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February 17, 2014

Discovery Communications: Bottoming Out After a Rough Stretch

Discovery Communications (DISCK) reported results roughly in line with Wall Street estimates and provided 2014 guidance just a little below expectations. Estimates for the December quarter and 2014 had been falling recently as DISCK’s leading U.S. networks, Discovery and TLC, had a rough patch of lower ratings. The stock has performed poorly during this period and traded off again after the earnings report. Encouragingly, the shares did not retreat to recent lows and bounced strongly the next day. Improved ratings accompanying new original programming so far in 2014 are a positive.

I think the worst is past for DISCK and with the expectations bar reset, the shares can again perform well. DISCK now trades at a modest premium to its peers on a P-E and price-to-EBITDA basis. Given the company’s well above average growth profile driven by its international exposure, low-cost model focused mostly on non-fiction programming, strong management, and steady share repurchases, I think the shares can trade toward $100 as 2014 progresses when investors find 2014 guidance was conservative and begin to look ahead to 2015 and EPS of at least $4.65.

In the December quarter, DISCK grew mid-single digits in the U.S., a slowdown from earlier in the year. Advertising only grew 4%, down from double digit gains, as ratings at the two leading networks were down more than 10% in the quarter. International growth continued briskly with advertising up over 20% and mid-teens growth in affiliate fees. DISCK not only grows fast abroad but has the highest proportion of revenue and operating profit earned internationally of any major media company. The company has double down on its international growth with acquisitions in Scandinavia and the Eurosport network. These acquisitions do add some risk and definitely complicate the analysis but management appears quite confident and the deals, while large compared to recent history, are mostly consistent with the company’s corporate strategy.

To reiterate, DISCK’s recent ratings and acquisition binge have pressured the shares but expectations appear reset and the company’s attractive competitive position globally and above long-term growth should get the stock moving again later this year.

DISCK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake regulatory filings can be found at www.sec.gov. DISCK is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Posted by Steve Birenberg at February 17, 2014 10:51 AM in DISCA