Just when executives think that everything in the world is rosy, analysts find the black holes that leave those same executives living on sleepless nights, and such is the case with Comcast.
Six years ago the company completed its historic $47 billion purchase of AT&T Broadband, which itself had been bought two years previous in the form of TCI Communications, the leading US cable operator. That move rocketed Comcast to the number one spot in the US, and the world, in terms of cable subscriber numbers. Since then it has had a simple business formula. It has not acquired customers (except around 3 million through the purchase of around half of Adelphia), it has not repaid debt, instead its strategy has been to transition to a totally digital network, offer more services, and take a bigger percentage of the spending in each home on pay TV, broadband and telephony first and later on music, HD and games, adding what cable parlance describes as RGUs, without hardly adding any new homes.
RGUs are Revenue Generating Units or customer contracts, so a home which takes TV, Broadband and telephony counts for three RGUs and although this is positive, right now, Comcast is shrinking slightly in the number of homes it takes revenue from, under competitive pressure, currently over 24 million of them.
In real terms that AT&T deal was made up of $22 billion through share dilution and cash plus taking on of a huge chunk of debt around $25 billion, which today has actually grown and is around $30 billion. Comcast doesn’t repay this debt, but recycles it, using its cash instead to buy back shares and keep shareholders waiting around for a payout.
We’re not sure why analysts for the past six years have thought it was okay for a company to have more debt than revenue. We have always thought this positions any company as a soft target. If another company competes head on, and drives the average market price down for services, and if that reduces revenues by 5% or 10%, then that company can no longer both service debt AND generate enough cash to spend, as Comcast plans, $8.2 billion on share buybacks, which it has just announced.
So when this quarter’s results came in with revenues up by 11% (to $7.8 billion) comparing like for like around the Adelphia additions, and the company was boasting RGUs up to 56 million for the first time ever, but forgot to highlight the fact that the rate of acquiring them had gone down, analysts have started to ask what is left for Comcast to achieve with its current network footprint. They have also started to ask just how little effort from a freshly aggressive AT&T it might take to eliminate all growth at Comcast.
Recently Verizon has released figures on broadband pricing falls in every market it enters, from its rival cable operators. If that self same process happens in every market, which Comcast alluded to in its investment call, then as AT&T enters with U-Verse, or worse, if AT&T does go ahead and acquire EchoStar’s Dish network and integrates it into a US wide quad play franchise, then Comcast will have to discount to continue acquiring RGUs, by approximately the price difference in between the two, some 15% to 20% for broadband. That would slash its growth horribly.
The top line was that Comcast earnings fell sharply, but that masked the fact that it made some gains over the Adelphia deal, selling some of the units to Time Warner Cable to even out their holdings, plus some investment gains, when it was cutting the Adelphia deal last year. Compare like with like and the company’s net income is merely static, rather than appearing to halve.
The really big news in the Comcast numbers are the 662,000 Comcast Digital Voice customers that the company added during the quarter, bringing its VoIP customers up to 3.8 million homes with annualized revenues around $2 billion up from a $1 billion run rate the previous year. This is the only part of Comcast that is genuinely growing at breakneck speed, and if it is stopped dead in its tracks it might well be enough to take Comcast ex-growth right away. Meanwhile the shift to digital TV is still happening with 490,000 homes shifting to the slightly more expensive digital cable from analog during the quarter, taking penetration of digital to 60% of the total. High speed internet lines are also still being accumulated at a pace, with 450,000 being added in the quarter taking the total to 12.9 million, now around 1 million less than AT&T.
But all the while some basic cable subscribers are opting out entirely and the video numbers fall slightly each quarter, and if pricing is squeezed on broadband (as it already is by DSL) and flat rate VoIP offerings are made by AT&T and others to stem the tide of Digital Voice, and with AT&T up to 10,000 new U-Verse subs a week (130,000 a quarter) working alongside the hybrid Homezone service which uses EchoStar’s DISH network, that could begin to eat into all of the high growth numbers at Comcast. It’s not the number of people that subscribe to AT&T services that are the issue. If one person in one town takes AT&T’s U-Verse service, and Comcast responds by slashing prices, it makes a big hole in Comcast revenues from the region because all new customers will soon pick up the trick of mentioning that they were considering AT&T.
AT&T (and of course Verizon) can also push bundles based on these service and also on cellular offers, perhaps for an entire family, which will force Comcast and the other cable operator’s hands in offering Pivot (the Sprint partnership with the major cable operators). If Pivot has to be discounted in bundles, then there will be little point in offering it at all.
The nightmare scenario for all of the US cable operators isn’t only that AT&T may buy one of the DTH suppliers, but that the two large remaining RBOCS ‘ AT&T and Verizon, may buy BOTH of the remaining DTH operators ‘ with Verizon adding DirecTV to its offerings (assuming a well disposed John Malone at Liberty Media) in response to AT&T acquiring EchoStar’s DISH.
That would give both RBOCs a sandwich video offering DTH priced below and IPTV priced above, digital cable, with more HDTV and a transition between the two, bypassing cable. The deals would happen in the near term and a quad play fight back could be on the ground being offered to customers by the middle of next year.
For now the weak financial performance, at a time when Comcast should be making hay, was enough to alert the US financial community to danger, and the stock fell from a valuation of $74 billion this week, to around $64 billion. But come the announcement of any purchase of DTH suppliers and you might expect it to go lower still.