Project 2: Case Study of One Firm: Comcast Corporation

CMCSA

A Fundamental Investor’s

Analysis of The Past, Present &

Future:

By:

Introduction/Background

Comcast Corporation, originally American Cable Systems, was founded in

Tupelo, Mississippi in 1963. The company began as a single service cable provider and

grew to become one of the leading US firms in the industry of Cable television systems

(specifically the consumer sector). The company also ranks fairly high in the

telecommunications, broadcasting and box office ticket sales industry. Today the

company serves over 47 million customers including video, high-speed internet and

Comcast digital voice customers. The company now provides a wide rage of product and

consumer services including Comcast Business Class, Programming Group, and Comcast

Spectator. However, their main focus has consistently centered on delivering high

quality programming content and the development, organization and running of multiple

cable networks.

During the first 10 years or so, American Cable Systems grew at a relatively

modest pace. Eventually, the company changed the name to Comcast Corporation in

1969 and incorporated in Pennsylvania. By 1972 the company was ready to go public

and made its first public offering on the NASDAQ Stock Market. From there, the

company began to follow an aggressive investment strategy that not only expanded its

current business but enabled it to enter into numerous new business lines. The first major

investment was in 1986, when the company doubled its size with the acquisition of 26%

of Group W Cable. After that, the company went on acquire and invest in companies

such as: QVC, American Cellular Network Corporation (AMCELL), The Golf Channel,

Greater Philadelphia Cablevision, Home Team Sports (now merged with Comcast Sports

Net), AT&T Broadband, and more recently PBS, a joint venture with GE, and the E

networks. Today the company is the largest cable and home internet service provider in

the US. (the information presented in this section is from Ref. 1 and 2 listed in the

Reference section that is included at the end of this report).

Understanding The Business

A typical mistake of the novel investor is that he/she doesn’t take the time to gain

a true understanding of the business. Although important, a mere historical summary is

far to abstract, if not outdated, to make a strong connection to the current market

statistics. At the same time, trying to look over too many pieces of information can make

your analysis extremely time consuming, complicated, and expensive if seeking outside

assistance (specializing in that industry). Some investors try to take the easy way out by

trusting that the market has done the work for them (passive), while others guess widely

based off of a gut feeling they have about a company (intuitive). The problem with

taking the easy way out; is the risk of paying too much for growth that doesn’t add value.

Even if the investor happens to make a good investment, the results cannot be duplicated

without knowing why or how the company got there. As a fundamental investor, I can

decrease my risk of paying too much and avoid information overkill by limiting my focus

to the major factors that affect this company and the industry in general. I summarized

these points in a S.W.O.T analysis (see Table 1 in the Appendix).

Behind The Numbers—Reviewing The Financial Statements

The financial statements tell a story about value; the story of how the business

added or removed value, and how it has changed over a period of time. Unfortunately,

the statements do not tell the whole story. Luckily, I was able to fill in some of the gaps

for Comcast’s story by using my understanding of the business discussed above. The

current financial statements represent the middle of the story; they only tell where the

company is now. Present financial conditions affect only the investors and shareholders

who were already invested in Comcast at the time. For managers, new investors, and

those with a continuing interest (current shareholders/debtholders), their primary concern

is what the future financial performance and market position will be. The problem is that

we have no way of knowing with exact precision what the future will bring. The

solutions: form our own opinion, or estimates, about the future outcome, or follow the

opinion of one of the other market participants, if not the market.

The current stock market price is determined by the supply and demand that exists

within the market. That price is a reflection of the current market’s opinion of the

company. That opinion is based on a wide range of public and even private information;

some of which is directly related to the company (earnings, growth potential, etc.), while

others relate to the systematic risk that is outside of the company’s control. As

mentioned earlier, the problem with price is that it does not always represent value. Part

of that value is revealed in the current financial statements. To extract that value, I

continued on to step two in the process of fundamental analysis: analyzing the

information. I began my analysis by making a simple time series using the company’s

annual report for the prior four years (including management’s notes) and the FASB

Template. Included in that template were a number of other financial analysis tools that I

found to be extremely helpful. The information I analyzed from the trend, common size,

and ratio analysis, told me how the company had performed in the past and what

direction this company was heading. Once I understand the company’s internal

condition, I needed to know how Comcast rated when compared to the rest of the

industry. Using a number of financial ratios & statistics, such as the P/E ratio, I rated

Comcast position against each competitor (select individuals and the industry). To test

the accuracy of this benchmark I reviewed the opinions within the company, other

analysts, and the market in general. Using all of this information, I was finally ready to

evaluate Comcast in terms of its current market price, to determine the appropriate

investment strategy. As a final check I ran through a residual valuation analysis. In

concluding my analysis, I added recommendations for improving Comcast’s financial

operations. I have summarized each step below; noting information I found to be

particularly useful or detrimental to my evaluation.

Evaluation Of Comcast’s Four Basic Financial Statements---Complications During

The Early Stages Of Analysis

Using the FSAP Template, I entered the financial data from the firm’s financial

statements, as reported in the Annual 10k report from 2004 to 2009 (2004 was included

in order to have a complete review for 2005). Once entered, I examined each statement

very carefully, noting general patterns and major year to year changes within each

statement and as a whole on the Data tab. I followed a similar procedure while looked

over the ratios, line item percentages, and growth rates on the Analysis tab. After

comparing notes, I quickly realized that year to year activity during that period was

extremely volatile. This volatility was directly related to the volatility in the US

economy, which comprises approximately 95% of the business. Volatility makes it

extremely difficult to make a true assessment of the firm’s current and possible future

position. This inconsistency in Comcast’s financial statements decreases the validity and

reliability of the financial trend analysis and any averages that were calculated for

benchmarking purposes. In order to correct for this decrease, I identified each material

year to year variance and researched the cause of said variance. The majority of my

research utilized the management discussion and analysis section, the additional notes

and supplementary information sections filed with the consolidated financial statements,

which were all included in each year’s Annual 10K report. Once my research was

complete, I continued on with my analysis. The next four sections summarize and

highlight some of the more critical items that were uncovered in reading over the

financial statements.

Evaluation Of Comcast’s Four Basic Financial Statements—The Balance Sheet

Reviewing a firm’s balance sheet is critical to the valuation process. The balance

sheet, or “snapshot,” (as it is often referred to in the financial community), summarizes

the financial condition of the business at one specific point in time, making it notably

unique from the other financial statements. While uncovering how the company has

historically positioned itself over the years; five of the line items were particularly

concerning; those line items were: cash & cash equivalents, marketable securities, PP&E,

intangibles—specifically franchise rights, and retained earnings. Before going any

further, I had to resolve the questions that each of these line items (and the overall BS)

“suggested.” The explanations to each of these questions are outlined below as follows:

1.) Why has there been an overall decline in the company’s most liquid assets? Is

this decline an indicator of increasing investment risk (liquidity and going concern

issues)?

-The market value of the firm’s securities has decreased primarily because of the

financial conditions within the market, and losses suffered on unusual items

(nonrecurring derivative transactions).

-Liquidity and going concern risk does not pose a significant risk at this time. Free cash

flow generated by operations continues to be strong. In addition, the company has a

sizeable credit line with its vendors to tap into for short-term liquidity needs.

4.) What are the “intangible franchise rights” and how does the company account for

these items?

-Intangible franchise fees are the rights the firm purchases in order to operate and offer

services to customers in that geographical area. As with PP&E, explained below, future

investments in these assets will likely decline as a result of the aggressive expansion

efforts taken years prior.

-Currently, these assets have an indefinite useful life—thus no amortization expense

recorded. The firm annually tests these assets for impairment by using a discounted cash

flow analysis. So far, no impairments have been made. However, future impairments

could be possible if these rights were later limited due to changes in regulatory and

market conditions.

5.) Why has the growth rate in PP&E declined over the last few years?

-Capital expenditures for cable services, historically a very sizeable portion of all

investments, have gone down. Other operating investments were not significant.

-New customer growth rate for cable services has decline due to fewer customer

segments to market to (market saturation) and the downturn in the housing market

(as foreclosures increased, the current customer base decreased).

6.) Why are retained earnings growing at an increasing rate--Does the company have

plans to use those funds for future investment, or are they contractually obligated to

retain earnings under a debt agreement?

-A portion of retained earnings are appropriated for: stock repurchases, pensions

obligations, and future dividend payments.

-Part of the reason for maintaining the stock repurchase plan is for the NBC

Universal transaction agreement the company has with GE.

-The GE transaction, once closed, will require a cash payment of roughly

$7.2 billion (expected to be paid at the end of 2010). This will give

Comcast a 51% controlling interest in the newly formed company.

Beyond the initial cash payment, the company will have the option to

purchase the remaining interest from GE, over two future redemption

periods using either cash or stock. The stock repurchase plan is expected

to continue until the remaining $3.3 billion approved is spent or the plan’s

expiration at the end of 2012.

-Increases were partially due to a number of new accounting and reporting requirements

and increased regulation requirements for the industry.

-Additionally, lenders and creditors require that the company maintain certain financial

ratio and appropriate a percentage of retained earnings for debt obligations.

Evaluation Of Comcast’s Four Basic Financial Statements—The Income Statement

The income statement is essentially an outline of the firm’s financial performance

over a fixed period of time, broken out into operating and non-operating sections. The

statement reveals the capabilities of the firm in generating sales from current product/

services lines (plus additional non-operating items), and converting those sales into net

income. Net income represents the profit or residual claim that remains to common

shareholders (minus any preferred/minority interest), after subtracting out all of the

expense incurred over that same period to generate those revenues. A firm can increase

profitability by doing one or all of the following: increase the sheer volume of current

product lines (assuming marginal cost rates remains the same), create new product lines

that have higher profit margins, eliminate individual expenses or discontinue entire

business lines that do not add value, and reduce the negative impact of the those expense

that are core to operations (with efficient and effective process improvements).

Unfortunately, due to a number of limitations, the income statements provide only a weak

assessment of the present and future potential. These limitations will be listed below,

followed by a comparison of the best and worst years of financial performance, and a

brief overview of the most recent year’s performance.

Limitations/Concerns In Evaluating The Income Statement

-The decline in the US economy, created large variances in P&L line item accounts,

making it difficult to accurately evaluate performance year over year.

-Sales from cable services represent a large portion of the total sales revenue generated

by the company. Over the last few years, additional customer cable sales have gone

down due to the market getting closer to market saturation.

-Based on the balance sheet analysis, outside investments have also declined.

-The company has historically relied on its free cash flow from operating

revenues to pay its debt obligations.

-The company has limited power in managing its two largest operating expenses: network

programming fees and video programming fees. Rate increases are common and

expected n the future.

Financial Performance Milestones-Triumph vs Defeat

Looking over the last five years, there are two years that visibly stand out among

the rest, 2006 & 2008. In 2006, the company had its overall best year of financial

performance. It was the only year in which the company was able to drive up sales

revenue, without marginally increasing every operating cost—thus converting more sales

into profits. The growth in sales relates to new customer subscriptions and pricing

markups for customer related fees. Expenses related to cable programming fee rates were

actually increased during this period, but, total expenses were maintained by the gains on

the sale of investment assets and the gain on discontinued operations. During this period,

the company’s stock was trading at an all time high (for year-end purposes) and investing

heavily to expand its cable segment operations.

Two years later in 2008, the US economy saw its worst recession since the Great

Depression. Comcast, as did many US companies, began to see their financial

performance go down. Comcast’s experienced a drop in comprehensive income, stock

market price, and sales and customer subscriptions growth over the prior year. Despite

these decreases, the company did have increases in terms of operating profit. The

increase was however limited due to increased operated expenses from supplier rate

increases. The reason net income fell below the prior year was due to investment losses

and impairments which were reported as other accumulated income/loss in a separate

statement following the statement of stockholder’s equity.

Financial Performance-2009

As the US economy began to stabilize and even improve, so did Comcast’s

financial performance. Sales revenue increased for all of Comcast’s major business

sections. Operating profit also increase in both amount and as a percentage of sales—

partially due to streamlining operations (layoffs). Non operating income (loss) also

improved--interest expense decreased due to prior and current year debt retirements and

decreased in interest rates and investment income (loss) improved due to reported

investment gains (realized and unrealized). The company’s stock price was down

slightly, however, that may have been due to the larger dividends declared and paid out

during the year. Net income and earnings per share for common were at record highs,

even beating out 2006 figures. Looking at just the income statement dollar amounts, it

would appear that Comcast has bounced back and is moving in the right direction—

especially if comparing 2009 to 2008. On the other hand, Comcast’s rate of growth

actually declined below 2008 percentages, so their ability to generate additional earnings

or value is still declining. The problem in figuring out Comcast’s true position at this

point, is not knowing how much, (if any) of that decline is due to the depressed economic

conditions. The section “Comcast vs. The Competition” below helps to shed some light

on this issue, but first an analysis of the two remaining statements.

Evaluation Of Comcast’s Four Basic Financial Statements—The Statement Of Cash

Flow

The statement of cash flow shows which of the firm’s activities (operating,

investing, or financing) generated cash, where the company used those funds, and

explains how cash is affected by changes in the prior two statements. It is also very

useful in valuing the firm in terms of liquidity and solvency risk—both of which seemed

to be cause for concern after reviewing Comcast’s statements. The financing and

investing activities only provided little, if any, positive cash flow and even that was

declining. The net cash used by the investing activities is decreasing, while the cash used

by financing has been increasing since 2006. During that same time frame, the cash

provided by operations has been increasing at a declining rate. These trends combined

with few other liquid assets on the balance sheet and declining sales growth from the

leading business segment (cable) signal major cash flow problems ahead. If the returns

on current business lines continue to decline without support from new investments, the

company will be forced to sell off less liquid assets at possibly unfavorable prices (fire

sale) or default and face bankruptcy. In order to grasp the severity of the situation, I

needed to find out whether or not this was a normal position to have in the industry—to

be addressed in the “Comcast Vs. The Competition” section.

Evaluation Of Comcast’s Four Basic Financial Statements—The Statement Of

Changes In Stockholders’ Equity

The statement of changes in stockholder’s equity summarizes the net transactions

that occurred over the period that affected stockholder equity. Although covered last, this

was the first statement I examined in order to find out how shareholder’s value had

changed, what were the causes of those changes, and what my share of it would be as a

common shareholder. Listed below are those items that would need to be reclassified for

valuation purposes.

-Equity available to common would need to be reduced by the minority interest. -

The company did not have any issued or outstanding preferred stock holders.

-From the dividends declared, the amount unpaid at year end would need to be

added back to shareholder equity.

-The company uses grant date accounting for its share based compensation

expense and employee stock option. Deferred compensation for the share based

compensation should be reclassified as a liability and the actual losses on the

employee stock plan made be over or understated.

-The 3.3 billion shares authorized to be repurchased could have an effect on future

shareholder equity if purchased in efficient market conditions.

-Hidden dirty surplus accounting items reported in the Other Accumulated

Income Statement—unrealized and translation gains and losses.

Ratio & Other Analysis

In addition to the information noted above, I evaluated Comcast using a number

of financial ratios and calculations---listed below are those which I found to be most

beneficial to my evaluation process. Values are from 2009.

-Liquidity Measures

Current and Quick Ratios: .44 & .34. Typically an amount less then one could

indicate liquidity risk.

Operating Cash Flow/Liabilities: 127%, low but also improving.

Net Working Capital Days: -73. Although negative it was showing yearly

improvement.

-Solvency Measures

-Altman Z Score: 1.3. A score below 1.8 generally means the probabilities of

bankruptcy within the next one to two years is extremely high.

-LT and Total Debt to Equity Ratios:.65 and 1.62. This means the firm has low

financial leverage, more assets were financed with equity then debt, less risk of

default but a higher initial borrowing cost (no tax benefit).

-Profitability

-ROA & ROCE excluding nonrecurring items: 16.7 & 8.7. Both figures have

shown steady improvement.

-P/E and P/B: 13.28 and 1 to 1. Both ratios have dropped since 2005.

Comcast vs. The Competition

For this section, I reviewed the statistics from Tables 2-6 which are provided in

the Appendix. This information was provided by Yahoo! Finance (Ref. 3) using

information available from December 2010. Comcast ranked relatively low against the

industry leaders. However, many of these leaders were competing in entirely different

customer markets (BSY. L a British Company), and so were not as reliable for

benchmarking purposes. The company did rank fairly high in terms of market

capitalization when ranked against the top cable and television companies. Market

capitalization is equal to the number of shares the firm has outstanding times its market

value. This statistic is useful in determining a company’s relative size in the market.

Currently Comcast still ranks highest against other US competitors. The company does

beat its direct competitors in terms of sales and profit margins, but it scores the lowest in

terms of EPS and quarterly revenue growth. The company’s P/E, ROA and ROE ratios

also rank fairly low when compared against the industry and direct competitors. To test

my liquidity concerns I reviewed the current ratio, operating cash flow and leveraged

cash flow ratios from the tables. Comcast had the lowest current ratio and had the least

percentage of funds left over from operating cash flow after debt payments (leveraged

free cash flow)—this only seemed to indicate further that Comcast was facing high

liquidity risk.

Comcast: Investment Opportunity or Liability Risk

Upon completing my analysis, I still had some uncertainty as to a definitive

investment strategy. As a final check I ran through a simplified residual income

valuation analysis. For sales revenue, I assumed growth would continue to show decline

at an increasing rate from forward years 1-5, with no long run growth expected. Due to

future supplier rate increases, I assumed operating expenses would increase at an

increasing rate yearly. I used the percentage of revenues from 2009 for all other income

statement line items except tax, which I calculated based on the average reflected in years

2005-09. Based on my valuation, Comcast should be trading at a price of $21.93 per

share. At the end of 2009 Comcast was trading at $16.86 per share. Currently the stock

market price is $20.60 per share. Had this analysis occurred at the end of 2009, I would

have recommended a buy strategy or a hold for those currently invested. At this time, I

would recommend holding off on making any additional investments at the current

market price. For current investors, I would still recommend a hold strategy. Overall, I

would recommend paying very close attention to US economic decisions. The company

has a beta of 1.2 (Yahoo!); which means that changes in the firm’s financial performance

will tend to mirror those seen in the US market. This mirrored effect was made even

more evident by the volatility in Comcast’s financial performance over that the last 5

years. As a final piece of advice, I would advise lenders and creditor to be weary of

increasing their lines of credit with Comcast. The firm might begin running into cash

flow shortages in the near future (forecast and valuation shown in the Supplemental

Information section).

Recommendations For Improving Comcast’s Financial Performance

-Increase cash flow management.

-Cable sales growth is going to continue to decline and profit percentages are going down

due to rate increases. In order to increase operating profitability, the company must find

new investment opportunities with value added return. In addition, look for investments

with less supplier power so that you can better manager your expense and profit margins

for those operations.

-Increase investment in intellectual assets to create new products and service lines and,

more importantly, to stay ahead of the competition.

-Expand into new markets outside of the United States to add some protection against

unfavorable US economic movements.

Appendix

Table 1: S.W.O.T. Analysis

Strengths Weaknesses-The firm is a leader in the U.S. cable

services industry.-Suppliers are highly concentrated,

substitute products are limited—strong pricing and overall market power

-The company serves more areas and has more customers than any other cable

service provider in the US.

-The licensing fees charged by programming networks are

singlehandedly the largest operating expense for Comcast.-Able to enjoy both economies of scale

and scope.-Similarly, video programming expenses

related to retransmission fees also represent a large chunk of Comcast’s total

operating expenses.-Able to cross-sell multiple products

within their customer base.. -Very long wait times to even reach a representative.-Reputation as one of the worst in customer satisfaction (esp. in

service)—Ranked # 1 twice in 04 & 07 by The American Customer Satisfaction

Index.

-Strong brand name recognition -Frustration once representatives were reached because they were poorly trained,

unprofessional, and rude to the point of abusive in some cases.

-Division integration, open communication, and an entrepreneurial

spirit within the firm.

-Numerous customer fee rate increases. Relatively low switching fees and short

contract periods

-Able to generate a lot of new/improved programming innovations and get them to

market quickly (high Idea/Product Turnover).

-No significant investments in customer markets outside of the US-at risk for

market fluctuations.

Opportunities Threats-The firm’s expansive operations allow them to develop new product lines in

multiple categories.

-Rates charged for both video programming and licensing fees are

expected to go up in the future.

-The joint venture with GE that was finalized at the end of December 2009 can significantly increase Comcast’s revenue

potential.

-This would likely force the company to pass some of this increase along to the

customer, via higher service fees.

-The combined assets and skills of the two companies will give Comcast an even stronger competitive advantage in the

entertainment and media industry.

-Higher fees will strengthen their already poor customer satisfaction reputation and

negatively impact their customer base.

-The company will be able to service a wider ranges of their current customer needs, while opening themselves up to

entirely new customer markets

-The company’s main industry, cable/TV/video industry is highly

competitive and intensifying. Harder to gain sales—closing in on market

potential.-The number of citizens in the U.S who have regular internet access continues to

increase, as does the time the average American citizen spends on the internet.

-The co. faces equally tough competition as it moves farther into the

telecommunications industry. Additionally, the struggle to gain market share & brand recognition is going up as the fight for advertising space increases.

-This will enable the company to offer services such as 4G high speed internet, to

a much broader area.

-The industry is highly regulated at the state, federal and even local levels—

future regulations pose a serious risk to Comcast’s future operating performance.

-As access and usage increases, Comcast can create highly customized consumer offerings—with greater profit margins.

-Services demanding customers, in a highly technologically dependent industry—one new competitor innovation could quickly wipe Comcast out of an entire costumer segment (i.e. visibly better

programming or faster internet speeds).Table 2: Comcast VS. The Industry

Table 3: Comcast VS Individual Competitors

Table 4: Direct TV Financial Ratios-P/B 50.24

Table 5: Dish Network Financial Ratios-P/B NA

Table 6: Comcast’s Financial Ratios-P/B 1.31

References

Ref.1: http://www.comcast.com/corporate/about/pressroom/corporateoverview/

comcasttimeline/comcasttimeline.html#1963

Ref. 2: http://en.wikipedia.org/wiki/Comcast#Financial_performance

Ref. 3: http://finance.yahoo.com/q/co?s=CMCSA+Competitors

Ref. 4: http://www.cxoadvisory.com/equity-premium/the-2010-equity-risk-premium-

from-academia/ --estimate for market risk premium

Supplemental Information

Comcast Income Statement Forecast

Residual Income Valuation: My Required Rate of Return: 1.5 R.F.R + 6% M.R.P.In testing out various rates of return, Valuation Per Share = 2009 CMP at 8.1%