Comcast negotiating with one hand, fighting perceptions with the other

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Entertainment industry CEOs never get tired of arguing that content is king.

But as a distributor, cable giant Comcast faces an uphill battle convincing analysts and investors that its potential deal for content player NBC Universal can create shareholder value, this despite wide agreement that Comcast knows how to integrate acquisitions.

Since reports of deal talks emerged a month ago, Wall Street observers have expressed concern that the largest U.S. cable operator might walk away with the Peacock but make its stock a turkey in the process.

During the past month or so, Comcast shares have underperformed those of Time Warner Cable, the second-largest cable firm, and Wall Street pros argue that the latter might look more attractive to investors interested in a pure-play cable investment.

News of the Comcast-NBC Uni talks emerged late on Sept. 30, when Comcast shares closed at $16.88. On Thursday, they finished nearly 16% below that.

By comparison, shares of Time Warner Cable have declined 5%.

For Comcast followers, the NBC Uni situation is mindful of a similar drop in investor confidence in 2004 during and after a failed $54 billion-plus bid for Disney, even though the NBC Uni deal is cheaper and comes at a time when sector valuations remain fairly beaten up.

Still, the idea that a marriage of content and distribution can create synergies has gone out of vogue, making it a tough time to be proud as a peacock about such a deal.

Comcast chairman and CEO Brian Roberts this week attempted to dispel concerns that a deal would hurt Comcast's ability to pay dividends and buy back stock or otherwise dilute shareholder value. Regardless, the deal could pluck some of Comcast's feathers by keeping a lid on the stock for a while amid concerns about future costs for buying full control of NBC Uni and the often-lacking synergies of past media mergers.

"Comcast has already spent five years in the penalty box post-Disney," Sanford Bernstein analyst Craig Moffett said in a recent report titled "Snatching Defeat From the Jaws of Victory?" "Now, Comcast has again clearly signaled its desire to be in the content business."

Collins Stewart analyst Thomas Eagan also delivered a Disney comparison in discussing the NBC Uni talks.

"Disney 2.0? Not quite but potentially dilutive," he said of a deal. On Thursday, he followed up with a downgrade from "buy" to "hold," citing lower medium-term growth prospects and predicting that "the stock will be range-bound for much of 2010 due to the overhang of an NBC Uni deal."

With Comcast potentially investing about $12 billion in cash and content assets in the proposed deal, "we expect many shareholders may rotate out of Comcast into TWC," Eagan said previously. After all, Comcast's content contribution to revenue would increase from below 4.5% to nearly 30%, leaving Time Warner Cable the only pure-play cable giant.

Others argue that rotation already has begun.

"Time Warner Cable is attracting significant capital inflows from Comcast investors who fear (correctly, given what Comcast is trying to do now with NBC Uni) the company will squander its free cash flow," Pali Research analyst Richard Greenfield said in a recent upgrade of Time Warner Cable shares to "neutral."

"Time Warner Cable is telling investors exactly what they want to hear: no acquisitions with free cash flow going toward debt reduction leading to meaningful multiple expansion."

What irks investors about a Comcast-NBC Uni deal is that most see little evidence from past entertainment-sector mergers that the combination of content and distribution power works.

Time Warner Cable previously was spun off from Time Warner, and News Corp. gave up control of DirecTV, leaving the planned marriage of DirecTV and Liberty Media content businesses as the main other example of a company with a big hand in both areas.

"Much has been made of the potential for vertical synergies between content and distribution," Moffett said. "But too little is made of the cost to achieve them."

He recently lowered his target price on Comcast from $21 to $18 and on Time Warner Cable from $60 to $55, but he still rates both "outperform."

But he made clear, "We continue to prefer TWC as the most attractive name in the sector."

Barrington Research analyst James Goss also recently voiced such a preference.

"From a valuation standpoint, the major foray of chief competitor Comcast into added programming exposure, via a potential transaction with NBC Universal, appears to complicate the investment story for Comcast, particularly in a year in which the TWC story has become very focused," he wrote.

Debt analyst Dave Novosel of Gimme Credit also highlighted concerns about Comcast's play for a big content firm. In a note titled "Just Say No to Content," he highlighted Comcast's "excellent growth prospects with other initiatives such as digital voice, its new commercial offering and high-speed Internet."
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