We Don't Expect Stellar Growth, but Comcast Should Churn Out Cash Flow

Director

Michael Hodel

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Cable Communications

NBCUniversal

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Comcast’s core cable business enjoys significant competitive advantages but will likely see growth slow as competition for incremental customers heats up. NBCUniversal isn’t as well positioned but holds unique assets, including core content franchises and theme parks, that should help ease the transition away from the traditional television business. Overall, we expect Comcast will deliver modest growth with strong cash flow for the foreseeable future. 

Comcast’s cable business has steadily gained broadband market share over its primary competitors, phone companies like AT&T and Verizon, as high-quality internet access has become a staple utility. We estimate the firm has increased broadband market share in the areas it serves to about 67% from 50% a decade prior, meaning Comcast’s customer base in the typical market area is twice the size of its rivals’. That gap is far larger in areas where the phone companies haven’t invested in recent years. With a network than can be upgraded at modest incremental cost, we expect Comcast will remain the dominant broadband provider in many parts of the country and compete well in areas where the phone companies are building fiber. The high margins on internet access should offset the decline in the traditional television business, where margins have plunged in recent years.

Comcast has managed NBCU well, more than doubling cash flow since the 2011 acquisition of the business through 2019, prior to the pandemic. However, the TV business is rapidly evolving, which presents challenges for NBCU as traditional cable revenue declines and the firm works to attract customers directly via the Peacock service. That effort has developed slowly, creating uncertainty around the long-term prospects for the business. However, we like that the firm is aggressively expanding its parks business, creating experiences that leverage and support key content franchises. Sky also adds distribution reach outside the U.S., though the core Sky business faces a tough competitive environment.

Business Strategy & Outlook

We believe Comcast possesses a wide moat, resulting from the strength of its core cable business. The majority of U.S. homes today can receive fixed-line internet access service from only two providers: the traditional cable or phone company. Across nearly half of the U.S., that cable company is Comcast. The cost to enter this market is enormous. While technological developments have made it possible to build more efficient and reliable networks than legacy providers possess, deploying these technologies still requires heavy construction spending, while also overcoming the regulatory hurdles that municipalities often impose. Assuming successful network construction, entrants then face steep customer acquisition costs and startup losses as they attempt to gain share, typically with a modestly differentiated product in a rapidly maturing market. Several firms have attempted to enter the fixed-line market over the years, but failures far outnumber successes. Most notably, Alphabet sharply curtailed its Google Fiber plans in 2016 after six years of effort and likely less than 1% of the U.S. connected, despite the firm’s deep pockets. 

Cable networks have provided a cost-effective platform for owners to steadily invest in upgrades to enable new service offerings. The costliest upgrade in the industry’s history, primarily undertaken in the late 1990s and early 2000s, involved the shift to a hybrid fiber-coax network architecture, a move that has paid handsome dividends since. This architecture, coupled with steady advances in technology, has enable Comcast and its cable peers to steadily add network capacity at modest incremental cost. For example, the firm deployed DOCSIS 3.1 technology across its network in 2017 and 2018, enabling gigabit speeds, without significantly increasing capital spending as a percentage of sales. 

By contrast, the phone companies are typically incapable of increasing network speeds broadly across their networks without heavy investment to bring fiber closer to customers. As a result, large swaths of the phone network remain incapable of delivering speeds beyond 20 megabits/second or so, increasingly falling short of customer demand. We estimate Comcast faces competition from Verizon’s Fios or AT&T’s U-verse networks across about 60% of its footprint. The high cost of Fios, a fiber-to-the-home network, has historically prevented Verizon from pricing the service aggressively, and the firm’s attention has primarily shifted to the wireless business. Verizon ceased heavily expanding Fios several years ago and sold off about 15% of the network to Frontier, a cash-strapped small phone company, in 2016. Under new leadership, AT&T started to invest in fiber expansion again in 2021, but its FTTH network only reaches about 22 million customer locations throughout its territory, only about one third of the total AT&T footprint. The firm recently curtailed its core fiber expansion initiative somewhat, though it formed a venture with BlackRock to build FTTH to 1.5 million new locations. In any event, Comcast will face only gradually increasing competition from fiber networks and large portions of its footprint will likely not see fiber for a decade or longer, if at all.

Comcast’s superior network position has enabled it to steadily take market share over the past decade. More than 55% of the households and businesses in its footprint subscribe to at least one service. Reported internet access penetration for the firm sits at 52%, up from 45% five years prior. We estimate the large phone companies like AT&T, Verizon, and Lumen have all seen penetration levels decline in aggregate over this period from about 27% to 23%, with wide variation depending on the level of investment individual firms have made. 

5G networks could eventually provide the capacity needed to compete with fixed-line internet access services on a wide scale. T-Mobile and Verizon have taken the lead in marketing fixed-wireless broadband service using the “midband” spectrum capacity that the industry is currently deploying. We’re skeptical fixed-wireless will take significant market share over the medium or longer term. We expect 5G and additional spectrum will provide incremental capacity to meet growing mobile wireless demands, but serving in-home needs is a challenge an order of magnitude larger. The typical wireless customer consumes around 5-10 GB of data on wireless networks per month while the typical fixed-line internet access subscriber uses several hundred GB. As consumers connect more devices in the home and stream higher-quality video content, we expect demand for superior capacity and reliability will only increase. At the same time, we doubt the wireless carriers will risk degrading the experience of their core smartphone customer bases. 

We expect Comcast will have a role to play in the wireless business over the longer term, but we’ve grown skeptical of its ability to build a widescale network on its own. The firm’s fiber network penetrates deeply into residential areas, providing an opportunity to either build a wireless network or partner closely with an existing carrier. But the firm holds only a tiny fraction of the spectrum licenses the three large carriers possess, and only T-Mobile doesn’t have a fixed-line network of its own. Comcast has begun offering wireless service to customers through an agreement with Verizon Wireless, signing up 5 million customers to date, but the long-term direction of this business is unclear to us. 

Comcast has leveraged its network advantage to enter the business services market, beginning with small businesses a decade ago and then steadily increasing the size and complexity of the customers it can serve. Comcast has invested about $12 billion of incremental capital into its network over the past 10 years to reach this market, creating a business that generates $10 billion in annual revenue and continues to grow at a mid-single-digit pace while delivering better margins than residential services. We expect Comcast will continue to edge out its network over the next few years to serve more and larger business customers in areas where competition is inferior, though the size of this opportunity will likely shrink as the phone companies expand their fiber offerings. 

While we believe Comcast has deeply entrenched competitive advantages in the cable, returns on capital in this business aren’t stellar. Of the firm’s roughly $210 billion of invested capital, we estimate about $100 billion is attributable to the cable segment. About 70% of this capital is in the form of goodwill and franchise rights, which given the nonexclusive nature of cable franchises, are functionally the same as goodwill. These assets reflect the fact that Comcast acquired, rather than built, most of its cable systems, including the 2002 purchase of AT&T Broadband, which nearly tripled the size of the company and accounts for more than half of these intangible assets. We estimate the cable business currently produces about a 10% return with all intangibles included in the capital base and about 40% without. We expect returns will trend upwards as the business grows. 

We don’t think NBCUniversal enjoys the same degree of competitive advantages that the core cable business does, and we don’t believe there are significant synergies between the two segments. But we still think NBCU as a stand-alone business warrants at least a narrow moat based on intangible assets. NBCU accounts for about $60 billion of Comcast’s invested capital base. The firm gained control of the business with two cash payments to General Electric totaling about $23 billion. Under Comcast’s ownership, the business has also invested about $15 billion to acquire theme park assets, real estate, and the DreamWorks Animation studio. We believe these moves, coupled with smart investment in the core business, have added value and enhanced NBCU’s competitive position. 

Comcast has modeled NBCU on Disney, in our view, investing heavily to create and bolster core content franchises, like Jurassic World and Despicable Me, while building multiple outlets to monetize and reinforce the popularity of this content. These outlets include theatrical distribution, a broadcast network that can reach nearly every household in the U.S., several cable entertainment networks, and theme parks, in addition to content distribution agreements with third parties around the globe. Comcast has also invested in its news and sports capabilities, including long-term Olympics and NFL rights. This real-time content solidifies its position in the traditional cable television bundle and provides increased optionality as television viewing habits evolve. 

Comcast has been slower than other media firms like Disney in reaching consumers directly. The firm's Peacock offering is taking a smart approach, in our view, leveraging the existing cable bundle ecosystem and Comcast's internet access customer base, but this effort has yet to generate significant revenue. The firm has disclosed that the service has about 20 million paying accounts in the U.S., far fewer than Netflix, Disney+, HBO Max, or Paramount+. NBCU expects to lose $3 billion on Peacock in 2023 after burning $2.5 billion in 2022, but we suspect the firm would be better served partnering with one of the larger platforms that has already built a large user base. 

The $50 billion Sky acquisition marks the latest iteration in Comcast’s business. Sky is the U.K.'s largest pay-television operator and a sizable player in Germany and Italy as well, claiming 23 million retail subscribers. While we aren’t fond of the long-term potential of satellite television distribution, the U.K. market has unique features that enhance Sky’s competitive position. Sky was early to build critical mass in the pay-TV market, enabling it to gain exclusive rights to premium content, notably the English Premier League. The firm was also early to recognize the need to own content production, building Sky News and an entertainment studio. Rolling Sky into the Comcast family promises to further enhance this content position, helping Sky cement its position with customers even as distribution methods change.

Wide

Economic Moat

Comcast

DreamWorks is an American film production label of Amblin Partners. It has produced or distributed more than ten films with box-office grosses of more than $100 million each.

DreamWorks

Fandango is an American ticketing company that sells movie tickets via their website as well as through their mobile app of which Comcast owns 70% of.

Fandango

NBCUniversal is an American multinational media conglomerate that is a subsidiary division of Comcast.

NBC Universal

FreeWheel is a technology platform for ad management and monetization, a private marketplace for premium television inventory, and advisory services.

FreeWheel

Comcast Corp. engages in the provision of video, Internet, and phone services. It operates through the following segments: Cable Communications, Media, Studios, Theme Parks, and Sky. The Cable Communications segment consists of Comcast Cable, which is a provider of broadband, video, voice, wireless, and other services to residential customers in the United States under the Xfinity brand. The Media segment consists of NBCUniversal’s television and streaming platforms, including national, regional, and international cable networks. The Studios segment focuses on NBCUniversal’s film and television studio production and distribution operations. The Theme Parks segment operates Universal theme parks in Orlando, Florida, Hollywood, California, Osaka, Japan, and Beijing, China. The Sky segment provides operations of Sky, one of Europe’s entertainment companies, which primarily includes a direct-to-consumer business, providing video, broadband, voice and wireless phone services, and a content business, operating entertainment networks, the Sky News broadcast network, and Sky Sports networks. The company was founded in 1963 and is headquartered in Philadelphia, PA.

Earnings data Q2 2023

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