Motley Fool Hidden Gems Investing - Comcast Spins Out Cable Networks

Episode Date: November 21, 2024

Comcast is shedding cable networks including MSNBC, USA Network, and CNBC from the parent, and putting them in a new company, temporarily called SpinCo. (00:14) Bill Barker and Ricky Mulvey discuss: - Nvidia’s quarter and data center growth. - Why Comcast is spinning off its cable assets. - Microstrategy’s unusual bond offering. Then, (17:04) a replay of Scoreboard, hosted by Anand Chokkavelu. Matt Argersinger and Anthony Schiavone take a look at Sunbelt REIT, Eastgroup Properties. Visit our sponsor: Get $1,000 off Vanta at www.vanta.com/fool Companies discussed: NVDA, CMCSA, MSTR, EGP Host: Ricky Mulvey Guests: Bill Barker Producer: Mary Long Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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i'm ricky mulvey joined today by returning champion bill barker bill how you doing i'm well thanks how are you i'm doing well and it's it's good to have you back on the show haven't seen you in a few months we've got a little bit of nvidia and then i want to talk about this comcast spinoff dylan's going to cover this more on on the friday show but i want to i mean it's the biggest company by market cap or it's consistently trading places is the biggest company by market cap, and they reported earnings yesterday. I think my big takeaways are that the data center business is rolling with revenue up more than 100% from the prior year, and that's from a base of $14.5 billion. Expectations are starting to match up to what they're doing,

and some investors are doing a little profit-taking. What stands out to you about NVIDIA's quarter well i mean it's a phenomenal quarter and as you as you say uh expectations uh were largely met and those that figured that nvidia always exceeds expectations and not only exceeds them by normal amounts but excessive amounts might find that this one time nvidia has only exceeded expectations by a kind of normal amount and that they have beaten expectations and raised guidance, but not to the extent that has been going on in some quarters in the past. And that's really a function of the law of large numbers. It gets harder and harder when you start talking about quarters involving $37 billion to just be increasing things by an annual rate of 100%.

Also, you get more eyes once you start getting into that trillions of dollars in market cap for folks to make guesses about what kind of money you're going to make. One number I want to zero in on, because I think this is incredibly impressive for NVIDIA, and a lot of investors believe it to be impressive. This is a company that makes 75% in gross margin. Have you seen anything come close to that? What is NVIDIA doing to make that? Well, certainly nothing close to it in terms of hardware and in terms of chips. And it's a function of the demand that they are able to sell at rates that are sort of unheard of. And these are gross margin rates above that level in the software space are not unprecedented. But, you know, you're talking about something in

the sort of 30% or so range for Intel. I think their current gross margin is 34% and AMD's is 48%. And so, NVIDIA's at 75%, 76%. That does, as you say, highlight that they are doing something that their competitors are nowhere close to doing. I want to get to this Comcast story. This is big news for media observers, and that's that Comcast is spinning off its cable assets, including USA Network, MSNBC, and CNBC. Spinoff is expected to be valued at about $7 billion, not going to take hold for a year, according to reporting I saw in the Los Angeles Times. Before we get into the specifics of why Comcast is doing this, this is something that stock market investors will experience sometimes. I think it recently happened with Kellogg spinning off its

serial division. It happened a long time ago when GE owned the NBC Universal Assets. So broadly, why do companies spin off departments, even when they're making money, making a profit, into new publicly traded companies? There can be a variety of reasons. In this case, I think it's a capital allocation decision. You've got one part of the company, for instance, that is growing, but not growing as fast as another part. And that slower growing part would like the attention of the company. It'd like to have money thrown its way. And they say, if you give us a billion dollars, we'll turn it into 1.1 billion over two years. We will grow your investment 10% over two years, and there might be another part of the company that is

saying, well, you give us $1 billion to improve our business, we'll do double that. This is a way of letting a very unified part of the company, that being the cable channels, operate with their own capital allocation decisions and prove that maybe they could raise money from outside of the company or they can make deals with other cable channels that might need a new home in a way that becomes very uninteresting to a very large company. That is, as I think Charlie Munger or Warren Buffett, maybe Charlie Munger said to Warren Buffett, if something isn't worth doing at all, it's not worth doing well. Even if you can take a small thing and grow it decently, if it just doesn't move the needle on a very large company, it's kind of like

who cares if you can do something interesting? It doesn't matter to the big parent. And you spin something off that's a smaller entity and increasing something by a reasonable percentage is meaningful once you identify a small company that can allocate capital well. Well, one thing the big parent certainly cares about is streaming, streaming subscribers and getting people to watch Peacock. And one may think that you could take these cable channels, USA Network, MSNBC, CNBC, and make them play nicely in that streaming world. But ultimately, why don't you think that NBCU could make these channels work in this new streaming environment? I think that a lot of the sports and news coverage they've got is consumed live. The sports coverage, in particular news coverage, maybe less so. But old news is just not interesting. To be able to forever go back and watch the November 21st edition of cable news chat uh is is not something that many people are going to going to go back to you if you've got

what peacock really uh is better at you know movies and and shows you don't need to watch a show within a year 10 15 years of when it came out uh it's just as good years later that's not the case for most of these channels that are going to be part of this uh spinoff yeah and i think it's impossible to have this discussion without mentioning. People have also lost a lot of trust in cable news outlets. And in terms of viewership, they're slipping viewers a little bit. MSNBC losing viewers after the election of Donald Trump. And one may think that after what happened in 2016, you would see a big spike in cable news viewerships, but that's not playing out this time. And also the median age. There's the median age for cable news viewership for

not just msnbc but fox news and cnbc is also around 70 so i i would imagine the executives here are looking at this and saying you know what this is really expensive and we don't think we're grabbing that younger generation of viewers that are that we want to get onto these streaming platforms yeah i think all those data points are true i think msnbc is also potentially quite an anchor around comcast neck if it wants to make acquisitions and the administration is hostile to MSNBC for not being sufficiently praising the administration. They may just do exactly what has been promised, which is to exact retribution on whoever isn't on board. I think that's maybe a consideration, but really, these things don't seem to have

a fascinating future in the current construction to Comcast and to many, many, many others. So let's talk about the spinoff, because the new CEO, who's currently the NBCU group chair, Mark Lazarus, told a group of employees, and this is according to Los Angeles Times reporting, quote, I completely empathize with people who think that this would be a bittersweet thing. I think it's exciting because very few times in life you have the opportunity to be part of what I'll call a well-funded startup. I think there is a way to make channels like CNBC work in 2024 and grab newer generations of viewers. But how could a group of cable networks function as a well-funded startup? Is it possible?

Well, I mean, they have real viewers, real revenues. They are profitable. So as a startup mentality with a new horizon to look at and we can take what we've got right now and rearrange it and make deals with the other bundlers, there are lots of ways to pursue the future in this business and have, at the very least, intellectually exciting time with a changing landscape. And they are not in desperate need of anybody to fund them. They've got profitable operations. So, look, he's obviously spinning things too, right? Let's, let's, he's saying that he perceives this before I get to why this is exciting. I understand why there's a lot of fear, right? But let me now spin that for you. All right.

Both of those things can be true. There's a, there are a lot of people that are, they're worried about their jobs and how this is going to play out and whether the future is any brighter than the present. And there are people put in charge whose job it is to be positive. Why don't you think Comcast shareholders are really reacting to this spinoff? The stock barely budged on the news. Well, they're going to spin this off. The shareholders aren't really going to wind up with anything that different than what they started with.

They will have Comcast independent of the spinoff and the spinoff, right? So they'll have a little bit of both, and both of them will be able to pursue their own agendas. And so it's marginally good, I think, if they had conflicting agendas, ones which the capital allocation decisions were affected by any politics or any internal strife. So it's marginally positive to shareholders, but not much. You're really, you own the same things, but in a different package. The stock has barely budged in the past five years, but it has paid a dividend. In 2014, Comcast paid a dividend of 45 cents a share in 2024. That's $1.24.

They're trying to use their balance sheet to return capital to shareholders. And sometimes mature companies returning capitals to shareholders can be wonderful stock investments. But is there anything about this company that gets you interested as a long-term stock investor? uh no not me uh okay there are there are those that are that are interested uh if you're talking about remain co so you've got spin co that's what's being spun off and remain co what remains and you know it's been a well-run company it's it's doing things with internet with cable bundling that that people will continue to use and certainly the internet there's some pricing power at the moment there. But I think that they are more looking like a utility than

they used to. Yeah. I want to move on quickly to this MicroStrategy story because, Bill, this is wild. So MicroStrategy, which is a Bitcoin holding company with a side of enterprise software, has announced that it will offer institutional investors the opportunity to buy convertible bonds at 0% interest. They're going to sell about $2.5 billion worth of these bonds at 0% interest so it can buy Bitcoin. First of all, how do convertible bonds work

and is it common for these bonds to pay nothing in interest? When you think of bonds, you think about getting a little paycheck until the company pays back the value of the bond. Well, it is not common to have a 0% interest. And so, a bond is like a regular bond in other cases and pays interest to bondholders and on top of that, has the option for conversion of the bonds into stock under certain scenarios. And so, you don't have to offer as high a yield rate, the bond, the coupon doesn't need

to be as high because you've got this kicker of some equity conversion opportunities. Micro strategies, 0%, and there were conversion strategies, and maybe there's a lot of fine print that you got to go through. So do your homework on this one. But you're betting on the price of Bitcoin held by micro strategy somehow making you money. Because the conversion opportunities on this one include dates out in 2028 and 2029 and MicroStrategy being able to convert into cash or a combination of cash and equity, depending on its price and what it feels like doing. So, buyer beware on this one. But there are many buyers today, as there are for virtually anything that has the residue of Bitcoin upon it.

So why not, instead of just the residue of Bitcoin, why not just buy the thing? Or even an ETF? I don't understand why an institutional investor would do the loop-de-loop of buying a convertible debt for MicroStrategy to go buy Bitcoin that they can then return whenever kind of they feel like it, instead of just buying Bitcoin. Well, I think you've raised a good point. i can't i'm not gonna i'm not gonna come out and defend what they what they've done although microstrategy has done this uh very effectively to date there's also a way in which it operates as a hedge against the actual direct holding of microstrategy uh so you can offset it with with

convertible bond and reduce your risk because MicroStrategy has such a volatile stock price that if you hold a lot of it, then you may want to hedge that with this. It's not something that explains itself on the first read, I would say, but as you point out, there is institutional interest and I think part of it is the hedging strategies made available through this. much like watching fight club it changes every time you watch it um i also want to do a quick note sub it's it's not any time micro strategy once there are rules of when it can call back the bond quote subject to certain conditions on or after december 4th 2026 micro strategy may redeem for cash all or any portion of the notes at a redemption price equal basically to the to

the principal amount i gotta get that one right if i'm talking about dead securities anyway bill Barker. Appreciate you being here. Glad to have you back. Thanks. Thanks for having me. How about a REIT without a chief investment officer? That actually might be a good thing. Up next, Anand Chakravallu hosts Matt Argesinger and Anthony Chavone for a scoreboard episode breaking down East Group properties. Premium Motley Fool members get access to all scoreboard episodes in the video library. But even if you're not a member, and by the way, you should be a member. It's a great way to get premium coverage of stocks and investment analysis. Anyway, if you're not a member, you can watch this one in full on YouTube. I'll include a link in the show

notes. From morning hockey with a cup of coffee to Timbits and road trips, Tim's and Canadian tire have always gone together now it's official you can now earn canadian tire money at tim's link your triangle rewards and tim's rewards accounts to earn twice with every tim's run terms and conditions apply visit tim hordens.ca slash triangle for details welcome the latest motley fool scoreboard i'm on in chocvaloo and we've got longtime fools anthony chabon and matt argersinger giving a 1 to 10 rating to the sun belt area focused industrial REIT that I may or may not have thought made backpacks. It's East Group Properties, ticker symbol EGP. As always, we'll rate East Group Properties business, its management,

and its financials. We'll talk valuation. If there's timefalls, play armchair CEO, and we will top it on about 12 minutes or less, maybe even shorter. So let's get to it. Matt, how do you rate the strength of East Group's business, including factors like its industry and its competition. Scale of 1 to 10, 10 is invincible, 1 is hopeless. Well, Anand, I'm going with 8, pretty high for Eastger properties. As you mentioned, it's an industrial REIT. It is mostly focused on the Sunbelt. Most of its properties, almost all of its properties are kind of shallow bay, distribution-oriented, think warehouses, logistics facilities, and what they call last mile locations. So really strategic real estate, that's important for three big trends that I'm

going to talk about, which one being the obvious one is e-commerce. We are living in a more and more e-commerce world. More and more retail sales are being driven, of course, by online sales. That fits perfectly into eSERP strategy. The second big trend is, you said it, Sunbelt. They derive about 70% of their operating income from states like Texas, Florida, Arizona, North Carolina. These are among the fastest growing states in the country. It's where a lot of people are moving to, a lot of businesses are going to. That's a big tailwind for them. And then post-COVID, we've seen this really need for companies to really optimize their supply chains, have higher inventory ratios, practice what they call just-in-case inventory management.

God, that's another big, huge tailwind for East Group properties. I would say the one reservation I have about East Group and why I don't give it a 9 or a 10 is they are among the smaller REITs. They are a large industrial REIT, but they're still less than a tenth of the size of Prologis, for example. It's still a highly fragmented market with lots of supply. And they're very development-focused at East Group. So it's more capital-intensive than maybe other REITs. So that's why I'm giving it an 8 out of 10. Yeah, I'll go with a 7 for East Group's business. Matt, you mentioned a lot of the major things. But another thing that I like about East group is that about 50% of their portfolio has been developed internally. So I think that's

really important because they can design the properties to their specifications. They can build them for the long term. And then the other thing I like about them too, is that they have the most diversified tenant base out of, I think, any industrial REITs. Their top 10 tenants account for just under 8% of their total annualized base rent. So I think that's really important. And then aside from the e-commerce and migration trends that you mentioned earlier, I just think industrial real estate is an advantage property type. If you think about a warehouse, right, it's just four walls, you have a ceiling, you have a roof. There's not a lot of recurring capital expenditures involved with maintaining a warehouse. And that allows more cash to ultimately be returned to shareholders.

And I'll only give it a seven because this business is a little bit reliant on outside forces that aren't necessarily within the company's control. So you think about like supply and demand fundamentals, the health of the economy and migration trends as well. Although those have been positive recently, but I'll settle with a seven. Given its smaller size, that diversification, Ant, that you were talking about really gives me some comfort where it's not just relying on, you know, you won't want to say 32% is from this one big tech company. Let's move on to management, Matt. Scale of 1 to 10. 10 is Warren Buffett, of course, and 1 is Homer Simpson. I might be a little high here, but I'm going 9 out of 10 on it.

And that's because I'm just really impressed by CEO Marshall Loeb and what he's done. His tenure goes back to 1991 with Easter Properties. He was with the company for the first 10 years of his career. He went off to be an executive at a couple of other publicly traded REITs before rejoining East Group in 2015 and then becoming its CEO in January 2016. And since Loeb became CEO in January 2016, East Group has outperformed the S&P 500 by more than 80 percentage points. That's hard to do as a REIT, especially in recent years.

Real estate has been in a pretty big bear market, yet East Group has continued to outperform and deliver amazing returns. And I'm going to steal a page from Ant's playbook here, but one of the great ways you can measure a REIT, REIT's management, is how they've grown the dividend versus the rest of the company. East Group has grown its dividend by about a 13% annualized rate over the last 10 years. Over that same span, East Group shares outstanding and total debt outstanding have both increased at just around 5% annually. So the dividend growth is way ahead of those critical capital parts of the company. I think that's a really strong sign of management. So I'm very impressed here. I'm also going to go high here at an eight. Matt, you mentioned Marshall Loeb,

just been a tremendous CEO since he's been there. I also like looking at the proxy statement too for REITs because at the end of the day, they're allocating capital and that's what we need to focus on as REIT investors. And if you look at their compensation incentives, they're based on FFO per share. So per share metric, that's good. Based on same property NOI growth. And then a couple of balance sheet metrics like debt to EBITDA and fixed charge coverage ratios, as well as total shareholder returns. So I think it's kind of rare for a REIT management team to be compensated on balance sheet metrics. So I think that's definitely a good sign. And then something unique about East Group's management team that you really don't see in any other REIT is that

they don't have a chief investment officer. I find that fascinating. All the development, in all the acquisition, all the disposition activity is decided by the local teams that are operating those assets. And I think that's good for talent development too. Like Marshall Loeb was in charge of that at one point in his career at East Group. So I just kind of like how that East Group has that decentralized culture. The only reason I gave him Nate is because of low insider ownership at only around 1.5% of shares outstanding. That tends to be fairly common for REITs, just because of the way they're structured. So I'll go with an eight. All right. Financials, Matt. A 10 is a fortress, a one is yikes.

I'm dishing out another nine here. So just a quick financial snapshot of East Group, looking at just their second quarter results, the most recent results. The operating portfolio was 97% occupied as of the end of June. Rental rates, new and renewing leases, up 60%. 80%. That's an incredible. Same property net income of 5%. Funds from operations, which is the key measure of a REITs cash flow, that was up 8.5%. I can't recall a quarter going back many years where East Group has not shown growth in funds from operations per share. So the business is performing really well. And if you look at the balance sheet, you've got debt to total market cap of just 16.9%. Debt to EBITDA is less than 4X. Both of these metrics are very strong for REIT.

And with interest rates at a lower now, eScript's balance sheet is only going to get de-risked and their liquidity is only going to get higher. So I just think they're in a really great position financially. Yeah, I'll go with an 8 for the financials. Matt, you mentioned the FFF per share growth, the earnings growth. That earnings growth has led to phenomenal dividend growth as well. eScript has paid a dividend for 179 consecutive quarters. They've also increased or maintained their dividend for 31 consecutive years, including increases in each of the last 13 years.

So this is a steady dividend grower. You can see that cash that they generate flowing back to shareholders, which we love to see. In August, they increased their dividend by more than 10%. So that's a good sign. And over the last 10 years, they've grown their dividend by just about 150%. So really impressive there. And Matt, you mentioned the strong balance sheet too. Debt to EBITDA is at an all-time best for the company.

Their debt-to-market capital is at 20%. I mean, typically, in the private real estate market, you'll typically see like loading the values closer to 60% or 70%. So, this is a very, very well-capitalized company. I only give them an 8 because of their size, which you mentioned earlier, Matt. They're a little bit smaller. They can't necessarily get the best terms, the best interest rates on new debt that they issue. like somebody like a prologist can. So that's the only reason why I give them an 8,

but definitely a strong company here. You can tell how much they like the company because they're both kind of apologizing when they give like an 8. Let's talk valuation. How well will East Group's stock do over the next five years and how safe is it? Keeping in mind that 10 is a short thing,

one is a lottery ticket. Yeah, so over the last 5, 10, 15, and 20-year periods, East Group has delivered a compound annual total return north of 10%. So, I'm going to go between 10% and 15% annualized of the next five years. Today, if you look at its dividend yields, it's got a yield of about 3%. It's growing its dividend at a 10% rate. So, theoretically, that should produce a total return of around 13%. So, I think that's reasonable. And when you factor in the tailwinds of e-commerce, Sunbelt migration, some of the rent growth that's already embedded in its below

market leases that it has within its portfolio, I think that's going to lead to at least double digit returns from here. I'm also going 10% to 15%. I'm a seven in terms of my confidence with that. The valuation is a little high. If you look at what they're guiding for FFO per share this year, the stock right now is trading for around 22, 23 times that figure. That's a little high, even though I think East Group does deserve a premium. As Ant mentioned, dividend yield is right around 3%. You add that to the dividend growth or to the FFO per share growth, easy to see double-digit returns here.

But valuation is a little high, so I'm not super confident in it, but I'll give it a 7 for that. And I should say, I don't think I mentioned, I'm also going with a 7 because of the valuation. We're going to skip Armchair CEO in the interest of time and go straight to everyone's favorite topic. I expect to hear Prologis somewhere in here. Anthony, is there a company in East Group Properties space that you like better?

Yeah, there's this company called Prologis. That's my top end. Just a massive company. I think it has a market cap of over $100 billion, but I still don't think the market fully grasps just how strong this company really is with its management team, its balance sheet, just everything involved with the company. It's just phenomenal. I got to say Prologis as well. And real estate size does make a huge difference for returns. And as Ant mentioned earlier, access to the capital markets. And so, yeah, Prologis was the pick.

I love East Group and I own both East Group and Prologis. But if I had to pick one, I'd probably go to Prologis. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. The Motley Fool only picks products that I would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.