Moving Past the M&A Malaise

The next couple of weeks should mark a turning point for US Cable.  We are hoping the Comcast / Sky deal will close before Comcast reports results on Thursday.  If it hasn’t closed by Thursday, it will be very soon after.   As soon as it has closed we would expect Comcast’s management to provide a more fulsome account of their ambitions with Sky, with updated guidance.

We published a detailed report on what Comcast would look like with Sky last week (LINK).  On our current estimates, the deal is modestly dilutive.  We clipped $2 off our price target to reflect the dilution.  We think management anticipates higher growth than we do, and we touch on some of the potential sources of that growth in the report.  If management makes a strong case for the value they see from the deal, we may be adding the relinquished $2 back next week, but if not, we aren’t too fussed.  There is still more than 35% upside to our $49 price target as is.

The most important part of closing the book on the Sky deal, is that it should allow investors to refocus on the 90% of the business that really matters, and most specifically on US Cable, where we think the trends are really compelling.  We are expecting broadband net adds to be higher year-over-year for the second quarter in a row.  3Q17 shouldn’t be too tough a mark to beat; it was the quarter where broadband adds faltered for the group; but we think Comcast is on track to do more than beat a weak quarter.  We think they will get close to 1.2MM residential broadband net adds for the year, which is close to as good as they have ever reported.

We think we will see a similar trend at Charter, who reports on Friday.  For Charter this will be the first quarter that they report accelerating net adds since they missed the mark a year ago.  As with Comcast, we think Charter will do more than best a lackluster comp.  Broadband growth is accelerating for the US Cable companies, and it has some ways to go.

We explored the sources of the recovery in broadband subscriber growth in a report over the summer (LINK).  We highlighted two major contributors: first, a slow-down in wireless substitution, and; second, slowing growth at AT&T in their new fiber markets.   Importantly, these are ongoing trends; the recovery in growth should continue for a while.  We would add to that a third, which is the efforts of Comcast and Charter to respond to new competition and, more generally, to refocus the business around broadband.

Charter may soon add a fifth source of growth for their broadband business.  Since early September, they have been pushing their wireless product.  It will offer significant savings to most households, without those households having to compromise on service quality.  Charter is hoping to use cheaper wireless, coupled with an entry-level broadband product to go after the 20% of households that don’t have a fixed broadband connection today.

Margins are the other metric to watch this quarter.  We expect margin expansion at Comcast and Charter, driven in large part by the high incremental margins that come with higher broadband growth.  We should see margins expand at ATUS too, although this will more likely come from price increases than from subscriber growth.

For much of the last year, as growth in the core business has faltered, the market has focused doggedly on threats to the Cable business (both real and imagined).  Sentiment has been overwhelmingly negative, and this has been reflected in the abysmal performance of the group this year so far.  With a recovery in broadband growth, and with the overhang from unpopular deals passing, we would expect sentiment to improve.  It should be a good time to own Cable stocks again.

For the full weekly review and updated comp sheets, see HERE.