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September 22, 2008

New Buy: Discovery Communications

After many months of monitoring and researching, I finally got long Discovery Communications in Northlake client accounts on Friday. The shares are temporarily trading under the tickers DISAD (voting) and DISCK (non-voting). In twenty days DISAD will revert to DISCA. There is also an illiquid class of super voting DISCB shares. New DISAD/DISCA shares no longer include the company's ownership of Ascent Media (ASCM) which was spun out to DISAD/DISCA shareholders as of last Wednesday night.

The reason I finally jumped in is because of unusual trading in the DISAD shares on Thursday. DISAD shares were not included the Russell 1000. Instead, DISCK shares are in the Russell. On Thursday, despite the huge rally DISAD shares fell at the close when everything else rallied.

My thinking in the very short-term is that if you add back $1.60 to DISDAD, to compensate for the Thursday spin-off of Ascent Media, at my $16.50 purchase price you really get an $18.10 price for DISAD or LESS than it closed at on Wednesday by about 2%. Since Wednesday the closest comparables Viacom (VIAB) and Scripps Interactive (SNI) are up 10% and 6%. Other media stocks are up similar amounts. Thus, DISAD got a lot cheaper vs. the group. The only good argument against DISAD shares on a relative basis to other media stocks is that it is expensive. I think I can now say it WAS expensive.

At Friday’s close of $17.29, if you add back the $1.60, you are just back to $19 or up 4% the last two days. Thus, I think you could get a further catch up move this week. While I like DISAD long-term due to my relative bullishness on cable networks, if the shares popped quickly to $19-20, I'd likely take the profit.

Beyond the short-term pricing inefficiency, several other things should work in favor of DISAD over the next few months....

....First, the completion of the recap creating a pure play operating company may open up the shares to more investors. Second, completion of the recap may lead analysts to reiterate buy ratings, or maybe even upgrade. Third, DISAD will begin holding conference calls with quarterly earnings. Thus far, no calls have been held. Obviously, I think DISAD has a good story to tell so increased exposure should support the stock.

There two primary risks in DISAD shares: slowing national ad growth and acquisitions. Thus far, national TV advertising has held up surprisingly well. However, at media industry conferences sponsored by Merrill Lynch and Goldman Sachs in the last few weeks several companies indicated some initial signs of slowing. Should this slowing accelerate, even the relatively good competitive position of cable networks will be penalized by Wall Street. On the acquisition front, I think it is possible that DISAD would be a buyer, especially given the insider control by John Malone and Advance Newhouse. Some investors may be hoping that DISAD is sold to a larger entertainment conglomerate.

Posted by Steve Birenberg at September 22, 2008 11:13 AM in DISCA