Cable stocks have been demolished–so much so that behemoth Comcast (CMCSA) is trading at 7-times trailing EBITDA. So is it finally cheap? Good God no.
Back in the dawn of the cable industry, cable execs quickly figured out that if they highlighted the only valuation metric that really matters, Free Cash Flow, no one would ever buy their stocks. Why? Because cable companies are huge capital hogs. It costs so much to build and maintain their networks that by the time they’ve finished paying their bills, there’s almost nothing left.
So cable execs decided to highlight a different, meaningless metric–Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). EBITDA tells you something about cash flow IN to a company, but it doesn’t tell you much about cash flow OUT. And from a shareholder’s perspective, the only thing that matters is the net of cash flow in AND out: a.k.a., FREE CASH FLOW.
What is Comcast’s Free Cash Flow?
Comcast EBITDA (Last Twelve Months): $11.3 billion
Comcast Free Cash Flow (Last Twelve Months): $1.8 billion
Where’s Comcast trading relative to that Free Cash Flow? When you include the value of its debt (Enterprise Value), it’s trading at 48-times. That means, if you bought the whole thing (for $84 billion), you would have to wait 48 years to get your money back. Sound like a good deal? Didn’t think so.
(And don’t fool yourself into thinking it’s just Comcast. Time Warner Cable has the same problem. In 2006, TWC generated $4.3 billion of EBITDA and only $800 million of Free Cash Flow.)
If you can persuade yourself that EBITDA is a relevant metric, now might be the time to look at cable stocks: Comcast, et al, aren’t going out of business, and despite Verizon’s baby steps, they still have the best position in the wired world.
If you care about the only metric that really matters, however, the value still isn’t compelling. Comcast will soon be scaling back the mountains of money it is spending to upgrade to digital, but even if Free Cash Flow suddenly tripled, it would only then reach the realm of reasonable: 15x-20x.
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