Comcast Sky “Entente Cordiale” masterstroke against Brexit backdrop

There is loud applause circulating financial circles for the move that Comcast put on Disney this week – bidding to buy out Sky from under its nose, while Disney tries to push through an agreed purchase of most of 21st Century Fox, including its 39% of Sky in Europe.

The fact that the other 61% of Sky is held by public shareholders means it is entirely possible, even without 21st Century Fox agreeing to offload a single share, for the Comcast bid to be successful and deny Disney the head start that it so dearly wanted for is 2019 bid to chase Netflix around the globe with a European wide distributor for its own international SVoD.

It is one thing to think this is a surprising and shrewd move by the Comcast management team, it is quite another to pull it off and there is a long way to go in this deal. Let’s first talk about why and the real reasons for this offer.

The deal is a 16% premium to the bid that has already been agreed by the Sky board to sell to 21st Century Fox. That deal has been at least temporarily blocked by the UK Culture Secretary, being referred to the Competition and Markets Authority which says it is not in the public’s interest.

Everyone in media knows there is little substance to the claims that the Murdoch family yields too much influence in UK media and the telecom regulator Ofcom cleared the deal. But the Competition and Markets Authority, in a parody of US politics, where it seems the elected leader of the day can overrule time tested precedent and get their way, and the CMA blocked the deal, offering up the remedy of spinning off Sky News before it might let it go through. Sky then promptly agreed to making Sky news independent but now UK politicians seem to want their cake and eat it and have Sky News continue to be “well-funded” by Sky despite it having to be made independent.

You have to have lived in the UK for the past 30 years to understand the anger, and disgust politicians who were once in the Murdoch pocket, now have for the family.

Regulators and government will get out of the way immediately if either Disney buys Fox and the 39% it owns of Sky, if it subsequently bids for the remaining 61%, or if Comcast wins the day. This is because with those organizations it is not personal.

There are other considerations. Comcast is the most hated brand in the US. Investors may not want to hold Sky shares while Comcast plays fast and loose with its customer care and customer bullying tactics. And of course the family dynasty at Comcast is the same kind of dynasty as the Murdochs, in that the Roberts family has run it for 40 years. Oh it is true that Brian Roberts has barely interfered with US politics, never mind that of the UK, but that family dynasty remains.

But the other part of this equation is purely financial. Disney has bid for the majority of Fox assets in the US and wanted to include the 39% and management control of Sky in that deal. This is because it wishes to take over control, and its management has none of the family dynastic issues around the Murdoch family, even less so than the Roberts family. The Disney family has long been ousted from control.

It would then have gone on to acquire the 61% of Sky it did not own. It may well have sweetened this bid, perhaps by as much as 16% extra over the current bid. If you are Robert Iger the current CEO of Disney, you prefer that Fox swings the Sky deal at its current price, before Disney buys Fox, and it simply inherits it in the single deal.

This is the brilliance of the move – by bidding now Comcast harms Disney one way or the other. Disney, with ABC, rivals NBC Universal as a studio and also as one of the four US national broadcasters. If you add Fox to that equation Disney may well eclipse NBC. Roberts does not want Disney getting its hands on a means of European-wide distribution. Either Sky investors wait for the Fox deal to go through and see if Disney counter bids, which at least raises the price, or Disney is entirely denied the prize. Seen like that it is apparent that Comcast would be insane NOT to bid for sky.

If truth be known, Comcast is much closer in nature, culture and shape to Liberty Global, and on the surface it would come at a similar price to Sky. It is similarly competitive to Sky and sits in more European markets, has bought somewhat into content, and offers broadband. Sky is in 5 markets (if you include Austria and Ireland) running an established satellite TV offering and in only one does it have a broadband offering, the UK. In Spain and Switzerland it has launched an OTT service and it has committed to introducing one to replace its DTH markets.

We know that DTH satellite is on the way down in many parts of the world for a variety of reasons. In the US Dish has placed its bet on becoming an OTT player. It is growing OTT in a market where Net Neutrality is not assured. It could find itself blocked with its OTT offering at any point, given the current political trajectory the FCC is on. Direct TV is owned by the second largest US broadband player in AT&T and is headed down the same track as Sky, with delivery of OTT video over broadband eventually becoming its main TV business.

In places around the world where wired infrastructure is weak, such as India, and even to some extent China where broadband lines carry not nearly so much data, Direct To Home DTH satellite remains a good bet for TV delivery. Africa is another fine example. But in markets which have 50% plus homes connected to wired broadband well over 20 Mbps or have the prospect of a future 5G wireless connection, the majority of video will be delivered over the internet within 5 or 6 years. In that time frame buying Sky may be a bad bet. But this is very different from buying a DTH supplier in a market which has no net neutrality protection – which at least Europe has.

If Sky was shifting to this OTT model in the US market it would need to be owned by a strong broadband carrier. In Europe it can get away with going OTT. But the OTT video market in Europe is exploding and Sky will face more and more competition. What will happen for instance to content like Game of Thrones if Sky becomes owned by Comcast, and Time Warner which owns HBO which produces Game of Thrones, becomes owned by Comcast’s main US rival AT&T? Does it lose that franchise? Almost certainly and how many subscribers with it?

Comcast would much rather own Liberty Global which almost exclusively uses cable infrastructure which is exactly the same as Comcast “in the ground” assets. It can strike out for strong broadband, which is not falling in price, but rising slightly, and de-emphasize video through partnering with OTT video players like Netflix, which is likely to fall in price.

Let’s look at the deal price. Sky has an EBITDA which is roughly £2 billion ($2.76) billion. And its market capitalization prior to the bid was £18.4 billion ($25.4 billion). It has now gone up to the bid price (£23.17 billion net of debt or £32 billion with debt added on) – showing how eager UK investors are to do this deal with Comcast.

Liberty Global has been sliding from its peak in January, falling around 20% to its market capital of $25.5 billion. It is far cheaper today than the price of Sky. The reason that Comcast is not bidding for Liberty Global is because John Malone, the biggest name in global media, owns control of Liberty Global and sits as its chairman. A bid by Comcast would be immediately rebuffed and Malone has the cash to defend his assets if need be. And yet rumors are rife that Liberty Global is in discussion for asset sales across Europe and Liberty Global Austria has already changed hands. He wants to sell, but not to a sworn enemy.

Malone seems to want to cash in low growth subsidiaries in Europe and push the money into high growth Latin American markets. Why not sell out to Comcast? Well there is bad blood between Roberts and Malone – in that Malone sold his broadband empire to AT&T some years ago, and failed to buy it back, being outbid by Roberts in a bold move that doubled the size of the business. This is why Malone has acted as the shadowy hand behind the rise and rise of Charter, steering it through a bidding war with Comcast, which he eventually won, to acquire Time Warner Cable and Bright House networks. He is a 25% shareholder there.

But while we do not think this acquisition is in the interests of either the shareholders of Sky, who might get so much more, nor the customers of Sky or its European public, who deserve better customer care, we cannot see how the deal can be derailed. UK politicians will be delighted at the “non-Murdoch” nature of the owner and will almost certainly ignore any protestations about Comcast’s history of poor customer service.

The Sky board is duty bound to recommend the offer, and although it may seek to delay its acceptance, and hope for the Disney cavalry to arrive, there are so few obstacles in a regulatory sense that the Comcast deal will happen way before the Disney deal. Disney will find it hard to mount a counter bid, given that it has to wait to find out if it owns the Fox 39% of Sky before it does so. Bidding for all of Sky at a higher price, given it already has a deal on the table that would net it 39% and management control, would make little sense at all. But Disney may well end up reaching the conclusion that it has to. Of course it could just go into the market and anchor 12% of the stock, which it can later add to the 39% it holds. Except that under takeover law that might be frowned upon.

Combining ABC in the US with Fox TV stations in the US will be enough of a tough act for US regulators to swallow, as this takes national broadcasters down from four to three including the independent CBS. It is also a major concentration of power of cable channels, large enough to threaten the stability of NBC and CBS, both so far losing out less in the latest ranking wars than the other two.

Questions from US analysts on the announcement call focused on mundane aspects such as debt leverage and whether or not it was buying Sky on the cheap (yes it is). But the idea that Comcast will accept as little as 50% plus one share as sufficient for it to take over, makes this deal easy to do. If the sentiment of the UK stock market continues as it has so far, Comcast will find itself with a full 61% and then can strong arm any relationship it wants with Disney once it inherits that 39% after its deal goes through for the Fox channels. This deal may even be enough to derail that deal, and of course that may be the point.

Comcast management promised continued investment in creative industries in the UK, support for news impartiality and the promise of further investment, and at a time when UK politicians are obsessed with Brexit, this will be seen as a US-UK “Entente Cordiale” to show two fingers to the Eurocrats of Brussels, instead of the granting of US sovereignty over the bulk of the UK pay TV market at a massive discount. Comcast’s track record in sticking to its word is pretty unimpressive too.

After the deal, Comcast for its part, will be trying at home and abroad to fight OTT video with all its might, and this is reminiscent of one of its suppliers Arris, which acquired both Motorola and Pace as a time when they were 2nd and 1st in the global set top market, so that 3 years on it could “de-emphasize” set tops, as it did at its last result conference. Comcast will buy Sky for its TV customer relationships and will be duty bound instead to focus de-emphasizing pay TV while growing broadband and mobile telephony, in a company that has almost no access to either.

Spare a thought too for the convergence of equipment vendors that supply Comcast and Sky – some will be identical, but companies like AirTies which built the WiFi which is such a strong part of the Sky Q set top box, failed to reach terms with Comcast, who instead elevated local US firm Plume to build a similar WiFi mesh technology. Comcast will almost certainly end up owning Plume, and by then it could insist that its technology makes an appearance in the successor to Sky Q. And remember that Sky makes many of its own set top boxes, and that could knock a big hole in Arris’ Comcast revenue, if it becomes at some point a certified X1 supplier.

After the Comcast announcement 21st Century Fox said it remains committed to its recommended cash offer for Sky announced on 15th December 2016 and added that it notes that, “no firm offer has been made by Comcast at this point. A further statement will be made if appropriate.”