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Spin City

 By Cloud atlas - Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=86062922
(Image credit: By Cloud atlas - Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=86062922)

Remember when analysts were pushing for cable and content to get together, citing the synergies of having content and distribution side by side, how that would lead to lower programming costs and help bolster what at the time was an eroding subscriber base? Yeah, me neither.

The concept of vertical integration has always looked better on paper than in reality. Analysts were generally against it even a decade ago, when Comcast first bought a majority interest in NBCUniversal. They’re even more against it now.

Now two more analysts have joined the chorus, asking Comcast to spin out its NBCU and Sky assets into a separate company. Bernstein’s Peter Supino even wrote an open letter to Comcast chairman and CEO Brian Roberts in June, laying out the points for a separation. On Nov. 20, Supino published a note citing a survey of Bernstein’s clients that showed investors favor divestiture too.

Yesterday, Lightshed Partners principal Rich Greenfield put it a little more bluntly, calling for Comcast to merge NBCU with WarnerMedia, a move he doubted they would make, but one he believes is sorely needed.  

Greenfield gave props to Comcast for the initial NBCU deal, adding that it added value in the early days, but in today’s landscape, owning linear networks and continuing to have a death grip on the old model is just, frankly, bad business.

“...[I]t is hard to invest strategic rationale for their continued existence under the same roof, with all due respect to Peacock,” Greenfield wrote of NBCU and Comcast. 

Supino followed up his June letter to Roberts with a report Friday that showed that investors are feeling the same way.

In a survey of its clients conducted by Procensus, 42.5% of respondents said they “somewhat disagree” that NBCU had adequate scale to compete. But they didn’t want Comcast to buy more content (52.5% were against large-scale content M&A, with 42.5% saying yes, but only through a separate content-focused spin-off). The final nail in the NBCU coffin was that 85% of the survey’s respondents said they would favor a corporate structure where Comcast separated itself into media and cable companies. Only 15% said they favored the current structure.

Bernstein didn’t say how many of its clients participated in the study. But in his research note, Supino, who since initiating coverage of the sector last year has been one of the more thoughtful analysts covering the sector, essentially said out loud what everyone is thinking: The content business is just not the place to be anymore.
Supino added that when he first released his note calling for Roberts to divest of NBCU and Sky, he expected to hear from investors defending the vertical integration model.

“We have not heard that…at all…not even from those of Comcast's largest investors with whom we've discussed these issues,” Supino wrote. “Instead, we hear frequently that Comcast's media businesses are not taking enough risk with direct-to-consumer initiatives, lack compelling synergies with cable, inhibit Comcast's financial flexibility, and drag down Comcast's equity valuation.”

When Comcast bought into NBCUniversal in 2011, it was a typical good deal for the cable operator -- they bought a distressed asset at a great price from a company [General Electric] that desperately needed cash. When Comcast bought the rest of the unit in 2013 for $16.7 billion, it was touted as another great deal at a great price. 

And it was, but not for the reasons that many initially thought. Comcast saw an asset that was terribly neglected in NBCU -- its broadcast network NBC had no retransmission consent revenue at the time -- and applied its unique management to right the ship. Just like it did with AT&T Broadband, Comcast turned NBCU into a well-oiled cash machine. Retrans revenue skyrocketed -- it was at more than $1 billion annually at last count -- and the cable networks were raking in the affiliate fees.  

It made sense for Comcast to buy NBCU then because they could use their expertise to beef up the business. And there were things to beef up like retrans and advertising revenue. But in the past few years NBCU has been a drag on the stock. In the pandemic era, it has been a 100-ton weight on the shares. 

Comcast stock has done OK -- it is up about 10% this year, mainly on broadband growth -- but it has lagged behind its pure-play peers like Charter Communications (up 34.1%), Altice USA (up 16.5%) and Cable One (up 33.3%).

Content companies have grown out of favor in the past few years as streaming has diminished the value of a linear pay TV subscription. With affiliate fees and even retrans revenue shrinking as traditional pay TV customers move to other options, preserving the old model doesn’t really seem to make that much sense anymore.

That analysts are calling for the separation of content and distribution is nothing new. Back in 2016, the concept of vertical integration started to gain favor in some circles, and a few small deals were done -- Verizon bought a 24.6% interest in AwesomenessTV and Comcast shelled out $3.8 billion for DreamWorks Animation. But even then analysts were cool to further deals, especially big ones.  After Comcast bought the rest of NBCU, MoffettNathanson principal and senior analyst Craig Moffett hoped that it wouldn’t start a vertical integration wave, adding that the economic theory behind it relies on guaranteed supply or guaranteed demand. Neither applies to cable. 

“What’s left is mostly just exclusivity, and unless you believe that the program-access rules are going to sunset, exclusivity is illegal,” Moffett said in an email message back then. “I get the appeal on a superficial level, and I even get the grass is always greener argument, but the historical evidence for real synergy between content and distribution is extremely thin.”

Internet video was already asserting its dominance at the time -- in 2016 Netflix had about 94 million global streaming subscribers (it has 195 million now). And analysts could see that the mood was shifting.

“In our opinion, distributors have the ability to subsume all content under their aggregation umbrellas, which makes the whole concept of cable networks irrelevant,” Barclays analysts Kannan Venkateshwar and Amir Rozwadowski wrote at the time.

So it should come as no surprise that some are calling for divestiture again. AT&T, which spent more than $100 billion on Time Warner in 2018, seems to be going the opposite way -- reports are rife that it is seeking to sell all or a piece of its DirecTV distribution business and keep the content assets. Satellite distribution doesn’t have a broadband component, which makes its future prospects murkier. And AT&T seems to have put its future in the hands of its streaming service HBO Max.

Comcast has a streaming offering too -- Peacock -- which debuted nationally in July. Peacock’s acceptance has been good so far, signing up about 22 million people in Q3. Disney Plus, The Walt Disney Co.’s streaming service, has about 74 million subscribers, while WarnerMedia’s HBO Max has about 38 million customers. Just about every content provider has started or has plans to start a direct-to-consumer offering, including ViacomCBS, Discovery and AMC Networks. While they still pay lip service to their existing linear TV relationships -- and to be honest, they still make most of  their money that way -- they all know where the business is heading. 

Heck, even Comcast realizes that the good old days are over. In its Q3 earnings conference call with analysts, Roberts said that Comcast knew the broadband ship was coming in years ago.  But he used that to justify the vertically integrated model, adding that content from Sky and NBCU can easily ride on any platform. 

In an October research report, Moffett likened Comcast stock to a Pet Rock, just sitting there, doing nothing. Even a blowout Q3, where broadband growth of 633,000 was its best quarter ever with that service, didn’t move the stock much.   

Moffett added that it may just take time for the stock to catch up to its peers, and waiting for a COVID-19 vaccine to bring people back to its theme parks and for the advertising market to come back, may be just the thing to do. 

“With time, Comcast might (might) even decide that its business would be better trading as two stocks rather than one,” Moffett wrote. “We can only hope.”