• by Diane Mermigas , December 7, 2007

For investors, Comcast's fall from grace represents the unwinding of the company's and the cable industry's bundled prosperity.

Comcast warned Wall Street several years ago that video would become a less prominent component of its packaged services as non-cable competition intensified and consumers increasingly embraced data and voice. But even the nation's leading cable operator could not anticipate recent swift shifts in consumer preference and deteriorating economics.

While cash flow remains plentiful, it is increasingly tapped for capital investment in network upgrades and new products. In addition, heightened economic and competitive pressures result in lower revenue. That is why Comcast has lowered its 2007 guidance two times in as many months. The second time came Dec. 5, after Goldman Sachs analyst Anthony Noto downgraded Comcast to a Neutral rating and lowered his 2008 price target to $22 a share. JP Morgan analyst Jonathan Chaplin echoed the Neutral rating, citing Comcast's rising capital expenditures and declining subscriber growth as "a red flag."

Comcast said it anticipates lower subscriber numbers (6 million new subscribers instead of 7 million), lower cash flow (down one point to 13%), and higher capital spending (now at $6 billion). The news slashed Comcast stock 12% to close at a new low of $18.18 a share on Dec. 5. Some analysts insist Comcast brought on some of the decline with its one-year promotional price of three bundled products for $100 monthly, off of which customers are now cycling. Others say negative catalysts outnumber positive growth catalysts near-term. Missing a seat at the wireless table--even if it means paying $10 billion to build or buy a wireless network--could handicap cable in a digital portable market.

"We believe the lowered guidance is a bigger issue than some may think," Noto said. "On the surface, the company made small adjustments (less than 1%) to 2007 revenue and EBITDA. The bigger issue: an estimated 10% reduction in RGU net additions has a more dramatic impact on 2008/2009." Having previously lowered estimates to reflect an "extreme downside" scenario, Noto now expects Comcast's 2008-2009 free cash flow to decline by 10% to 13%, and earnings per share to fall 8% to 12%.

With Comcast lowering its 2008 free cash flow estimates 30% in the past 11 months, and watching its stock price dive 27% over the same period, Pali Research analyst Richard Greenfield predicts the company's free cash flow will barely muster $2.8 billion next year. Greenfield is imploring Comcast to go on the defensive by "drastically reducing its 2008 free cash flow" estimates, rather than damaging its credibility with piecemeal reductions, and going "all digital rapidly" to give it a definitive competitive edge.

This cascade of bad news was unfathomable several years ago, given Comcast's careful crafting of its fortunes and public image. It is testament to the extensive, quick-changing economics for media concerns historically considered recession-proof. A rise in subscriber delinquency and cancellation numbers is expected at all cable operators in the coming quarters as a byproduct of the worst housing slump and credit crisis in decades, even as Comcast and its peers sink billions of dollars into increasing their network speeds and services.

Cable operators are likely to begin slashing prices to compete with discounted services being offered by Verizon and other new broadband Telco competitors, while having difficulty matching satellite's HD and live sports offerings. Comcast's squeaky-clean image has been sullied by charges that it interferes with some subscriber applications and traffic. In an effort to quell investor concerns, Comcast management has backed away from making such new acquisitions, like Clearwire and 700Mgh spectrum being auctioned by the government in February. It prefers to remain in an undeveloped wireless consortium led by Sprint. Like its cable peers, Comcast faces a series of new federal regulations that, among other things, would restrict its size. Credit Suisse analyst Bryan Kraft has termed the turmoil a "Comcastrophe."

Comcast's woes highlight a major re-setting of value and expectations occurring for all cable, satellite and telecom operators, which appear to be splitting industry analysts into two camps. Morgan Stanley analyst Benjamin Swinburne Dec. 6 said he was going "from bear to bull" Dec. 6, when he upgraded the cable and satellite industry to Attractive, making Comcast and DirecTV his top picks. With valuation levels having fallen to historic lows, an all-out price war is unlikely as cash-rich balance sheets and rising free cash flow levels are sustainable, Swinburne said. Debt-to-earnings ratios will be reduced by half by 2010 at the top four cable and satellite operators, any of which could begin pacifying shareholders with a dividend strategy that would yield a premium multiple.

"While no business is recession-proof, we see pay-TV and broadband revenue as defensive relative to the broader market," Swinburne said, noting that the average U.S. household spends 9 hours daily watching television or surfing the Web. Still, that did not keep Swinburne from lowering his 2008 price target and EPS forecast for Time Warner Cable on concerns that overly optimistic expectation for the uplift provided by Time Warner Cable's acquisition of Adelphia Cable systems won't materialize.

"Cable is fighting an all-out war on multiple fronts, putting operators in a position they have never faced before," Greenfield observes. Indeed, Comcast and other cable operators have enjoyed a dominant gatekeeper position that is being eroded by satellite and telco players competing in the same video, voice and data space, as well as unlikely mobile and computer electronics rivals using devices rather than networks. Telcos such as Verizon and AT&T and consumer electronics manufacturers like Apple have invested billions in their own infrastructure.

The economics bundled services cable operators thought they could rely on are no longer a sure thing, given the high level of effective competition. In a recent interview with Fortune, Comcast CEO Brian Roberts preferred to call this a period of "slower growth" that masks the company's second-best year ever in new product rollout. "There's increased uncertainty over the future, and unfortunately, it may take time for people to get comfortable with the idea that more competition doesn't necessarily slow down growth," Roberts said. Hmmm.