Strategic Overhang Sinks Comcast Following Strong Quarter

“Comcast reporting a quarter that looked on the face of it pretty good. But as you might expect, a lot of investors still waiting. There is what they call “a strategic overhang” when it comes to Comcast and its future. That is the deal that I’ve been talking about for NBC Universal, which we’ll get to at the end of this report.

But as for the numbers, you see it their earnings per share, not bad. They increase subscriber ads across every category except basic video. But we’ve seen that. Cablevision yesterday, basic video subs losing them. That’s sort of a story at cable. But Comcast will say, hey, we’re losing the number at a slower rate than we were losing them last quarter. EPS, up to 33 cents or 27%, generated $1.1 billion in free cash flow…” — CNBC’s Squawk on the Street 11/4/2009

Comcast (CMCSA) reported earnings on Wednesday morning that were quite strong financially speaking. The stock was up following the earnings release but that did not last long, and in afternoon trading the stock is down more than 2% on the day. The reason for the sell off is what the pundit on CNBC this morning described as strategic overhang as investors await more concrete details on the fate of the deal for NBC Universal. Management refused to discuss the negotiations which have been widely reported and even went so far as to call the talks “rumors”. Clearly, CEO Brian Roberts and his team hoped to separate the past quarter’s good results from the potential of this deal.

From the report, Comcast gained a total of 1.067 million revenue-generating units in the quarter, which was better than most analysts had expected. Broadband Internet and digital voice both were the sources of gains, while basic video subscribers fell at an improved rate than the past few quarters. In addition, the average monthly billing per customer rose to $116.91 from $110.67 a year ago. In sum, revenue grew by 3% to $8.5 billion just under the analysts estimates of $8.55. Net income rose by 22.5% to $944 million or 33 cents per share. Excluding items the cable giant brought in 28 cents per share or three cents better than expected.

For us, the free cash flow was the most impressive fundamental improvement of the report. Comcast tallied $1.112 billion in free cash flow for the quarter, up nearly 20%. This was enabled in part by cuts to capital spending by 6%. However, many investors fear that a deal to buy a majority stake in NBCU would eat away a lot of this cash and possibly their ability to generate it as rapidly in the future. Surely some investors would like to see Comcast continue to grow organically rather than take the risks associated with NBCU.

If you discount the possibility of the deal for NBCU, we think that Comcast stock is extremely attractively priced. In fact, our methodology has a Greatly Undervalued rating on the stock because we evaluate stocks based on standard reported metrics such as price-to-cash earnings, price-to-sales, dividends, ROE, etc and by any of our measures Comcast is attractive. Management at Comcast must agree that their stock is too cheap as they bought back $250 million in shares in the quarter, and $3.6 billion more has been set aside for further share repurchases. For a long term investor who believes that the market is overreacting to the possible NBCU acquisition, this stock should be right in the sweet spot. With the negotiations with NBCU parent General Electric (GE) likely in the final stages, a deal or lack thereof will be known in the next few weeks.

Strategic Overhang Sinks Comcast Following Strong Quarter

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