Discovery Communications (DISCK) reported good 3Q10 results. EBITDA beat estimates indicating fundamental health of the business but EPS missed due to incentive compensation costs related to the steadily rising stock price. Also disappointing was an almost complete lack of share repurchases. DISCK reported after the close on Tuesday, a week ago. The stock had closed at $44.49, also just off its 52 week high. By the end of the first day of post earnings trading, DISCK was down 5.3%. The stock has fallen every day since then as well and is now down 8% since immediately preceding the report against a 2.1% increase for the S&P 500.
For DISCK, the main “problem” was that domestic margins did not expand enough, raising fears about rising programming expenses. Domestic revenues grew 11% on a 16% increase in advertising but reported EBITDA was only up 12%. Adjusting EBITDA for a legitimate one-time item, the gain was 17%. But this was not enough since International revenues grew 10% but that led to a 23% increase in EBITDA. So despite the key metric, domestic advertising growth, exceeding high expectations, the shares were sold.
I really don’t see anything wrong at DISCK. The big gain in the stock over the last few years and an industry high valuation (P-E or Price-to-EBITDA) had just left the expectations bar too high. Perfection was required and not delivered. What to do now? Sit tight. Northlake clients own the DISCK non-voting shares which are trading at a 15% discount to the one-vote but still non-controlling DISCA. Management clearly indicated they are a buyer of the DISCK shares on weakness. DISCK has some downside protection and fundamentals remain sound. Double digit top line growth, expanding margins, and growing free cash flow built on the back of low cost, easy to produce, and easy to export non-fiction programming is a story that will continue to be discovered.
Disclosure: Discovery Communications is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC-registered investment advisor. Discovery Communications is a net long position in the Entermedia Funds. Steve Birenberg is co-portfolio manager at Entermedia, owns a stake in the Funds’ investment management company, and has personal monies invested in the Funds.