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November 04, 2005

Comcast: Disappointing Quarter Delays Potential Upside

Elements of Comcast's 3Q05 earnings report are disappointing and they are elements that will matter to the Street. While top line revenue growth and EBITDA growth closely tracked Street estimates, rising 10% and 14%, respectively, a loss of 37,000 basic subscribers in a seasonally strong quarter and higher than expected capital spending, and thus lower free cash flow, will be the key takeaways from the quarter. These facts caused Comcast to decline more than 5% yesterday....

Comcast lowered its 2005 corporate EBITDA growth rate guidance but that is due to the NHL contract at OLN and should not be of concern to analysts. There is no change to revenue or EBITDA at the cable division, which represents over 90% of corporate revenue. However, Comcast did raise its capital spending guidance for 2005 by $200-300 million which leads to a reduction in corporate free cash flow growth guidance from 35% to 30%. Higher capital spending is attributed to greater than expected spending for the Comcast Digital Voice (CDV) telephony initiative which is about to ramp up and higher take rates for high end set top boxes. Management notes that 80% of current capital spending is success based and variable so they are not as concerned about the increased spending as the Street will be. Comcast wants to add customers to its new services including high speed data, digital TV, DVR's, high definition TV, and CDV. Management is comfortable it can continue double digit EBITDA growth based on these services even if basic video subscribers are not growing or declining very slightly.

Unfortunately, this quarter will serve to feed the bear case on Comcast. Bears will say that double digit growth is sure to slow if basic subscribers stagnate or decline and that as the RBOCs start to offer video, basic sub declines may accelerate and growth in news services will slow. It is hard to argue with this thesis other than for the company to continue to kick out double digit growth quarter after quarter. I think that will occur, especially since Comcast is matching growth at Cablevision and Time Warner Cable without the churn reduction and growth benefits of VOIP telephony. In 4Q, Comcast guidance calls for the addition of over 200,000 VOIP subs in the CDV initiative. I think that will be a positive catalyst for shares that are awfully cheap at less than 7 times 2006 estimated EBITDA. Free cash flow of $2.5 to $3 billion a year and underleveraged balance are also ongoing positives to a bullish investment thesis for Comcast.

I would not be a seller on this morning's weakness but I suspect that a significant rebound or attainment of my low to mid-$30s target is not going to happen within the next few weeks.

Posted by Steve Birenberg at November 4, 2005 09:02 AM in Comcast/Cable TV