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September 16, 2010

Trimming Discovery as Initial Long-Term Target Achieved

Yesterday all client positions in Discovery Communications (DISCK) were cut back by about 40%. Discovery has been an extremely successful investment with original purchases of the DISCA voting shares made near $16 in the fall of 2008 when the company first started trading as a separate asset-backed stock following a spin-off from Liberty Media. The DISCA shares were swapped for the DISCK shares earlier this year because the non-voting DISCK shares traded at a 15-20% discount. The discount has since shrunk to 13% as both stocks kept moving up.

As a result of price increases, DISCK was getting to 4% or higher of many client portfolios. Generally, Northlake enters new ideas at 2-3% and begins to take profits if they move to 4% or higher. In the case of DISCK, I had long felt that in a good advertising environment the stock could reach the upper $30s. Since that target has been achieved, prudent portfolio management discipline says it is time to take some profits.

However, since DISCK still has attractive fundamentals, the sales still leave about a 2.5% across most accounts. This is a core position that is appropriate for a stock with 20-30% upside but also has risk should the advertising recovery falter.

As a reminder, Discovery operates cable channels focused on non-fiction in the US and abroad. Non-fiction programming is cheap to produce and translates easily internationally making Discovery a unique investment compared to other entertainment based cable networks. Strong programming and ratings at Discovery Channel, Animal Planet, and TLC have been driving recent growth. These channels are now being joined by recent rebranded channels, especially Investigation Discovery. Coming over the next few years are more rebranded channels including OWN, with Oprah Winfrey, and The Hub, a kids network in partnership with Hasbro. DISCK shares also should receive a boost from debt reduction, high free cash flow, and the company's first ever share repurchase announced a few months ago.

Disclosure: DISCK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietorof Northlake, an SEC-registered investment advisor. DISCK and DISCA comprise a net long position in the Entermedia Funds. Steve is co-portfolio manager of the Funds, owns a stake in Entermedia's investment management company, and has personal money invested in the Funds.

Posted by Steve Birenberg at September 16, 2010 02:25 PM in DISCA