I’ve been spending some time this morning digesting the news that the UK’s Competition and Markets Authority (CMA) has blocked the $MSFT acquisition of $ATVI. The announcement from the CMA is linked here and is about twenty pages long. After reading and organizing some thoughts, I decided I want to share major points on the decision.
CMA’s Conclusions
After the CMA’s investigation and assessment of the acquisition, they concluded that the action may result in a “substantial lessening of competition” (SLC) in the cloud gaming services within the UK. This is a very different reasoning from the initial concerns surrounding the ideas that Microsoft would withhold the large Call of Duty franchise from competitor’s platforms. The CMA says that the deal could change “the future of the fast-growing cloud gaming market, leading to reduced innovation and less choice for UK gamers over the years to come.”
Microsoft provided a Cloud Remedy Proposal to the CMA in which they would be committed to license Activision games royalty-free to specific cloud gaming providers for 10 years. A proposed change in consumer licenses of the games would also give the right to stream an Activision game within the cloud service provider’s online store. This essentially means that if Steam’s online store was selling Activision games, the consumers of those games would be able to play it on Steam’s cloud service (assuming they have one) and wouldn’t be forced to use Microsoft’s cloud gaming service. Microsoft also offered to appoint a monitoring trustee to ensure compliance with the proposed remedy.
The CAM determined that the proposed remedy was unlikely to provide structural remedies to the SLC. Their reasoning for this is that the proposal limits different types of commercial relationships between cloud gaming service providers and game publishers, restricting arrangements like exclusive content, early access, or gaming subscription services. They also conclude that this proposal lessens the incentives for Activision to make their games available on non-Windows operating systems which may exclude or restrict cloud service providers who wish to use other operating systems now and in the future.
The CMA ends their conclusions by stating that the “only effective remedy to this SLC and its adverse consequences is to prohibit the Merger.”
My Opinions
I was shocked to read that this rejection was literally only about cloud gaming. The CMA even recognized that they understand the public support for deal as it would
It is extra odd when considering the fact that cloud gaming is such a small part for the entire video game industry, let alone Microsoft. Google’s cloud gaming attempt with Stadia failed and was officially discontinued in January of 2023, only three years after it was launched in November of 2019. Amazon’s attempt at cloud gaming, called Luna, is still up and running but has mixed reception and not a huge base due to major complaints around impracticality, lag issues, and extra monthly fees to access all the content.
These other players aren’t struggling because Microsoft is out-competing them, its because cloud-gaming just isn’t as good compared to console or PC gaming. I’ve messed around with Xbox’s cloud service called X Cloud Gaming. It’s not mind-blowing.
As internet speeds improve over time and as it becomes more cost effective for companies to house all of the necessary computing power that is needed to offer cloud gaming services, I’m sure the sector will grow. With Microsoft having a 60-70% market share in cloud gaming, the CMA is concerned that this deal would make their market share greater, and as a result make the industry less competitive. The CMA seems to believe they are forward-looking in terms of the potential growth in cloud gaming, but given the context of the small size of cloud gaming relative to the entire industry and the significant time and money it will take to get cloud gaming anywhere close to being competitive with console/PC gaming, it seems the CMA’s focus on cloud is extremely misled.
Moving Forward
Next steps lie at the Competition Appeal Tribunal (CAT). This is the special judicial body within the UK that hears and decides on cases involving competitive regulatory issues. Just last November, the CAT overruled the CMA’s decision on a case involving Apple for disregarding statutory time limits. In Apple’s case, this was a procedural error and was overrule quickly. Microsoft’s case does not have any procedural issues (though if there are some they may appear in the near future).
The CMA’s initial key concern when the merger was first reviewed was regarding foreclosure in the console market. Their concerns then of Activision games becoming exclusive to Game Pass or removed from Playstation were entirely misinterpreted on the CMA’s part. Now the focus is on cloud gaming and their decision to block a merger over an infant market at the expense of greater aggregate consumer benefit within PC and console gaming. The CMA may have a hard time explaining to the CAT why this is reasonable.
Immediately following the CMA’s decision, Microsoft and Activision reaffirmed their commitment to this deal and that they would appeal the decision. Lulu Cheng Meservey, CCO of Activision Blizzard, tweeted that “the UK is closed for business”. Brad Smith, Vice Chairman of Microsoft, tweeted that they will appeal the CMA in an offical statement. Their statement says that the decision “reflect[s] a flawed understanding of this market and they way the relevant cloud technology actually works.”
The deal has been cleared in other jurisdictions such as Japan, South Africa, Brazil, Saudi Arabia, Serbia, and Chile. It should be cleared by others in the near future as the European Union has a May 22nd deadline, an August trial within the US is expected, and Australia and New Zealand appear to be waiting further outcomes from the CAT as their historical ties with UK show.
Microsoft has been more cooperative and friendly with regulators than nearly any big tech company I can think of. Now, they have no choice but to fight to back as they have shown they dedicated to this deal and will see it to the end. I hope we get to see this to fruition, however, there is always the risk impatient and despairing investors push Activision to take the $3 billion break up fee. Only time will tell.
In the meantime, $ATVI is down over 11% in today’s trading session, wiping out almost three months of uptrending gains for the stock. My current position is still up over 3% with a cost basis of $74.07. If prices manage to drop below my cost basis before more news develops, I may look to add to my position.
This weekly market recap is brought to you by Koyfin, a powerful analytical tool that I am proud to partner with. Their platform is entirely customizable for whatever data you want to look at including stocks, ETFs, mutual funds, currencies, economic data releases (one of my personal favorites used often for these posts), crypto, and even transcripts of company events! Click the link above to get a special offer only for Dividend Dollar readers or go give my product review a read if you’re interested!
Dividend Dollars’ Outlook & Opinion
Boy is this market difficult to wrap your head around. From a bullish perspective, inflation has continued to trend lower, earnings kicked off to a solid start, and consensus sentiment may be too bearish and lead to a continued “melt up” so-to-speak. On the other hand, bearish perspective is that valuations are too high, technicals show we are close to strong resistance levels, and there is still too much uncertainty surrounding global economic health, inflation, and rate movements.
This week was heavy with economic data that contributes to everyone’s potential differences in market perspectives (all of these releases will be broken down in the recap below). We received good news on the inflation front, but bad news in soft retail sales and rising unemployment claims. The consumer sentiment report surprised with higher-than-expected inflation expectations. Q1 earnings from the big banks came in above analyst estimates, with more to come next week.
Last week we said that this week was technically bearish but positive data and earnings report could “flip the script”. That’s exactly what we saw. Two weeks ago, we also mentioned that April tends to be a relatively bullish month. Though the first week of the month didn’t hold true, this week definitely did.
Technicals-wise, the S&P 500 is nearing the upper end of the 3,800-4,200 range that was established in November. From a technical near-term perspective this skews favor to the bears. It is possible that the uptrend continues and breaks above the range, but this may be difficult for a number of reasons. For one, the current forward PE multiple is roughly 19, and earnings revisions aren’t shifting up to justify a higher multiple.
We have a fair number of economic data releases next week, but none of them really stand out. All eyes will be on earnings reports which include some big names like $JNJ, $BAC, $NFLX, $WMT, $TSLA, $T, and $PG.
As these earnings reports roll in, expect volatility. But it’s impossible to know if they’ll be positive or negative for the market. Therefore, I think the official and safe outlook for next week is volatile and neutral with an expected week ending next week around current prices, especially since upper resistance on the SPX is close. However, the bull in me really wants to see earnings surprises push the market higher to 4,200 and even above. But only time will tell.
Weekly Market Review
Summary:
The stock market had a mixed but overall positive showing for the week. All major indices made gains, but modest ones on the back of continued inflation and Fed concerns.
Early week was a slow trend up as investors awaited economic data and Q1 earnings reports from banks on Friday. Coinbase Global ($COIN) was an exception here, gaining 6.0% on Tuesday after Bitcoin breached $30,000.
Inflation concerns came up after the Consumer Price Index (CPI) came in for March. Total CPI fell YoY, which was a welcome development, but core-CPI did not. The total Producer Price Index (PPI) and core-PPI fell in March, but the uptick in core-CPI offset some excitement about PPI disinflation.
Also, comments from Fed officials this week indicated that the new inflation readings are not likely to convince the Fed to pause its tightening efforts just yet. Fed Governor Waller (FOMC voter) said on Friday that the Fed hasn’t made much progress on its inflation goal and that he thinks monetary policy needs to be tightened further and remain there for a while.
The data and comments did not change forecasts for the Fed’s May FOMC meeting. According to the CME FedWatch Tool, the fed funds futures market is pricing in a 78% chance of a 25 basis points rate hike.
Q1 earnings season kicked off on Friday with $JPM, $C, $BLK, and $PNC all finishing the day with a gain on a good report. Strength from the financial sector was not enough to carry the market on Friday, though as regional banks were weak on Friday despite gains from their larger peers.
Still, the S&P 500 hit its best level since mid-February. Trading had noticeably light volume this week, which could be attributed to a larger wait-and-see mindset as investors await the bulk of Q1 earnings season.
Only 4 S&P sectors closed with a loss this week — real estate (-1.35%), utilities (-1.32%), information technology (-0.28%), and consumer staples (-0.24%) — while financials (+2.78%) led the outperformers by a decent margin.
Monday:
The stock market looked weak at the open as the main indices fell under the weight of mega cap losses. Even at session lows, though, the broader market showed nice resilience in front of several market-moving data releases later in the week.
The Dow Jones Industrial Average was the strongest of the day, declining just 0.4% at its low for the day, while the tech-heavy Nasdaq saw a loss of 1.3% at its low before settling the day close to flat. Monday’s best performer, however, was the small cap Russell 2000 (+1.0%).
The main indices all improved noticeably when the mega cap stocks started to recover earlier losses. The Vanguard Mega Cap Growth ETF ($MGK) was down as much as 1.6% before closing with a 0.3% loss. This recovery effort helped the market close near its highs for the day, which had the S&P 500 above 4,100.
There was no economic data of note for Monday.
Tuesday:
Tuesday continued the trend of relatively light volume, again showing resilience to selling efforts ahead of big events later in the week.
Some of the mega cap stocks were able to climb off their session lows as the broader market settled into a steady grind higher in the afternoon. The main indices took a sharp turn lower, though, with about 30 minutes left in the session as names like Microsoft (MSFT), Apple (AAPL), and NVIDIA (NVDA) retested early lows.
Coinbase Global (COIN) made an outsized move Tuesday after Bitcoin reached $30,000, Moderna (MRNA) dropped 3.1% following its acknowledgment that its influenza vaccine candidate did not accrue sufficient cases at the interim efficacy analysis to declare early success, and CarMax (KMX) logged a nearly 10% gain after its better than expected fiscal Q4 earnings results.
Again, there was no economic data of note for Tuesday.
Wednesday:
The day started on an upbeat note as investors digested the Consumer Price Index (CPI) for March. The S&P 500 and Nasdaq logged gains of 0.6% and 0.9%, respectively, shortly after the open.
Early gains disappeared, though, as mega cap stocks rolled over and Treasury yields also climbed.
There was a subsequent rebound effort that took root after the S&P 500 dipped below 4,100. The market was moving cautiously forward into the release of the FOMC Minutes from the March 21-22 meeting.
The Minutes revealed that members agreed that inflation remains too high and that the banking problems increased economic uncertainty. Still, all agreed that it was appropriate to raise the target range for the fed funds rate even though the staff economic outlook included a mild recession starting later this year given the potential economic effects of recent banking-sector developments.
Things rolled over again in the late afternoon with mega cap stocks leading the slide.
The selling interest was likely also driven more by valuation concerns rather than a negative reaction to the Fed forecasting a mild recession, in my opinion. The cyclical S&P 500 sectors pulled back along with the rest of the market, but still finished the day in a position of relative strength.
The weekly MBA Mortgage Applications Index rose 5.3% with purchase applications jumping 8.0% while refinance applications were flat.
Total CPI was up 0.1% MoM on February’s increase of 0.4%, 0.3% was expected. Core-CPI, which excludes food and energy, increased 0.4%, as expected, following a 0.5% increase in February. Services inflation was up 0.3% MoM, versus up 0.5% in February, and up 7.3% YoY versus up 7.6% in February. Excluding shelter, services inflation was flat, compared to a 0.1% increase in February, and up 6.1% YoY versus up 6.9% in February. On a YoY basis, total CPI was up 5.0%, versus up 6.0% in February. That is the smallest 12-month increase since May 2021. Core-CPI was up 5.6% year-over-year, versus up 5.5% in February.
The key takeaway from the report is the disinflation seen in March. That trend doesn’t necessarily take a rate hike at the May FOMC meeting off the table, especially with core-CPI tipping slightly higher, but it is fostering a belief that a rate hike in May could be the last hike in the Fed’s tightening cycle.
Thursday:
Thursday was strong and only strong. Gains from the mega cap space gave the main indices a big boost. The positive bias was partially a reaction to the pleasing economic data in the morning and there was likely some short-covering activity contributing too.
The major indices spent most of the session in a steady climb, closing near their best levels of the day. The S&P 500 hit 4,150 at its high of the day, marking its best level since February 15.
By the close, bonds had given back all of their post-PPI, knee-jerk gains to settle the session with losses across the curve. Notably, stocks advanced as bond yields rose from their post-PPI lows, which were set around the time the stock market opened for trading, suggesting perhaps that there was some asset reallocation within the day.
The Producer Price Index for final demand declined 0.5% MoM in March compared to an expected 0.1% and following an upwardly revised 0.0% reading in February. Excluding food and energy, the index for final demand fell 0.1% MoM. YoY, the index for final demand was up 2.7% versus 4.9% in February. Excluding food and energy, the index for final demand was up 3.4% versus 4.8% in February.
The key takeaway is that producers are seeing some welcome disinflation, aided by declines in energy prices; however, the stickiness of core CPI in March has offset some of the excitement about the improvement in the PPI data in March.
Initial claims for the week ending April 8 increased by 11,000 to 239,000, above expectations by 3,000, and continuing claims for the week ending April 1 decreased by 13,000 to 1.810 million. The key takeaway from this report is that it reflects some softening in the labor market but not any clear-cut weakness.
Friday:
Friday was the big day. Trading sent many stocks lower. The main indices tried to move higher, but quickly fell below their flat lines and remained in the red through the close. Investors were digesting a slate of economic data and corporate news ahead of the open, including some pleasing Q1 earnings results from several large banks.
$JPM, $C, $BLK, and $PNC were among the top performing stocks Friday, driving a 1.1% gain in the S&P 500 financial sector.
While the financial sector was providing support for the broader market, mega cap losses offset much of that support and drove a lot of the index level weakness. Names like $META, $AMZN, $GOOG were able to recover their losses and finish with at least a modest gain. This coincided with the broader market rebounding from its lows of the day.
Investors were also reacting to Fed Governor Waller’s remarks in a speech before the open that the Fed hasn’t made much progress on its inflation goal and that he thinks monetary policy needs to be tightened further and remain tight for a substantial period of time.
Also, some added selling pressure kicked in after the preliminary Consumer Sentiment Index for April showed year-ahead inflation expectations rising to 4.6% from 3.6%.
Import prices fell 0.6% MoM and were down 4.6% YoY. Excluding fuel, import prices were down 0.5% MoM and down 1.5% YoY. Export prices fell 0.3% MoM and were down 4.8% YoY. Excluding agricultural products, export prices were down 0.2% MoM and were down 5.2% YoY.
Total retail sales fell 1% MoM in March, much lower than the expected -0.4%, and the 0.2% decline in February. Excluding autos, retail sales were down 0.8% MoM. The key takeaway is that sales declines were seen across most retail categories, reflecting weakness in consumer spending on goods that should exacerbate concerns about an economic slowdown that cuts into earnings prospects.
Total industrial production rose 0.4% MoM in March. The capacity utilization rate jumped to 79.8%. The key takeaway from the report is that the entire gain in industrial production in March was driven by the increased output of utilities, which is to say the headline print contradicts an otherwise soft environment for manufacturing output.
The preliminary University of Michigan Consumer Sentiment Index for April was 63.5, above the 62.7 consensus and the final reading of 62.0 for March. YoY, the index stood at 65.2. The key takeaway from the report is that short-run inflation expectations were up noticeably from the prior month, which is something that could compel the Fed to press ahead with another rate hike in May even though long-run inflation expectations remained stable.
That’s it for my recap! If you would like to see how I am building my dividend portfolio using my predictions/strategy written here, you can read about my buys in my weekly portfolio update on this link.
And if you like updates like this, follow my Twitter or my CommonStock page where I post updates on the economic data throughout the week.
This article is brought to you by 3X Trading, a community that highlights experience and expertise of the professionals within. While other groups rely on algorithms or inexperienced traders, 3X relies on its team of seasoned professionals to navigate markets, providing you with analysis, classes, and a personal service to ensure you are always informed and making good trading decisions, for any strategy. Join the Discord server for free and learn from dividend investors and day traders alike. I frequently share analysis and insights throughout the week, so I hope to see you in there! Thank you Discord members @Jenlevit and @Alladin for working on the marketing and the charts of this piece!
Market Cycle
The market is in a weird spot to kick off 2023. So far, this year feels like the inverse of 2022. High inflation, which defined most of the last year, seems to have given way to a narrative of falling inflation. Wages data, small business surveys, CPI, and ISM data (all items we cover regularly on the weekly market recaps) suggest softening.
The graph above is called “The Psychological Pitfalls Of A Market Cycle”. It’s broken up into four distinct areas indicated by the colors. The orange color on the far left is the Mark Up phase of a cycle, next is Distribution, followed by Mark Down, and ending with Accumulation in the dark red before the cycle repeats again with Mark Up.
We have had three consecutive inflation reports that showed no major inflation concerns. In fact, two of those three reports actually contained negative surprises! The Fed on Wednesday acknowledged weakening inflation while also mentioning that they still have work to do. Anyways, it is clear that the market’s narrative has shifted to declining inflation and that the Fed will pivot dovish sooner or later. Therefore, now is a great time to look for some early cycle outperformers.
The Soft Line Industry
Before I dive into why this sector could be good for cycle moves in the near term, lets discuss what soft lines are. If you google what the soft line industry is, you will see a site that says they sell primarily soft merchandise. Not a very helpful explanation, but it is technically correct and is a term that is used in retail quite often.
Soft lines are retailers that sell smaller items that are usually soft. Consumer items like linens, clothing, shoes, bags, towels, mats, pillows, and sometimes even beauty products. These kinds of goods may be called soft items. They are typically more difficult to handle in the supply chain than hard goods. Hard goods are stackable, easy to store, and easy to transport while soft goods need to be packaged carefully, they can wrinkle, they need to be presented aesthetically in stores, and are more sensitive to restocking.
Soft Line – Early Cycle Mover
Now back to the cycle. The uncertain backdrop of the economy appears to be closely tied to the health of the US consumer. With that said, I believe the soft line industry is at an interesting value point. Morgan Stanley’s US Soft Lines Retail Equity Analyst, Alex Straton, called the coming year a ‘tale of two halves’ in a Thoughts on The Market Podcast last week when discussing soft lines.
What they meant by this is that the first half of what retailers are facing is harder expectations from an income statement perspective caused by an ongoing excess inventory overhang (Nike’s large inventory in the end of 2022 is a great example of this) and possible recessionary conditions from a macro perspective. An article from Morgan Stanley claimed that census forecasts for the S&P 500 have earnings growth at almost 4%, this is overly optimistic in their view. Consensus earnings growth expectations specifically for soft lines are even more optimistic at 15%.
These stocks can be moved significantly based on earnings revisions. If we have negative earnings revisions ahead based on the assumption that expectations are unrealistic, it’s likely that the stocks move downwards from here, hitting a bottom sometime in the first half of the year.
The second half of the year presents a very different story – hence the tale of two halves. If earnings revisions/expectations become more realistic, the industry will be in a position to more easily meet top line returns and margins may receive year-over-year relief. This relief may come from falling fright costs, falling price of cotton, promotions, etc. On top of that, as we go through the year, inventory should mostly reach normalization. Lastly, a recovering macro perspective should be more solidified in the second half of the year. With this improving backdrop and the fact that soft lines are early cycle outperformers, they could quickly pivot off the bottom and see gains.
It is impossible to ever call a bottom accurately and consistently on anything. But given the case for the industry turn around as we have laid out, there are a few data points to keep an eye on to help you realize when the time to initiate might be near. The first indication is 2023 guidance, and we should get more information on this in the coming weeks as earnings season continues.
The other item that we will spend more time explaining is inventory levels. Cleaner levels are essential to having a view on how long the margin risk that hit retailers in the second half of 2022 could potentially linger into this year. Last year, there was a lot of market discussion around the inventory problem. It was seen as a key risk to earnings with oversupply and lagging demand creating the perfect storm for pressuring margins.
Today, retailers have made good progress of working down inventory levels in the third quarter of 2022, but there’s still much room to go. Look at the examples below from Tapestry’s ($TPR) Q1 2023 earnings report, Ralph Lauren’s ($RL) Q2 2023 earnings report, Nike’s ($NKE) Q2 2023 earnings report, and VF’s ($VFC) Q2 2023 earnings report. What we would rather see here is that inventory levels are in line with forward sales growth.
How To See The Opportunity
As we look across the soft line space for opportunities to take advantage of for an early cycle move, make sure that you’re sticking to sound fundamental and intangible analysis. What I mean by fundamental is if the company is growing or outperforming (beauty stores like Ulta are a great example of this), look for diversification in selling channels, be aware of company events such as restructuring or leadership changes, understand if their margins reasonable, and look to see if investors are rewarded with buybacks, dividends, and/or sufficient price appreciation. What I mean by intangible is if the company has a strong brand, if the brand has value, if that brand value had an upward trajector, and do the products speak to the consumer.
If you can answer most of these items in a positive light, then you may have located a good company for this early move.
For me, certain subsectors of this industry particularly interest me and others that don’t. One to avoid, in my opinion, is activewear. These items saw strength in Covid as people gained a higher affinity for staying healthy, exercising, and taking care of their bodies. Long term, the category has really nice upside potential, but for the purposes of getting early cycle returns, the lingering strength from Covid may negate the strategy.
My other point is on mid-tier brands vs luxury/high-tier brands. A debate as old as time. I lean high-tier, for a couple of reasons. One is that higher wealth consumers will be less affected by a recession if one happens. The global economy is growing, China is opening, and India looks to be on the verge of its most performative decade ever. These items will boost attention to and desire for world-renown luxury brands. Another point I have is called revenge shopping. The Economist touched on this phenomenon which is where people are more willing to splurge on high-end items currently because they have been pinching pennies and living a stressful life since Covid that they feel they should treat themselves.
My Picks
Having said this, here are a couple of stocks I have my eyes on:
Tapestry ($TPR), the luxury brand company that operates through Coach, Kate Spade, and Stuart Weitzman. P/E ratio of 12.3, pays a 2.57% dividend, and has had decent sales growth over the last five years.
Ralph Lauren Corp. ($RL) sells premium lifestyle products including the well-known Ralph Lauren clothing brand but also sells accessories, home furnishings, and many other soft line products. P/E ratio of 17.3, pays a 2.35% dividend, and has performed great share buybacks of the last 10 years.
Steven Madden Ltd. ($SHOO) designs, markets, and sells fashion-forward footwear through several well-known brands including Steve Madden, Anne Klein, GREATS, and others through wholesale and direct-to-consumer segments. P/E ratio of 11.4, pays a 2.3% dividend, and has shown impressive sales growth over the past decade with the exception of 2020.
Burberry Group PLC ($BURBY) is a holding company that designs, manufactures, and sells apparels and accessories under the luxury Burberry brand. P/E ratio of 21.18, dividend yield of 2% that pays semi-annually, and touts some very stable margins and impressive FCF per share.
I also like Columbia Sportswear ($COLM) but did not dive into them too much as I believe seasonality may dampen the early cycle mover strategy discussed here.
Of these five, I have initiated a small position in Steven Madden Ltd. ($SHOO) and will wait for their earnings report on February 23rd before adding heavy. The reason for this is so that I can get another temperature check on the inventory levels, sales levels, and the margins are trending in the right direction. So far, sales and margins are. Inventory, which is the key, still needs improvement however.
Thank you for reading! If you like pieces like this, follow my Twitter or my CommonStock page where I post updates on the economic data throughout the week. And go check out the 3X discord where I’m actively conversing about ideas like this!
This earnings break down is brought to you by 3X Trading, a community that highlights experience and expertise of the professional within. While other groups relay on algorithms or inexperienced traders, 3X relies on its team of seasoned professionals to navigate markets, providing you with analysis, classes, and a personal service to ensure they are always informed and making good trading decisions, for any strategy. Join the Discord server for free and learn from dividend investors and day traders alike. I frequently share analysis and insights throughout the week, so I hope to see you in there!
Summary
On Thursday, 1/26/2023, Comcast ($CMCSA) reported fourth quarter earnings that beat most expectations despite a lack of strength in subscriber growth and losses from Peacock (their streaming service).
Performance
Earnings per share came in at $0.82 for the quarter, beating expectations of $0.77 by 6.4%. Revenues came in at $30.6B beating expectations of $30.4B and a previous quarter of $29.8B. Good news so far!
Unfortunately, Adjusted EBITDA fell by 15% to $8B from $9.5B from the prior quarter. This was mostly due to higher severance expenses as hinted at by CFO Mike Cavanagh in the third quarter call. He said, “As we enter the fourth quarter and look to our year ahead, we remain focused on driving long-term growth during an increasingly challenged economic environment… We expect we will be taking severance and other cost reduction-related charges in the fourth quarter in anticipation of expense reduction actions that will provide benefits in 2023 and beyond.”
Cable Communications
Comcast report 26,000 lost broadband customers for the quarter, attributing impact to Hurricane Ian which hit Florida and South Carolina in September. The hurricane caused severe damage and losses to the homes of subscribers. When looking at total customer relationships, the firm estimates the total number decreased by 36,000 and broadband increased by 4,000 when excluding the effects of the hurricane.
Though subscribers are growing, the pace has slowed compared to quarters prior to Covid. Competition from telecom and wireless providers are growing, and a housing slowdown in the US contributes to a lack of new customers as the shift to new homes. Total customer relationships of 34.3M increased slightly form 34.2M last year.
Comcast’s wireless segment, Xfinity, added 365,000 customers in the quarter, brining the total subscriber base to over 5.3M. Wireless customer growth has been consistent since jumping into the business in recent years. This was offset by a loss of 440,000 cable video subscribers as customers continue to cut traditional TV bundles in favor of streaming.
NBCUniversal
NBCUniversal is the business segment that contains the media (cable, streaming, and related advertising figures), studios (movie studios such as Universal Pictures, Dreamworks, and Focus Features) , and theme parks (5 Universal Parks and Resorts) businesses.
Revenues for Universal were up about 3% from the prior quarter to $9.8B. Revenues was boosted by the 2022 FIFA World Cup which aired on Peacock and their Spanish-language network Telemundo.
Though overall results are good, Peacock has continued to weigh on the business. Adjusted earnings fell by nearly 50% to $817M due to Peacock losses and severance expenses. $978M of that is attributed to Peacock losses compared to a loss of $614M last quarter.
This quarter, Peacock added 5M new paying Peacock customers to the subscriber base, brining the total number to 20 million. This increase could be attributed to the World Cup, football season, and English Premiere League. The company remains committed to earning a return on their Peacock investment, though next year doesn’t look like the year for it. Overall, Peacock’s losses for the year of $2.5B were in line with the company’s earlier outlook. Next year, Michael Cavanagh says they expect losses to be near $3B.
Theme parks remained a bright spot for the segment this quarter with $2.1B in revenue, right behind the studios revenue of $2.7B. Studios revenues were actually down compared to last quarter, however the segment ended the year strong with a #2 rank in the world wide box office for year thanks to movies like Jurassic World: Dominion and Puss In Boots: The Last Wish.
Sky
Lastly, Sky, the segment that holds one of Europe’s leading media and entertainment companies, reported 129,000 net customer additions. This was reflected in a revenue growth of $163M compared to last quarter. For the year, Sky revenues decreased 11.5% to $17.9B. When excluding the impact of currency, revenue only decreased $1.2%, highlighting the segment’s sensitivity to exchange rates.
Final Thoughts
These 4th quarter results won’t change any negative sentiment around the company, but it’s a step in the right direction. Broadband customer growth is still anemic. I believe the lack of growth in the broadband service is mostly an economic one. Comcast is well positioned to combat competition and maintain pricing power. Broadband business lost customers this quarter for the first time. Average revenue per customer, however, grew 3.5% year over year. The cable segments’s EBITDA margin was flat versus last year, but would have hit a record 45% if the higher severance costs hadn’t hit.
Peacock showed better growth this quarter with 5 million net adds, but still reported a loss, crushing the margins of the Universal segment. Universal faces more challenges, but a rebound in theme parks and the growth in Peacock is a good step in the right direction.
Free cash flows took a hit for the year, dropping to $12.6B from $17.1B. Expenditures were heavily tied to a rebound in content and higher cash taxes. Both items should show less of an impact for 2023. The company’s balance sheet is strong and has allowed the company to raise its dividend by 7.4% to $1.16 for 2023, their 15th consecutive increase. Approximately $17.7B was returned to shareholders this year through $4.7B in dividends and $13B in share buybacks.
Overall, $CMCSA still looks undervalued to me. It has the stability of a telecom stock with it’s focus on broadband, has potential growth aspects of similar streaming companies with Peacock, an impressive ability to bring in revenues at the box office, and a knack for stretching profits out of popular franchises with a growing theme park business. All of these items make them a diversified company that is hard to compete with and an attractive opportunity for long-term investors.
All information provided is available on Comcast’s Earnings page with access to the earnings releases, presentations, and transcripts. Both the Q3 and Q4 2022 earnings materials were used in this article.
