical cable lines will provide this, and in many areas Comcast is the only provider.
  • Recurring income.

Valuation:

I suspect Comcast has a discount for being a “conglomerate”. For long-term owners this is good: you can buy more shares at fair valuations, and hopefully the board and the management resume buybacks soon. Forward PE for 2020 is below 15, which is way below the market, but slightly more than for example AT&T (but Comcast’s management is superior to AT&T).

This chart shows the trailing P/E over the last 15 years:

Comcast’s P/E ratio (TTM). Source: My own calculations.

Recession “proof”?

Comcast’s operations are pretty non-cyclical because TV and internet are one the last things people would cut-off, meaning the revenue and income is less likely to go down if we hit a recession. This is of course good, because the main reason for the outperformance of low-volatility stocks is the simple fact that they fall less in a downturn, thus recovering from a higher level than volatile stocks. Because of the compounding effect I like stocks which are as less cyclical, an attribute I think is very underrated among private investors. Furthermore, Comcast is now trading at multiples way lower than the market, and thus should give some kind of protection.

During the GFC in 2008/09 both the earnings and cashflow increased, but the share price still declined: A price of 10 in August 2008 was followed by a low if 5.6 in March 2009. The share price recovered quickly and in mid-2010 it almost touched 10 dollars again, a much faster recovery than S&P 500. Business has of course changed quite a bit since then, but I believe this is one of the better stocks to own in a recession.

Conclusion:

To summarize:

  • Monopoly market share in cable and theme parks.
  • Great owner-management.
  • Fair to cheap valuation.
  • Fairly recession proof.

I’m long.

(This article was published on 22nd of February 2020.)

Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.

 

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