Comcast's Sky Deal "Remains a Mystery," Analyst Estimates $36B in "Value Destruction"

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"Comparisons to DirecTV are perhaps inevitable," says Craig Moffett, though he keeps his "buy" rating on Comcast.

More than a year and a half after Comcast acquired European pay TV giant Sky in a $40 billion megadeal, MoffettNathanson analyst Craig Moffett in a Monday report said he is still not convinced of the deal's financial and strategic value to the U.S. cable and entertainment conglomerate.

"The rationale for its place in the Comcast portfolio remains a mystery," he wrote in the report entitled "Sky Diving," maintaining his "buy" rating and $49 stock price target on Comcast shares, which had closed at $38.65 on Friday. "Given everything going on in traditional media, we think the burden of proof remains on Comcast to prove the value of Sky." 

Moffett started off by highlighting that "after a six-month bidding war with Disney that was roundly criticized by Comcast's investors, Comcast sealed the deal for Sky in September 2018 for the princely sum of $48 billion (total enterprise value), an astounding 16 times enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) multiple that represented a near tripling from the roughly six times multiple at which the shares had been trading just a year before."

Even incorporating his recently lowered weighted average cost of capital for Comcast, "our warranted multiple framework suggests a target multiple for Sky in the range of six times EBITDA," the analyst concluded. "In dollar terms, the business is, by our estimate, worth something like $10.5 billion today. With the cash Sky has generated for Comcast since the acquisition, the total value since deal rises to just under $12 billion." Highlighting the "yawning $36 billion delta between the transaction's cost and its realized value," he concluded: "Net of the free cash generated since the acquisition, that $36 billion of value destruction in such a short period amounts to nearly $8 per share." 

Like others on Wall Street, the analyst lauded the Sky team for running its business well. "Despite the quality of Sky's brand, and its relatively strong market position and technology, Sky is still a legacy media business," he noted though. And the novel coronavirus pandemic "has reignited the controversy that surrounded the acquisition." After all, "next to the theme parks segment at NBCUniversal, perhaps no business under the Comcast banner has been more impacted by the coronavirus crisis," Moffett argued.

Live sports have been canceled, the U.K. advertising market "utterly imploded," and pubs and clubs that have Sky subscriptions were shuttered amid the pandemic. Comcast CFO Michael Cavanagh during a recent investor conference acknowledged that "the macro climate in Europe is as challenged, if not more challenging, … across Italy, U.K. and Germany" amid the pandemic. But he added that "the good news is sports is starting to come back," particularly soccer in Germany and the U.K. "Now as sports are coming back, our point was it's easier to control getting that revenue stream back online."

"These COVID-related pressures have exacerbated, and accelerated, the longer-term secular concerns that we and so many others had even when the deal was first announced," Moffett argued Monday. "Comparisons to DirecTV are perhaps inevitable, especially for U.S. based investors. Sure, there are some important differences between the U.K. and U.S. pay TV markets. But video is being fundamentally disrupted by Netflix and Amazon and a growing ensemble of well-funded, direct-to-consumer focused SVOD entrants globally." 

Ironically, the analyst argued that "the fact that Sky was then, and remains today, a well-run asset, was actually a negative, not a positive, as it left little room for obvious improvements." And he added: "Interestingly, the same might have been said of DirecTV circa 2013" before AT&T acquired it. 

Comcast management has always spoken of the Sky deal as providing strategic and financial benefits for the long term. Executives have highlighted such benefits of owning Sky as the fact that its U.S. streaming service Peacock could leverage Sky know-how and technology, that Comcast has funded an increase in Sky's push into original content to turbocharge it, and NBCUniversal and Sky are planning to launch a global news service. In addition, the planned Sky Studios Elstree near London will provide studio space for Sky and NBCUniversal. Plus, management has talked about the opportunities to roll out Sky services into additional countries, such as the recent launch of broadband services in Italy.

Comcast chairman and CEO Brian Roberts addressed a question about Sky's value to Comcast on a Jan. 23 earnings call by saying: "Sky has been a great addition to Comcast and positions us to better compete in a world where global scale matters." He added that the U.S. and Sky's biggest markets of the U.K., Germany and Italy represent 50 percent of the world's broadband and video revenues.

But Moffett said he was looking for more. "What remains more than anything else is the open question of strategy" for Sky, he concluded. "What did they originally intend to do with it when they bought it … and what do they intend to do with it now? It is hard to imagine that they bought it at the price they ultimately paid simply because they thought it was a better business than the market thought it was. Did they ever plan the pivot to a pan-European, or global, even, OTT service? If they did, do they still? If not, what changed?"

The analyst calculated that Comcast's shares "have already paid" the $8 per share in destroyed value Sky that he arrived at, "and then some." Explained Moffett: "In the end, we still believe the shares have been overly punished; they are cheap even with the 20 percent haircut we continue to apply" to account for his concerns about management's capital allocation and a conglomerate discount.

But he said despite his "buy" rating on Comcast, he prefers Charter Communications, a cleaner and more focused cable company, among pay TV stocks. Concluded Moffett: "Our frustration with the needless complexity of the Comcast story has kept us from being more vocal in our recommendation."