Comcast’s happy divorce has future partners waiting in the wings

Mature couples are the fastest rising divorce demographic in the US. This paradigm finds an echo in US cable & media conglomerate Comcast which has finally decided to split into two separately listed cable and media entities. The cause is not dissimilar to what is driving many mature couples to cut the knot: they just don’t have that much in common anymore. When Comcast & NBC Universal got together back in 2011, Comcast was a video distribution business with 52% of revenue derived from video subscriptions and only 23% from broadband. Today, video is down 20 percentage points to 32% of cable revenue whilst broadband and the new mobile business now account for 37% of revenues. When we consider the arguably more important metrics of EBITDA and free cash flow, video’s share has fallen even further based on the much richer gross margins on broadband compared to video which is encumbered by rising content costs. It was those content costs that drove the original decision to get together. Comcast saw the opportunity to not only hedge itself from content cost inflation but also get involved in content valuation upside. Hence, as the business mix shifted from video to data connectivity (fixed cable or wireless mobile), the logic to stay together gradually dissipated and divorce has now become an option.

However, there was probably also another driver: both parties could see better partners out there. Once unshackled they would be free to start a new life and enjoy all the related benefits of either playing the field or settling down with a new partner.

In Comcast cable’s case, it is operating in an increasingly mature and competitive market with fibre, fixed wireless (“FWA”) and now satellite broadband nibbling away at cable’s once dominant share. The other major cable operator Charter Communication shares this pain as a mature market leader. A merger would offer the combined entity significant cost synergies but without the baggage and political approval headache of owning a media business. From a pure regulatory perspective, we would expect the deal to not be problematic. Comcast was blocked in the past from acquiring Time Warner Cable (eventually acquired by Charter) but that was when fibre, FWA and satellite were nascent or not even imagined as viable technologies.

Looking at the racier media business, Comcast’s NBC Universal is a kind of “mini Disney” with strength in theme parks, movies and sports content. However, sitting under the overall Comcast umbrella it is part of an entity trading at only 5x EV/EBITDA whilst Disney trades at around 10x and Warner Bros. is being bought for almost 13x by Paramount. Galled to be valued at so lowly a multiple compared to peers enjoying materially higher valuations, Media will be able to show off its attractions and free to take their pick of a new partner.

For credit investors, this is a big issue. Comcast is a major IG issuer with US$95 billion debt outstanding. Charter straddles the IG and HY indexes with a massive US$85bn IG and US$27bn HY debt pro forma the pending acquisition of another cable business, Cox Communications.

Looking at the initial Comcast split, the lion’s share of debt should remain with the dominant cash generative cable unit. The credit rating agencies have already put Comcast’s A Stable ratings on Credit Watch Negative which implies ratings cut(s) to come. However, it is not a disaster. Although the cable unit will assume the debt it will also benefit from pre close cash hoarding (buyback suspended), a one off material dividend from the media unit, and the proceeds from the sale of 20% of the media unit equity (given as a sort of reverse dowry). It’s therefore not beyond the realms of the possible for Comcast to maintain leverage in the mid 2x area and hence probably secure high BBB ratings despite the agencies’ increasingly sceptical view of the cable sector.

Looking beyond the initial split, a subsequent tie up with Charter would be a monster transaction with a potential debt load of around US$200bn. Despite this, it is feasible based on PF leverage in the mid to low 3x area (much is acquisition structure dependent) aided by material synergies and FCF hoarding prior to deal close. If we combine that with a firm deleveraging commitment driven by strong cash flow that should positively inflect with an expected capex step down from 2027, it is conceivable for the combined entity to achieve mid BBB ratings.

And what of media? Its life post split will likely be more colourful with a variety of possible dance partners and roles as acquiror or acquiree. However, Comcast indicated a desire for “strong investment grade” balance sheets for both entities post split which implies mid BBB at worst with a commensurately low debt load at media based on its limited FCF. Although it might seek to consolidate smaller assets, media is a scale game and we suspect it might attract the interest of larger, better capitalised players that typically reside in the single A rating category. This bodes well for any debt that remains with media or any new media issuance. A happy ending after all.