Summary
- The shift away from traditional pay TV to an OTT model has left investors wary of smaller players and how they will adapt to the new environment.
- Discovery has popular content on its flagship channels and its low cost of content (unscripted business model) should allow for steady fcf through the transition to OTT streaming.
- Discovery will need to sign up around 15M subs to Discovery+ to offset traditional tv declines.
- Discovery trades at an EV/EBITDA (TTM) multiple of 7x which is significantly below the industry median of 10x.
Recommendation
Discovery, Inc. (DISCK) is cash flow machine but the changing media landscape has investors nervous smaller players will struggle to deal with the transition from traditional cable/satellite TV to OTT platforms. This has left Discovery trading at some attractive multiples (EV/EBITDA- 7x & P/E- 7x, P/FCF- 6x), all below the industry averages.
While it is true that scale is an essential factor for this transition, Discovery has a library with over 60,000 hours of content and can produce roughly 8,000 hours annually (Discovery owns its content and as the saying goes “content is king”). Discovery’s launch of its own OTT service is expected in Q1 2021 and its low cost of production (unscripted shows), planned niche offering, and expected affordable price point should allow Discovery to create a successful streaming service. Discovery is also still making solid margins in the cable TV business and will continue to do so despite the secular industry shift.
Company background and recent developments
Discovery is a global media company that provides content across multiple platforms such as pay TV, FTA, authenticated TV applications, and OTT platforms. Its channels include Discovery, HGTV, TLC, Animal Planet, and Eurosport. They operate in two segments; U.S. Networks and International Networks. The U.S. Networks segment generates 65% of revenue and 80% of adjusted OIBDA (operating income before depreciation and amortization). Advertising and distribution revenues make up 98% of their revenues and their largest costs relate to producing and acquiring content. John Malone, the famed media mogul, is a major shareholder and has significant voting power.
Source: Discovery
In March 2018, Discovery purchased Scripps Networks Interactive, Inc. for $12B ($8.8B cash and $3.2B stock). At the time of the acquisition, Scripps was generating approximately $3.6B in revenue, $650M in net income, and $900M of fcf on an asset base of $6.5B (based on Scripps FY17 numbers). At the time of the deal Discovery expected $350M of annual cost savings from the deal, but this was later adjusted up to around $600M. The deal added female focused channels such as HGTV, Food Network, and Travel Channel to Discovery’s predominantly male portfolio. Analysts agreed with the acquisition’s rationale (consolidation to increase leverage over cables providers and to create a larger library of content), but viewed the deal as expensive and not enough to offset the secular move away from traditional cable TV. The stock fell to around $15 after the acquisition was announced (was trading around the $25-$30 before rumors of the deal) but recovered to $20 by the time Discovery took control of Scripps. The stock currently trades at around $24.
