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The Success Story Wall Street Ignores

Comcast has everything going for it, except its stock price 8/29/2004 08:00:00 PM Eastern

On the first Monday in August, at 5:15 a.m., Stephen Burke, president of Comcast Cable, began his day the way he always does—sipping a cup of coffee, ripping through two newspapers and scanning the news on the Internet.

The Monthly Comcast Bill Is In
Here's what the average Comcast subscriber now pays monthly compared to other major cable operators, and what investment firm Morgan Stanley thinks the bill will be next year. (Both are estimates.)
2004E 2005E CHANGE
Source: Morgan Stanley
Comcast $59.76 $63.36 6.0%
Cablevision $64.39 $65.98 2.5%
Charter $56.71 $58.97 4.0%
Cox $58.02 $61.31 5.7%
Insight $54.71 $57.98 6.0%
Time Warner $59.45 $61.38 3.2%
DirecTV $68.04 $71.35 4.9%
EchoStar $53.56 $55.94 4.4%
Total $55.66 $58.80 5.6%
The Comcast Universe
Asset Ownership Est. value (in millions except per share)
Source: Morgan Stanley
Core cable systems 100% $83,826.0
Comcast Spectacor 66.30% $612.2
E! Entertainment Network 60.50% $2,128.4
Outdoor Life Network 100% $548.3
The Golf Channel 92% $1,067.3
Other system investments $7,763.5
Other investments $3,921.1
Total asset value $91,589.4
Net debt $21,036.5
Total equity value $74,474.0
Equity value per share $32.67

Just before lacing up his Nikes and heading out at 6 a.m. for his usual six-mile run in the suburbs northwest of Philadelphia, Burke called Brian Roberts, Comcast Corp.'s chairman and CEO, on his cell phone. He wanted to alert him to a piece of breaking news on the Internet: The Cox-Kennedy family intended to take Cox Communications, the nation's third-largest cable company, private. And it was prepared to pay a premium of some 15% over the share price at the time, spending nearly $8 billion in all.

When they connected on the phone early that morning, Burke and Roberts "agreed that there can't be anything but positive news from this [Cox proposal] for Comcast," Burke recalls. "It's a tremendous sign of faith in the business—a family that's been around the cable industry for decades basically saying that their valuation is higher by 15% than where the market is. That's got to be a great thing."

But the stock market didn't think so, and that lack of enthusiasm is similar to Comcast's plight. It's had a plethora of positive news, a decline in capital expenditures and the rise of free cash flow—and for all of that Comcast's shares have lost nearly one-fifth of their value since early this year. Its biggest gaffe was its clumsy and failed $54 billion attempt to acquire The Walt Disney Co., which left shareholders unimpressed.

Burke recalls that, after the Cox announcement, "You read in The New York Times, 'Cox must be going private because the industry's so competitive now that they need to make investments that public shareholders might not like.' Almost no matter what [news about cable] comes out, people put a negative spin on it. I think it's just one of those times when that's the funk that everybody's in."

Bigger and better

Like the children and grandchildren of Cox's founder, who were behind the bid to take their company private, Comcast's two leaders were born into the business. Roberts is the son of Ralph Roberts, Comcast's founder. Burke, recently named the new chief operating officer of Comcast Corp., is the son of Daniel Burke, the well-regarded former CEO of Capital Cities/ABC before it was acquired by Disney.

In many ways, these should be Comcast's—and cable's—glory days. The industry is completing a decade of physical-plant upgrades, designed to phase out old-fashioned signal amplifiers and analog-only technology. The installation of optical fiber, digital transmission and two-way Internet protocol (IP) broadband technology came with an industry-wide price tag of about $85 billion, but the rebuild allows cable to offer the new products, tiers and entrepreneurial possibilities that it dreamt about for more than a decade.

Comcast, formerly the third-biggest multiple-system operator (MSO), became the largest in late 2002, when it more than doubled its subscriber base with the purchase of AT&T Broadband in a $47.5 billion deal.

The company led the cable industry through the rebuild years, and it's among the first to deploy cable modems and digital TV. Now, Comcast is in a position to set the agenda for technical standards, programming and program-renewals for the entire industry.

And this year, Comcast reached the long-awaited Promised Land of free cash flow, which is expected to hit $2 billion this year and reach above $3 billion in 2005. Comcast's most recent quarterly report, issued in late July, painted a glowing picture of rosy prospects and corporate health, with quarterly operating results that John Alchin, co-chief financial officer, executive vice president and treasurer, couldn't help but call "terrific."

The company earned $262 million in the second quarter, compared to a loss of $22 million for the same period a year ago, on revenues of $5.1 billion, up 10.2%. It added 1.1 million digital subscribers, far exceeding the 96,000 subscribers who churned out in the quarter.

Advertising revenues, a cornerstone of Comcast's future prospects, were up 15% percent in the first half, compared to the same period last year. The company's margins are on track to hit 40% in the next few months, well ahead of its own projections. In fact, the company already has "achieved most of the goals" it set at the time of the AT&T acquisition, according to Alchin.

All that good news came after 2003, when the company "met every single one of the financial guidance metrics that we put out to the Street," Alchin says. In that same year, Comcast brought its customer services in-house and ramped up its capabilities significantly, opening 10 new call centers and investing some $90 million in customer services, says Suzanne Keenan, Comcast's senior vice president of customer services.

The DirecTV challenge

Comcast's own rebuild is about 98% complete. As a result, Alchin says, its capital expenditure profile will be down dramatically for 2004. Unfinished rebuild projects in Chicago, Miami and the Bay Area will be completed within six months, according to Burke.

Several analysts blame the weak showing of many cable stocks on the Adelphia scandal, which rocked the industry. Roberts is sure that the cable industry's biggest task ahead is to win back Wall Street's confidence. If any company in the industry is well positioned to earn that trust, it should be Comcast. The company has a massive national footprint and is steered by a senior executive staff of youthful entrepreneurs who are well-regarded and fiscally prudent.

For one thing, Wall Street analysts tend to evaluate the cable industry as a whole. Not all MSOs have reported upbeat quarterly news. Cablevision, for example, posted a loss of $187 million in the most recent quarter, almost $30 million more than in the same quarter last year.

For another, there is the gathering strength of the competition, the direct broadcastsatellite (DBS) providers and regional telephone companies that in some cases have cut prices and joined forces to battle cable for prized "high value" subscribers on the digital frontier. And with Rupert Murdoch recently taking the reins of DirecTV, the biggest satellite provider of all, competition is likely to heat up, with both price and tech wars looming ahead.

That Disney deal

Comcast's approximately $22 billion in debt is still massive, though it's significantly down from the $34.8 billion in debt on its ledgers at the end of 2002.

And finally, there is that failed Disney deal.

When Comcast's unsolicited offer to acquire the Magic Kingdom was rebuffed, Comcast didn't up the ante; it simply walked away. That drop-dead move was hailed by some on Wall Street, including Jessica Reif Cohen, Merrill Lynch's influential analyst, who saw it as a reaffirmation of the cable giant's fiscal discipline.

Others, however, saw the bid as a token of what could be Comcast's biggest weakness in the years ahead—a relative lack of content ownership.

Roberts "should have persevered in his pursuit of Disney and made a more convincing case to his own shareholders that it was crucial to Comcast's long-term prospects," says Steven Cohen, principal and chief investment officer for Kellner DiLeo Cohen & Co., a hedge fund that owns Disney stock. Cohen even complained about it in a letter to The New York Times.

According to Burke, however, Comcast's Disney offer came at the invitation of a current Disney board member, whom he declined to name. Furthermore, he says, it never occurred to Comcast's senior executives that the Disney offer would be interpreted by Wall Street as a sign that Comcast itself had lost faith in its own core business.

The company has more than 21.5 million cable customers in 35 states, and it reaches 22 of the top-25 TV markets. Its content businesses include networks G4techTV, E! Entertainment Television, Style Network, The Golf Channel, Outdoor Life Network, TV One and Comcast SportsNet.

It's expected to add new networks, beginning with a children's network, in the weeks and months ahead. Big-league sports assets include the Philadelphia Flyers hockey team and the Philadelphia 76ers basketball team.

Not surprisingly, the Television Bureau of Advertising (TVB), the local broadcasting industry's trade organization, points to the failed Disney deal when it makes its anti-cable case, citing it as an example of broadcasting's "importance" to the future of cable.

Angling for content

But the Disney deal would have been about more than just broadcast. Acquiring Disney would have instantly given Comcast a broad-based Viacom-like profile, adding not just the ABC network and a broadcast-stations group to its portfolio. That would have been the least of it. Comcast would have ESPN, its offspring and a major film studio, as well, and the result would have had seismic implications for video-on-demand (VOD), the technological application on which cable has placed such a massive bet.

Comcast's Burke tells the story of going into Mel Karmazin's office approximately 18 months ago, when the combative and plain-spoken Karmazin was Viacom's chief operating officer. Burke proposed that CBS News and other Viacom programming be included on Comcast VOD. After a 45-minute presentation, Karmazin's joking reply, according to Burke, was: " 'Here's what I wanna do. I wanna put my head on the table and I wanna close my eyes, and when I open my eyes I want you out of the office.'"

If Comcast had succeeded in acquiring Disney, there already would have been a pay-per-view premiere of a first-run Disney theatrical movie. Furthermore, Comcast wanted to take a lot of the ABC schedule and make it available on-demand, Burke says.

"Yes, they are being punished by Wall Street," Merrill Lynch's Reif Cohen says of Comcast, "because there's a perception they went to Disney because they believe that their base business isn't growing. I don't agree with that. I think that if you look at the financials, in one year they're going to be under-leveraged, significantly under-leveraged."

Comcast's already massive subscriber base will grow, but it won't need to acquire bankrupt Adelphia assets or another cable system. Through the no-cost expedience of "unwinding" its existing partnerships with Time Warner Cable, Insight, Adelphia and others, Comcast will add almost 2 million subscribers to its rolls over the next few years.

Programming costs are presently Comcast's biggest single expenditure. However, the rate of increase is trending down since the AT&T acquisition made economies of scale possible, to around 5% this year (and under 4% for the second quarter) from up to 15% around the time of the deal.

In the wake of the failed Disney bid, Comcast is expected to focus on either creating or buying its own content, beginning with a new children's channel that is expected to include programming licensed from Disney.

As for the company's past and future, Burke says, "There's a disconnect between the [vision] that we see so clearly inside the company and what Wall Street sees. For whatever reason right now, the world is very negative about cable. These cycles happen in industries, and it's happening to us right now."

Disgruntled customers

Why are cable subscribers so negative? Because of competition from the direct broadcast satellite (DBS) business and the regional telephone companies.

Cable has been losing customers to satellite now for a decade. With the small Ku-band home-satellite dish entering its second decade as a consumer option, there are now some 23.5 million households in the U.S. that receive TV via satellite, according to the Satellite Broadcasting and Communications Association (SBCA).

According to the SBCA, the four biggest factors cited by consumers who chose satellite over cable were, in descending order: more channels, lower prices, better picture and sound, and dissatisfaction with cable's customer service. Of those who signed on to satellite in the past year, 53% switched from so-called "standard" cable, and 9% switched from digital cable.

"Our friends in cable are beginning to acknowledge that DBS is emerging as a viable competitor," says Richard DalBello, president of the SBCA. "To take on the challenge of DBS, they now tout new upgrades like digital cable and DVR capabilities. Satellite has led in both categories since our inception."

Because of satellite's inroads, penetration for what the TVB calls "wired cable" fell from 67.9% to 66.9% over the past year. The last time wired cable was that low was in March 1995, according to the organization's less-than-rosy analysis of Nielsen data.

In response, Comcast's executives maintain that satellite growth doesn't really matter to their future prospects, though they readily concede that DBS spurred cable's own digital transition. And they point out that the desirable (and lucrative) digital subscribers tend to stay with cable.

Moreover, they say the future belongs to cable because only cable can deliver all the high-tech digital bells and whistles that will lure upscale subscribers and provide them with a digital nirvana—namely, convergence. Competition is intense, and it's going to intensify, says Roberts. "It's going to push companies like Comcast to do better."

One of the ways that Comcast intends to do better is to find broadband's elusive "killer application," which might turn out to be video instant messaging. Another is to provide all three of its major products (TV, high-speed Internet and IP telephone service) through a single pipe—something that Burke contends that neither satellite nor telephone companies can match.

The cable business will change more in the next five years than it has in the previous 30, Burke says. As for competition: "Our viewpoint is bring it on," he says. "We're ready."


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