Here’s an opportunity to pick up shares of a growing media company at a discount.
Discovery Communications (DISCA)
From: Cabot Benjamin Graham Value Investor
Discovery Communications (DISCA) is a significantly undervalued stock with conservative growth prospects. The company is a global media company that provides contents such as Discovery, TLC, Animal Planet and The History Channel across multiple distribution platforms.
In 2016, revenue from U.S. networks and international networks were $3.28 billion and $3.04 billion, respectively. Discovery’s two main revenue streams are distribution revenue and advertising revenue. Distribution revenues include affiliate fees charged to the distributors (cable, DTH and telecommunication service providers) of Discovery’s television network’s first-run content, and digital distribution fees charged to digital distributors for licensed contents that was previously distributed to Discovery’s television networks. Advertising revenue came from ads sold in its television networks and digital products. The two graphs show segment-wise revenue and operating profit margin since 2009.
U.S. Distribution, International Distribution and U.S. Advertising have been steadily increasing, while there was some recent setback in International Advertising revenue though it seems to be recovering in 2017. The operating margin in the U.S has been around 50% to 60%, while the margin from international had dwindled from 40% in 2002 to 20% in 2016, primarily due to increasing sports content costs in Europe. That said, I’m assuming a conservative 2%-3% long-term growth in Discovery’s earnings without accounting for the synergies that will be achieved by its acquisition of Scripps Networks Interactive.
Discovery will acquire Scripps Networks Interactive for $14.6 billion. Scripps provides lifestyle and interactive content on channels like Food Network, HGTV, Travel Channel, DIY Network, the Cooking Channel and Great American Country. Scripps’ annual revenue was $3.4 billion in 2016, with a net profit margin of around 20%. Discovery and Scripps anticipate the merger to provide a $350 million in cost synergy and international exposure to Scripps’ female audience-targeted contents. The combined firm will also allow for better bargaining power with advertisers and distributors due to its sheer size.
I believe that Discovery’s $14.6 billion offer was at a considerable premium. However, the premium will be offset by the significant bargain in Discovery’s stock. The current market undervaluation of DISCA is a result of ongoing concerns on cord cutting and emerging competition from internet-based content providers like Netflix, Amazon, Hulu and YouTube. Even after these considerations, Discovery is a bargain considering its stable and attractive free cash flow, and I foresee stable growth for the company and expect the market to appraise the stock at a reasonable valuation in the future. BUY.
Azmath Rahiman, Cabot Benjamin Graham Value Investor, www.cabotwealth.com, 978-745-5532, November 9, 2017