One Cable Stock Worth Watching
By Howard Choe
This week's S&P Focus Stock of the Week is Comcast Corp. (CMCSK ), which carries S&P's highest investment ranking of Five STARS, or buy. As the third largest domestic cable operator, Comcast stands to benefit from not only a sector rotation into defensive sectors but also improving industry fundamentals.
Comcast has three principal business lines: cable, commerce and content. The cable communications business, which accounted for 51% of total revenues in 2000, develops and operates analog and broadband cable networks in the United States. Comcast's cable systems are located primarily on the East Coast and are one of the most clustered (concentration of cable TV viewers) in the U.S. Commerce (42%) is comprised of its subsidiary, QVC, Inc., an electronic retailer that markets a wide variety of products directly to consumers primarily on merchandise-focused television programs. Content (7%) is mainly provided through subsidiaries including Comcast-Spectacor, Comcast SportsNet and E! Entertainment Television, Inc.
Amid the volatility in the broader market and the faltering technology sector, cable stocks represent a safe haven for investors. While consumers tend to cut down their discretionary spending on large-ticket items, vacations, restaurants and luxury goods, outlays on cable TV is usually spared. Cable services offer a great value to consumers as the average monthly cable bill is below the cost of taking a family of four out to the movies twice in a month. Ironically, the growth in the cable industry is being fueled by greater use of technology in broadband services.
Over the past several years the industry has invested vast amounts of capital to upgrade its plant (cable wire/fiber) to accommodate the demands of broadband services, such as digital cable, high-speed data for Internet services, telephony, video-on-demand and interactive television. While video-on-demand and interactive television are in their infancy, digital cable and high-speed data has rolled out to consumers with tremendous success. S&P believes the industry added nearly five million digital cable subscribers in 2000, almost double the 2.6 million in 1999. High-speed data subscriber growth has been robust as well and we estimate that the subscriber count nearly tripled to 3.7 million in 2000. S&P expects 2001 digital cable and high-speed data subscriber growth of 60% and 90%, respectively.
Some investors are concerned about putting money in cable stocks as they often see losses on the income statement, which reflects high interest costs tied to debt loads taken on by cable companies to finance the large capital expenditures necessary to upgrade cable plant from analog to digital lines. Those investors may be comforted to know that cable companies generate solid cash flows and the debt burden will fall drastically as companies approach the completion of their plant upgrades over the next few years.
Meanwhile, the companies should be experiencing an acceleration in revenues and operating cash flows as demand for advanced digital services surges. From that point on, free cash flow growth should be significant and can be utilized for acquisitions, product/service enhancements, and share repurchases.
Standard & Poor's believes the recent U.S. Court of Appeals decision to strike down the FCC's rule restricting a cable operator's market size to 30% will spur consolidation in the industry. Comcast, the third-largest operator, with a strong balance sheet and strong cash flows should be acquisitive. Comcast has an industry leading debt/EBITDA ratio of 4.5 and should be able to raise capital with ease. S&P is also confident that with management's strong focus on return on invested capital (ROIC), the acquisitions will be strategic and accretive to earnings over both the mid and long term.
For the year ended December 31, 2000, Comcast's cable division revenues rose 9% on a pro-forma basis, driven mainly by new digital cable and high-speed subscribers. Comcast ended 2000 with close to 8.4 million subscribers, up from 8.1 million in 1999 on a pro forma basis. The number of digital cable subscribers has more than doubled since last year to 1,354,000 and high-speed Internet subscribers have increased 253% to 400,000. Cable revenues should climb nearly 10% in 2001, driven mainly by higher digital cable and high-speed data subscriptions as well as increased advertising revenue. S&P is projecting Comcast to add 750,000 digital subscribers in 2001, up 55% from 2000. In high-speed data, Comcast should at least double its subscriber count to 800,000.
Standard & Poor's believes an increasing level of band-intensive Internet content will drive the rapid migration to broadband services. Comcast recently formed Comcast Business Communications (CBC), which will market broadband services to small and medium-sized businesses in eight markets, including Philadelphia, Baltimore, and new Jersey. CBC also has a 62% ownership in Broadnet, a European broadband communications and data solutions provider. While CBC should contribute revenues of only $40 million to $50 million in 2001, we believe the division should enjoy solid growth over time as it exploits the favorable economics and features of cable service. We expect cable operating cash flow, defined as earnings before interest and depreciation and amortization (EBITDA) to grow 11% to $562 million.
Comcast owns 57% of QVC, a domestic and international electronic merchandise retailer that markets merchandise-focused television programs and operates an interactive shopping service, iQVC, on the Internet. QVC sells a variety of consumer products and accessories including jewelry, housewares, electronics, apparel and accessories, collectibles, toys and cosmetics. In the United States, QVC is transmitted live 24 hours a day, seven days a week, to 70 million cable television homes. In 2000, QVC revenues rose 12% to $3.5 billion driven mainly by strong sales by its domestic electronic retailing operations. Operating cash flows advanced 15% to $620 million, aided by improving gross margins and operating efficiencies. QVC revenues should grow between 12% and 13% in 2001, reflecting strong domestic and international growth. Operating cash flow growth should range between 13% and 14%.
WORTH THE PREMIUM.
Consolidated pro forma revenues should grow around 11% in 2001 driven by solid performances by the cable and QVC divisions. Operating cash flow (EBITDA) per share should increase to $3.14 in 2001, from $2.61 in 2000. Comcast was recently trading at 14X S&P's estimate of 2001 operating cash flow per share, representing a slight premium to its peers.
Standard & Poor's believes the shares should be trading at a higher premium to the company's peers due to Comcast's superior financial condition, operating strategies and top-flight management team. S&P's 12 month price target is $52 or 17X our 2001 EBITDA estimate, representing a potential 16% appreciation from current levels.
Choe is a cable industry analyst for Standard & Poor's