Revisiting an old topic once again

It has been more than a year since I spent some time discussing analyzing and discussing the implications / impact of Telephone companies entering the cable tv arena with their fiber optic interenet and tv initiatives. Both Verizon and ATT consider this an important part of their strategy in the coming years as they can be a one stop shop for homes for all of the following services: mobile phone, long distance, local, cable tv, internet. Cable companies like Cox and Comcast are able to offer all of the above with the important exception of mobile phone. However, this may prove ironically to be the most important and impossible to acquire service at this point in the game.

Some important legislative developments in California and other states have been completed since the earlier discussion. If readers recall back in the good old days when Comcast or Cox wanted to offer cable television in a certain city they had to set up a meeting with the local government and sign a specific contract with that city. The contract had a set term and provided for both royalties and tax revenues for the local governments. This was a very costly and drawn out process. If Verizon and ATT were forced to endure the same process the barriers to entry would likely prove too large for them to get up and going in a state as large as California for many years.

So the Telecom companies decided to opt for an important shortcut. First they went to the FCC and requested specific legislation be enacted to grant them a Federal exemption to immediately offer service in any state they desired. When that measure failed they then began to approach each state directly. The largest state by population in the USA with more than 30 million people (California) recently approved a bill that effective January 1, 2007 will permit them to offer their cable services in any local city without going through the costly and time consuming negotiation process - cite - see SFGate article.

Now to the interesting business / accounting side of things. Comcast and Cox fought this legislation tooth and nail because their main competitive advantage was based on these formerly valuable "franchise rights" which they had acquired over so many years. In fact if we take a close look at the Comcast balance sheet we can see that it includes over $54 billion (thats right no typo) in "intangible assets." If we were to exclude these from the balance sheet Comcast would have a negative stockholders equity (accumulated deficit) of OVER $14 billion. Granted not ALL of the intangible assets have to be franchise rights (some could be other TV networks that were purchased or other internet related assets) - altthough any aquisitions would probably be included under the additional $14 BILLION in goodwill which is listed as an asset on the balance sheet. Here is a glance at the balance sheet:



This is getting brought up now because I noticed that Comcast common stock is up over 100% already this year to over $37 per share. See snapshot below:


So why else do I bring up apparently overvalued stocks? So that we can at some point in the game make money off of shorting them. I will bring this up later via the profit potential in some speculative LEAP PUT options (which happen to be ridiculously cheap).

Back to the analysis now - we need some sort of comparison. Who better than the leading competitor - ATT. ATT has also had some good price action this year - up more than 30% to $32+ per share. However unlike Comcast they appear to be in an admirable competitive as well as financial position.

Here are a few glances of ATT's financial position:


And a closer look at some important - balance sheet statistics of both:

ATT




Comcast


Now - based on the relatively low amounts of intangible assets on ATT's balance sheet I think that we can accept their book value and debt to equity ratios as reliable statistics. However, when we look at Comcast I think this book value number is grossly inflated and should probably be NEGATIVE. The debt to equity ratio would also be much higher - probably greater than 1! If we were to exclude the intangible assets.

Back to the point though - why are we looking so much at balance sheet and intangible assets - when the whole game is about earnings! Comcast has had good earnings growth and its PE multiple reflects that strength. The reason we are focusing on balance sheet is that the high PE which reflects a monopolistic market with high barriers to entry is going away and we can expect a lower PE more reflective of the coming price war.

If the value is going to get due only to PE compression (forget any earnings decline) then we have to ask ourselves about staying power? Which company can hold out and has the cash flow to beat the other ones. Both Verizon and ATT have their wireless businesses which are just dumping free cash flow into their hands - not to mention yellow pages businesses and local telephone business. They can use this strength to outspend and outperform Comcast and Cox which are heavily dependent on the cable TV as the core strength and driver of their earnings along with the internet.

To summarize:

Comcast advantages: Existing TV customer base (HUGE)
Comcast disadvantages: Leveraged balance sheet, removal of barriers to entry in main industry, no cellular phone service

ATT advantages: Superior TV/Internet technology (Fiberoptics), Mobile phone service, removals of barriers to entry in the tv industry, good balalance sheet and financial strength
ATT disadvantages: Few cable TV customers YET (a lot of other customers though)

Now that we have looked at some important fundamentals lets check out the PUT options on Comcast and see why the opportunity is so attractive.

If we look at the $45 2009 puts we can gain 5+ times leverage at a cost of less than 1%. This is unheard of for such longdated options and indicates a very low implied volatility level for these options.

I have not discussed timing yet - and I say might as well WAIT - do not jump the gun yet. Still this is an unfolding story that will be key to watch and presents some great paired trade options (Long VZ, ATT ; Short CMCSA, Cablevision, Charter)

I dont know what the end game will be yet - nobody does - but Comcast looks like a house of cards to me and would love to see some comments about what I am missing.

Best regards,

BG