Comcast Reality Ahead of Fears

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Comcast (CMCSA) reported an inline quarter with upside in the closely watched video and broadband subscriber metrics.  Consolidated revenues grew 4% and adjusted EBITDA was flat after taking into account $171mm in employee bonuses related to tax reform.  The cable business grew revenues 3% and adjusted EBITDA 4% as margins expanded. NBC Universal had 4% revenue growth and 6% EBITDA growth.

Comcast raised the dividend by 20% and announced another share buyback of “at least $5 billion” after repurchasing $5 billion CMCSA shares in 2017.  Other guidance commentary for 2018 was positive with cable margins expected to expand by up to 50 basis points and capital spending intensity in the cable business expected to fall.

CMCSA shares continue to be a battle between the bull case of modest growth in financial measures and the bear case of increased competition for video and broadband subscribers.  Our favorite analyst of the cable sector, Craig Moffett of MoffettNathanson Research put it well:

“By now the litany of worries that has kept investors on the sidelines should be familiar to everyone.  Video subscribership is being hammered by cord cutting.  Video margins are being squeezed by vMVPDs.  Broadband industry growth is hitting a wall.  AT&T is expanding its fiber footprint.  Verizon is deploying 5G wireless.  Cables growth phase must be over.

Against this bleak narrative, it may come as a surprise that Comcast’s Fourth Quarter video subscriber losses were better than expected (just a little over 1/10th of 1% in the quarter), broadband subscriber growth was also better than expected, and consolidated revenue growth was healthy 4.2% for the quarter and 5.1% for the year.”

The key to the bull case on Comcast is the balance sheet.  The company guided its long-term leverage ratio of net debt to EBITDA to the current level of 2.2X.  This is among the lowest in the media and communications industry and is a real strength for the investment case given secular headwinds.  This target also strongly suggests that the “at least” part of the buyback announcement is conservative.  Free cash flow should be north of $10 billion again and the new buyback and dividend will only consume about $8.5 billion.  EBITDA growth will add another $3 billion of free capital against the 2.2X leverage target. Looking out several years, Comcast should have annual excess free cash flow of $10 billion.

On the call, management said its balance sheet was of “strategic value.”  We interpret this to mean that the company may be looking to participate in the wave of consolidation underway in the media industry.  We know Comcast was a player for the Fox assets being purchased by Disney.  Discovery Communications and Scripps Interactive are merging.  CBS and Viacom merger discussion may be back on.  AT&T is trying to buy Time Warner.  T-Mobile and Sprint came close to merging and may try again.

We strongly suspect that Comcast is awaiting the outcome of government review of all these mergers, especially the upcoming court case between the DOJ and AT&T.  Once it is clear what can pass antitrust review, Comcast will deploy its strategic value.  Importantly, whether that is done through acquisitions or additional share buybacks, it is accretive to the value of CMCSA shares.

Northlake concludes that the bull-bear battle rages on but the shares are worth holding as the valuation on a free cash flow basis outweighs the long-term growth concerns that we believe are worse than the current reality.

CMCSA 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’s regulatory filings can be found at www.sec.gov.  CMCSA is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Shifting Away from Small Caps to Begin 2018

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Northlake’s Market Cap model shifted from small cap to mid cap to start 2018.  The Style model still recommends growth although the underlying indicators shifted strongly toward value.  The new mid cap signal shifts the Style model from small cap growth to large growth since the Style model will only be in small cap mode if the Market Cap model is as well.  The new signals led to the following trades:  (1) sell the Russell 2000 (IWM) and reinvest in the S&P 400 Mid Cap (MDY), and (2) sell the Russell 2000 Growth (IWO) and buy the Russell 1000 Growth (IWF).

The Market Cap model saw two internal and one external indicator shift from small cap to large cap.  This was enough to move the overall model form small cap to mid cap.  There is not too much to read into the latest movements.  Most significantly, there remains a split between the internal and external indicators with the internals favoring small caps and the externals favoring large caps.  Whether another step change occurs to large cap will be dependent on the relative performance of small cap stocks over the next few months given the trend and technical internal indicators.

The Style model moved sharply in favor of value for January.  The single month reading actually is in value territory but the model works off two month averages in order to reduce signal volatility and smooth the data.  Remember that the models are attempting to capture long-term trends in market themes not month-to-month volatility.

The changes in favor of value were in both internal and external indicators.  External indicators now favor value as they pick up improving economic data.  Several internal indicators also moved toward value as investors are playing the beneficiaries of better GDP growth through more cyclical value stocks.

The latest signals did not work out that well on a relative basis as small caps lagged the gain in large caps over the last few months of the year.  Both models produced nicely positive returns as they did get a nice boost from the broad gains in the stock market.  One benefit of Northlake’s strategy is that a majority of client funds invested in stocks are in index-based ETFs allowing even less accurate signals to participate in market upside.

MDY and IWF 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.  Northlake’s regulatory filings can be found at www.sec.gov.  IWM is used as a hedging vehicle in the Entermedia Fund.  Entermedia is along/short equity hedge fund managed and controlled by Steve Birenberg