We had the two largest Wireless companies and the two largest Cable companies report results this week with trends that were a little different between the two companies in each category and market reactions that were starkly different.
While some of the differences in operating trends were more surprising than others, and some of the difference in market reaction less welcome than others, the reactions aren’t that surprising in retrospect. We try and dissect what happened, and why, in this edition of the Global Weekly Review.
Starting with cable…
Comcast: Accelerating Broadband Growth; Expanding Margins
Comcast reported a great set of results on Thursday, with broadband accelerating even more than expected, margins expanding even more than expected, and both trends set to prevail for the next several quarters (see earnings notes on Comcast HERE and HERE and report on drivers of broadband growth HERE).
We don’t think the management team won many converts to the merits of buying Sky at the price they did, but they did do a solid job of differentiating Sky from similar assets, and they highlighted several areas that could produce higher growth for the company in coming years. They also made a case for expanding margins that, coupled with a little more growth, would result in a better FCF trajectory than investors had anticipated previously. It wouldn’t take much more growth for the transaction to be accretive to Comcast’s FCF per share (see our integrated model HERE and our report on the combined company and potential sources of upside HERE).
Most importantly, the Sky deal is behind us, and now investors can focus on the 90% of the business that matters most. With sustainable growth in Cable unlevered FCF of 10%, the Cable asset seems too cheap at less than 7x EBITDA. The consolidated business looks cheap too at just 11x FCF, with FCF per share set to grow close to 20% annually over the next five years (even with a two-year hiatus in share repurchases).
Charter: Still Finding its Way Home
Charter followed on Friday with results that simply weren’t as good as Comcast’s (sometimes it sucks to be second; see results HERE). It left investors questioning why they should pay so much of a premium for revenue and EBITDA growth that is pretty similar (and Comcast’s Cable EBITDA growth is substantially better). We would sympathize with this view if we thought that the current trends would continue for Charter.
The case for Charter hinges on broadband subscriber growth returning to historical levels, once they are through all the challenges of integrating TWC. Management made a strong case for why they expect subscriber growth to accelerate, and we think the case is plausible, though we understand the frustration of investors who justifiably thought the acceleration would be in full swing by now.
Broadband subscriber growth at legacy Charter was ~8.5% before the TWC acquisition. Market growth was a little higher back then, and AT&T hadn’t started deploying fiber to homes yet. Adjusted for these two factors, growth would be 6-7% if the business was performing comparably. That is deceptively far from the 5% we have seen for the last few quarters; it would require adds of 1.4 to 1.6MM vs the 1.1MM they are on track for this year; but they were growing at this pace on a smaller base with a worse product a couple of years ago. Broadband subscriber growth of 6-7% would drive EBITDA growth of 8-10%. If management can get there, you would want to own the stock.
So, can they get there? It is plausible that churn has been high while the company has been converting homes from analog to digital, integrating billing systems, and changing pricing. It is similarly plausible that it should trend lower once these processes are complete. Broadband growth has already started to accelerate, and it should continue to do so in successive quarters, we just need to see the pace of acceleration increase. That may only happen starting in 1Q19, when the integration is complete.
The market isn’t in a trusting mood at the moment, so the equity may not get much credit for accelerating growth until it shows up more materially in results in early 2019. For some, that may seem like a long wait. The most compelling reason not to wait is the possibility of M&A between now and then. The odds of a deal may be low; our thesis is based entirely on our view of the organic opportunity; but there is some value in an M&A option that may offset the cost of waiting.
Shifting to Wireless(1)…
Verizon: A Focused Wireless Company
Verizon reported a solid set of results on Tuesday with subscribers, revenue and EBITDA all beating expectations (we published two notes on Verizon on Tuesday HERE and HERE). Service revenue growth accelerated to 2.6% and wireless EBITDA accelerated to 7%, helped by cost cutting (both adjusted for accounting changes). There is a growing expectation that revenue growth may be sustainable, with a benign competitive environment that could improve further if Sprint and T-Mobile are permitted to combine.
Verizon closed at its highest price since the wild and crazy days before the dot-com-bust. At its close on Wednesday the multiple didn’t look challenging at 12.5x consensus earnings. That is close to a 20% discount to a market that doesn’t grow that much faster and offers half the yield. We have a slightly different view of Verizon’s future growth prospects, but we will get to that in a bit.
AT&T: The Very Model of a Modern Major Media Company Mess?
AT&T came second on Wednesday (see our earnings note on AT&T HERE), with results that we would characterize as “a dogs breakfast”(2). In wireless, revenue growth improved thanks to price hikes, but EBITDA failed to grow despite the same price hikes. Moreover, it isn’t clear to us that the price hikes are sustainable. They drove higher churn, that management hopes will subside, but we suspect T-Mobile will only increase the pressure in the fourth quarter while Charter will be attacking ~40% of AT&T’s base with a low-priced offer for the first time.
That was the good part. The entertainment segment is in rough shape, with hopes of stabilizing EBITDA in 2019 seeming increasingly implausible. Enterprise may never grow again. Warner Media looks fine, but it is unclear whether it will remain so under AT&T’s management(3). Some were hoping that either higher synergy guidance or creative merger accounting would lead to higher earnings estimates, but it didn’t happen this quarter.
We have no idea how to value this collection of businesses. The most sensible approach may be to just value it based on the dividend. Over the last ten years the dividend yield has averaged a ~300bps premium over the ten-year bond yield. That would imply a yield of 6.2% and a stock price of $33 (+13%). However, the business is in worse shape now than at any point over the last ten years, with consolidated revenue and EBITDA still declining, leverage at higher levels then ever, and a newly acquired media business that is far more economically sensitive than their legacy businesses. The yield spread has been as wide as 470bps, which would imply a dividend yield of 7.8% and a stock price of $26 (-10%).
Which Would We own As Wireless Gets Tougher
We think T-Mobile’s share gains are going to accelerate, and the next leg of growth is going to be much more painful for AT&T and Verizon (see our thoughts on the next leg of growth at T-Mobile HERE). AT&T will be particularly exposed following their recent price hike.
And then there is cable. We think Comcast will steadily increase net adds over the course of the next year, and Charter will be on an even more aggressive trajectory following their product launch in September. AT&T’s higher pricing leaves them more exposed to Cable too.
The wholesale traffic on Verizon’s network will offset much of the EBITDA pressure from retail share loss; however, AT&T has nowhere to hide. Verizon can’t be complacent about this set up; the Cable companies will look to move traffic off the MVNO and onto their own network as they acquire and deploy CBRS spectrum; however, that may still be a year or two away.
Both companies are inexpensive; however, with competition likely to increase after a lull that has allowed subscribers and revenue to recover, we would continue to avoid both. Verizon is exposed in that they could relinquish some of the expansion in multiples that they have enjoyed over the last six months (multiples have expanded specifically on easing in competition and the hope that it will endure). AT&T doesn’t have much multiple to lose, but their EBITDA is more exposed. If we were forced to choose between them we would choose Verizon, but we would really far rather own Comcast.
For the full weekly review and updated comp sheets, see HERE.