Comcast Purchase of Time Warner Looks Good

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Comcast’s (CMCSK) pending purchase of Time Warner Cable (TWC) improves upon an already positive story for CMCSK shares. Assuming approval effective 1/1/2015, analysts are estimating 5-10% accretion in free cash flow per share vs. Comcast continuing as a standalone entity. Accretion emanates from synergies in operating expenses and capital expenditures, estimated by management at $1.5 billion and $400 million once fully implemented over a 2 year period. Analysts are being a little more conservative in their forecasts assuming a three year implementation period. Management is not assuming any synergies on revenue. This strikes me as conservative, especially for the already rapidly growing business services at each company. With cable lines in 23 of the largest 25 markets in the U.S., the enlarged Comcast seems particularly well-positioned to accelerate focus and growth in business services.

My experience with Comcast management and large mergers generally is that management synergy estimates are usually conservative in terms of scope and time to achieve. Within the cable industry, synergies are relatively straightforward as the companies do not compete head-to-head so savings are mostly in overhead and scale purchasing economics.

Presently, combining the companies for 2014 and assuming no synergies, free cash flow per share is projected around $2.85 based on analyst estimates. With CMCSA/CMCSK shares trading at an average price of about $53 that puts the multiple around 18.5x and the free cash flow yield near 5.5%. Assuming a 1/1/15 deal close, analyst estimates (admittedly with a wide variation) show free cash flow growth of 16% in 2015, 20% in 2016, and 23% in 2017. Growth accelerates as synergies and share repurchases kick in.

Given this growth outlook, I think CMCSK shares can sustain their current free cash multiple, equating to a price target of $65 on 2015 estimates. This provides about 20% upside, plenty to justify owning CMCSK shares.

CMCSK shares traded a little lower on the deal announcement as arbitrageurs began positioning long TWC/short CMCSK. Given that I found CMCSK undervalued even before the merger announcement, I think downside is limited even if the government rejects the merger or imposes even stricter conditions than assumed. I think approval is likely with an extension of the consent decree CMCSK already operates under from its NBC Universal acquisition. The consent decree runs through 2017 and I would not be surprised to see it extended for a few years on the enlarged company.

CMCSK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. CMCSK and TWC are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Liberty Global Growth Set to Accelerate

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Liberty Global (LBTYK) reported its slowest quarterly growth of 2013 in the December quarter, with low single digit gains in revenue and operating income. The numbers were not a surprise as a difficult competitive environment in the UK and Netherlands and initial dis-synergies form the acquisition of Virgin Media in the UK held back results. With synergies at Virgin Media starting to kick in, Netherlands beginning to stabilize, and German, Belgium and Switzerland continuing to perform well, LBTYK appears poised for accelerating growth in 2014. In fact, management forecast exactly this on its quarterly conference call. This should set the stage for continued good performance for LBTYK (up 43.5% in 2013).

Free cash flow is the key measure for LBYTK and the company appears on track for rapid growth over the next three to five years as capital spending declines as a percent of revenue while core operations grow in the 5-7% range. LBTYK runs a levered equity capitalization strategy with debt at 5X operating cash flow (smart balance sheet management has cost of debt under 7% and 85% of debt due in 2017 and beyond). As long as the numbers come through, this works to the great advantage of shareholders. Excellent management, a long history of success, and basic stability of the cable TV and broadband business provide investors with great confidence in LBTYK. Free cash flow per show should surge over $10 in the next few years, easily enough to justify the shares comfortably over $100 as time goes by.

Beyond operational and financial risk, the biggest issue for investors in LBYTK is the company’s aggressive acquisition strategy. Management clearly sees the low interest environment as an ideal time to build scale and reinforce its competitive person throughout Western Europe. This has led to purchase of Virgin Media and the buying control of Ziggo, LBTYK’s larger cable peers in the Netherlands. Given difficult conditions in these two markets, I believe the acquisitions have added some caution into the LBTYK investment story. This strikes me as a buying opportunity but it will be important for 2014 to show improved results in both countries.

One other thing to keep an eye on is the possible spin-off or sale of LBTYK’s operations in Chile and Puerto Rico. Management has announced a spin-off is under consideration and has taken concrete steps in that direction. This type of transaction could create some hidden value for LBTYK shareholders, especially as Chile is now growing rapidly following a period of intense investment in its mobile operations.

LBTYK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. LBTYK is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Discovery Communications: Bottoming Out After a Rough Stretch

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Discovery Communications (DISCK) reported results roughly in line with Wall Street estimates and provided 2014 guidance just a little below expectations. Estimates for the December quarter and 2014 had been falling recently as DISCK’s leading U.S. networks, Discovery and TLC, had a rough patch of lower ratings. The stock has performed poorly during this period and traded off again after the earnings report. Encouragingly, the shares did not retreat to recent lows and bounced strongly the next day. Improved ratings accompanying new original programming so far in 2014 are a positive.

I think the worst is past for DISCK and with the expectations bar reset, the shares can again perform well. DISCK now trades at a modest premium to its peers on a P-E and price-to-EBITDA basis. Given the company’s well above average growth profile driven by its international exposure, low-cost model focused mostly on non-fiction programming, strong management, and steady share repurchases, I think the shares can trade toward $100 as 2014 progresses when investors find 2014 guidance was conservative and begin to look ahead to 2015 and EPS of at least $4.65.

In the December quarter, DISCK grew mid-single digits in the U.S., a slowdown from earlier in the year. Advertising only grew 4%, down from double digit gains, as ratings at the two leading networks were down more than 10% in the quarter. International growth continued briskly with advertising up over 20% and mid-teens growth in affiliate fees. DISCK not only grows fast abroad but has the highest proportion of revenue and operating profit earned internationally of any major media company. The company has double down on its international growth with acquisitions in Scandinavia and the Eurosport network. These acquisitions do add some risk and definitely complicate the analysis but management appears quite confident and the deals, while large compared to recent history, are mostly consistent with the company’s corporate strategy.

To reiterate, DISCK’s recent ratings and acquisition binge have pressured the shares but expectations appear reset and the company’s attractive competitive position globally and above long-term growth should get the stock moving again later this year.

DISCK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. DISCK is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

CBS Keeping Its Bullish Eye

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CBS reported another healthy quarter and provided reassuring commentary on the near-term and long-term outlook. Revenues grew 6% and segment level operating cash flow grew 7%, both ahead of expectations. Advertising at the CBS Network grew 4%, better than feared given concerns over ad demand and pricing that arose following the government shutdown. Management noted that current ad trends look good adjusting for tough comps (Super Bowl and more NCAA March Madness last year) and headwinds (Winter Olympics on NBC).

CBS also announced an accelerate share repurchase of $1.5 billion related to the pending spin-off of its Outdoor advertising business. The Outdoor division borrowed money which it upstream to CBS. In turn, CBS used virtually all of the proceeds to buy back stock immediately. Further reduction in the share base will come later this year when Outdoor completes an exchange offer with its former parent. In addition, the company remains committed to using free cash flow and appropriate debt leverage to buyback $2 billion in shares per year. While earnings per share is only measure upon which to value a stock, CBS capital allocation strategy led to a 22% boost in EPS in the latest quarter and plenty more where that came from lies ahead in the next few years.

Another bullish development was management raising and extending its guidance for retransmission fees. These are the fees that cable and satellite and telco companies pay to CBS for the right to carry the network on their multichannel TV services. CBS also gets a share of the retransmission fees that multichannel TV service providers pay to local affiliates of the network. CBS is now saying these fees, with virtually a 100% profit margin, will reach $2 billion in 2020 vs. prior guidance of $1 billion in 2017. One analyst calculated that retrains fees alone can drive 5% annual growth in operating profits through 2020.

With all this good news, CBS shares rose about 5% since reporting earnings, reaching a new all-time high. I think more upside remains as the multiple can still expand against the rapid earnings growth with CBS becoming a less cyclical company – headed to 50% advertising/50% subscription and content. I think earnings are headed north of $4.00 in 2015. A high-teens multiple, in line with peers, would put the stock in the mid to upper $70s. That is 20% upside, enough to continue holding the shares.

CBS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. CBS is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Disney All Good with More to Come

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Disney (DIS) reported better than expected first quarter results with all divisions except ABC performing ahead of Wall Street estimates. EPS of $1.04 exceeded street consensus of 91 cents with over half the beat coming from operating factors. DIS faces a few quarters of tougher comparisons and slower growth but investor sentiment should stay very positive as focus shifts to FY15 and FY16 when a strong lineup of films and the opening of Shanghai Disneyland should accelerate growth. DIS should earn over $4.00 this year, rising toward $5.50 in 2016. I think the shares can reach $90 by yearend based on 20x 2015 estimated EPS of $4.60. This would put DIS at a small premium to its peer group and the market but given operating momentum and an underleveraged balance sheet and accelerated share repurchase program, a premium multiple is warranted.

In its latest quarter, DIS reported 7% revenue growth and 27% operating income growth. Good news all over led by (1) EPSN advertising growth of 10%, (2) theme park margins, and (3) initial benefits from the massive success of Frozen. Consumer products were helped by Frozen and the long lagging and money losing Interactive unit finally is reporting good profits following the successful introduction of the Infinity game. The only poor performing unit is ABC where poor ratings are pressuring advertising growth.
Looking ahead, Disney will open the Shanghai theme park in 2015 and have new movie releases from the Avengers and Star Wars franchise and a new Pixar film after a year off. ESPN faces a pickup in sports rights fees in the second half of calendar 2014 but once those reset, operating income should benefit as the major new contracts signed last year with most of the top cable and satellite companies allow affiliate fees to grow in the high single digits.

The next few quarters are unlikely to show the upside surprise witnessed in the latest quarter but the positive sentiment off the latest quarter should carry the company given the big potential in 2015 and 2016. It is rare to find big blue chip stocks with above average growth potential and accelerating operating momentum. DIS is well loved by investors and seems like a perfect core holding in a still sluggish US and global economy.

DIS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. DIS is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Another Good Quarter Builds Bull Case for Google

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Google (GOOG) reported another good quarter. Please note I am defining “good” as satisfactory to investors. GOOG went through a roughly six quarter stretch in 2012 and early 2013 where despite showing sustained 20% plus growth, investors were concerned. These last two quarters have addressed the concerns and GOOG shares have moved up sharply to all-time highs. Northlake’s investment thesis on GOOG is that the shares offered a lot of value given steady 20% growth. The divestiture of Motorola’s handset business, two quarters accelerating growth in paid clicks (searches), and better expense management leave the bullish investment thesis very much intact. I think the shares can trade to at least $1,300 this year based on 20X 2015 earnings estimates plus some benefit for the $150 cash balance. There are very few large cap stocks with substantial revenue bases that can grow 20% a year. GOOG should continue to be rewarded for its unique growth and value profile.

In the latest quarter, GOOG core revenues grew 22% and margins showed stability. Core results exclude Motorola. GOOG appears to be handling the transition the mobile search well, while also getting more than its share of display ads through YouTube. Paid clicks grew 31%. If you believe as I do that mobile ad pricing will eventually improve then paid click growth is the single most important indicator for GOOG’s future financial results. Mobile searches today bring in less revenue and the mix shift toward mobile means GOOG’s realized ad prices are still falling but as long as GOOG remains dominant search market share and mobile growth continues, when mobile pricing improves the company will be able to sustain its growth profile.

The last two quarters seem to be convincing investors that the mobile transition is going to be good for GOOG without a major hiccup as the mix shifts from desktop to mobile. With Motorola no longer a worry, the bull case for sustained double digit growth is even stronger. GOOG represents an excellent core holding for patient investors…and that includes Northlake Capital Management.

GOOG is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. GOOG is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Models Unchanged for February: Still Like Mid Cap and Value

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There were no changes to the signals from Northlake’s Market Cap and Style models for February. The Market Cap model continues to favor mid cap and the Style model still recommends value. With no changes to the signals for this month, Northlake client positions in the S&P 400 Mid Cap (MDY) and Russell 1000 Value (IWD) will be held for at least another month.

Underlying movement in each model was modest. The Market Cap model remains on a somewhat weak mid cap signal. It is a little stronger this month as the advisory service sentiment indicator shifted toward large cap. This occurred because bullish sentiment reversed slightly from extreme levels. A reversal from extremes often indicates a shift in market momentum. In this case, coming off very bullish levels is a bearish signal, so the advisory service indicator shifted to less volatile large caps.

The value signal on the Style model strengthened this month as the U.S. dollar indicator shifted to value. The dollar has strengthened vs. most currencies over the past month due to turmoil in emerging markets. Value stocks are less sensitive to dollar movements than growth stocks as growth stocks are more reliant on overseas growth and thus get hurt when the dollar strengthens in terms of competitiveness and currency translation.

During January, the models put in a decent performance. Mid cap was a good call as MDY fell just over 2% while the S&P 500 fell over 3%. Value/IWD did slightly worse than growth last month but performed in line with the S&P 500.

MDY and IWD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov.