Morgan Stanley Upgrades Comcast

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Morgan Stanley, which was early, aggressive, and correct with a bearish outlook for cable stocks upgraded its industry outlook yesterday to attractive. Comcast was raised from a sell to a buy. Here is a summary from the morning notes on Comcast: “We base our upgrade on three factors. First, concerns over a maturing product set have shifted to fears of an all-out price war, which we believe is unlikely, and multiples have compressed to historical lows. Second, consensus has moved to our camp of higher capital spending related to competing on high-def with satellite, and we see lower risk of capex misses going forward. Finally, voice share gains, HD/DVR deployments, and increasing data speeds should all help support 15-20% normalized EPS/FCF growth – compelling growth at this historical low multiple.”
Morgan’s upgrade is consistent with my post from yesterday: fundamentals for cable are actually pretty good with double upper single digit to low double digit revenue and EBITDA growth and a probable resumption of free cash flow growth in 2008….

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December 2007 Model Signals

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There were no changes to Northlake’s Market Cap and Style models for December. The signals remain on large cap and growth. As a result, client portfolios continue to own the S&P 500 (SPY) and the Russell 1000 Growth (IWD).
It looks like we could get a move in the Market Cap signal fairly soon, however. The model reading is on the very cusp of switching to a mid cap signal. If that occurs, positions in SPY will be sold in favor of the S&P 400 Mid Cap (MDY). For December five of the ten indicators in the model favor large cap and five favor small cap, a shift of two indicators in favor of small caps. Falling rates and widening yield spreads led to shifts this month. Lower rates definitely favor small caps which presumably have less access to capital. The credit crisis has widened spreads enough that they are now in a mode where in the past small caps have outperformed. These two indicators join bearish market sentiment, the steepening yield curve, and low consumer confidence in the camp favoring small caps. As a reminder, small caps often perform best when sentiment and the economy look worse. The model attempts to look ahead toward the next big move and when things look bleak the next big move is often up which creates an environment where the added volatility of small caps works in favor of investors.
The Style model, on the other hand, looks unlikely to make a shift away from growth any time soon. The model is still firmly in growth mode reflecting sluggish economic growth where unit growth stories are more valuable to investors. For December, two of the underlying indicators moved from value to growth mode: measure of relative strength for consumer stocks and the return of the yield curve to a normal upward sloping shape.
I find the current model signals consistent with my own views of how to invest in a weakening economy. My big worry about the current signals is that a countertrend rally in favor of small caps and value (financials are a big component of value indices) seems overdue.

I Was Wrong On Comcast

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I enjoyed going on TV with my buddy Cody Willard. Unfortunately, since I debated Comcast with Cody and took the bull side, I’ll probably never get invited back!
Not much I can say at this point other than admit the bullish stance I took in July when the stock was $27 was wrong. Nevertheless, I still think that the penalty the stock is paying is far worse than the reality of the company’s fundamentals.
However, revenue and EBITDA growth are decelerating and, at least for 2007, free cash flow is down. Competition is rising, and cable bills are more sensitive to the economy than was previously thought. Against this backdrop, investor sentiment toward cable is not likely to improve. As a result, I don’t expect much of a recovery in the shares even though I see them as oversold.
What will it take to for the shares to make a meaningful comeback? The first step is decent guidance for 2008. Management needs to guide revenue growth to at least 9%-10% with margin expansion pushing EBITDA growth to 11%-12%. More importantly, capital spending must be no worse than flat with the new elevated 2007 level. The most devastating part of company’s new guidance is that they brought down the number of revenue generating units they will install (an RGU is a subscription to video, broadband or telephony) in 2007 while increasing capital spending. Comcast had assured us that as growth gradually slowed, capital spending would stabilize or fall, thus providing a big boost to free cash flow….

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