DISCA/DISCK - Discovery Communications

[ander]

vince am curious how are you estimating the 8+ billion of FCF. I know they guided for 60% FCF conversion. But with some of their entities the FCF assumes adjustments for vendor financing, etc. Curious if you had done anything more specific.

Agree if it's true 10x FCF, it's a great risk / reward.

Edited May 21, 2021 by ander

[Spekulatius]

Anyone noticed that DISCA actually has underperformed T over the last ten years when you account for T‘s dividends.

Also look at Zaslav‘s pay Package:

Frankly, DISCA is a sh$tco, just like T, except that DISCA‘s management  is better paid. What is the baserate for two sh$tco‘s merging becoming just a larger sh$tco? I think it‘s pretty high.

[Jurgis]

2 hours ago, Spekulatius said:

Frankly, DISCA is a sh$tco, just like T, except that DISCA‘s management  is better paid. What is the baserate for two sh$tco‘s merging becoming just a larger sh$tco? I think it‘s pretty high.

Bbbbuuutttt Malone!

 

Nah. Just

[peridotcapital]

Discovery FCF:

2010: $0.72 per share

2020: $3.48 per share

Yes, the stock has not mirrored that growth (multiple has gone from 25x to 8x) but I don't think you can argue that management has failed shareholders with respect to value creation. They can't control the multiple. It is entirely possible that 2025 FCF is $5 per share.

[LearningMachine]

1 hour ago, peridotcapital said:

Discovery FCF:

2010: $0.72 per share

2020: $3.48 per share

Yes, the stock has not mirrored that growth (multiple has gone from 25x to 8x) but I don't think you can argue that management has failed shareholders with respect to value creation. They can't control the multiple. It is entirely possible that 2025 FCF is $5 per share.

Thanks @peridotcapitalfor sharing that history.  

I had to go back and confirm, and you're right

 

Any thoughts on why stock was trading below $20 for so long?  Fear of cord cutting, Amazon/Apple getting into streaming, or more? 

Edited May 21, 2021 by LearningMachine

[LearningMachine]

On 5/20/2021 at 4:32 AM, CorpRaider said:

I think that's Discovery's fee.  Seems like each deal break fee is in proportion to the relative size of the respective enterprise as valued by the parties via the merger.

@CorpRaider, I couldn't find the fee info in the SEC filings.  I might have missed it as I was skimming fast. 

Anyone found the original source? 

I see two conflicting media reports:

• "AT&T and Discovery included significant termination fees under the deal, agreeing to pay $720m or $1.8bn respectively if the deal fell through." https://www.ft.com/content/a424c8ae-c879-455c-8b57-fcf0605f03af
• "AT&T will owe Discovery Inc. $1.77 billion if it terminates the merger between WarnerMedia and Discovery. Meanwhile, Discovery would owe the telecom giant a $720 million breakup fee if it backs out of the merger. However, if U.S. regulators kill the deal, there will be no termination fees." https://www.hollywoodreporter.com/business/business-news/att-discovery-warnermedia-termination-fee-1234956763/

[ander]

Definitely fear of cord cutting (most of their customers were linear) and then an inability to capture enough streaming share. 

[LearningMachine]

7 minutes ago, ander said:

Definitely fear of cord cutting (most of their customers were linear) and then an inability to capture enough streaming share. 

There is some truth to that fear.  A colleague was telling me yesterday Comcast wouldn't let him get only internet in his area, and that they forced him to buy a cable package.  I think the cable-middleman setup allowed content providers to up their charges each year while letting the cable-middleman be blamed for low customer satisfaction.

Anyway, cable customer satisfaction is so low right now that he claimed he would never go back to cable even if they offer him a cheaper deal than what he is able to get from a non-cable broadband provider.  I think cable middle-men might be underestimating how much pent-up customer exodus is about to burst once customers start getting other internet options, e.g. 5G fixed wireless. 

If this merger can go through, and Apple/Amazon don't come in, Discovery/Warner combined entity has a chance to do somewhat better at streaming though. 

Edited May 21, 2021 by LearningMachine

[ander]

"A colleague was telling me yesterday Comcast wouldn't let him get only internet in his area, and that they forced him to buy a cable package." Wow! I've never heard of that. I've got to imagine antitrust will come into play if they keep doing that. What area of the country is your colleague in?

[LearningMachine]

Just now, ander said:

"A colleague was telling me yesterday Comcast wouldn't let him get only internet in his area, and that they forced him to buy a cable package." Wow! I've never heard of that. I've got to imagine antitrust will come into play if they keep doing that. What area of the country is your colleague in?

In the exurbs in Pacific Northwest, where there was no other competitor until now. 

[ander]

Interesting so he was able to go with a competitor that gave him internet only?

[LearningMachine]

4 minutes ago, ander said:

Interesting so he was able to go with a competitor that gave him internet only?

Yup, and he is already prepared to not be enticed even if Comcast now comes back and offers him a lower price for internet-only than what he is getting at the competitor.  The dissatisfaction with cable has been building up over the years, and there was no outlet so far.  This is a theme I see with several folks in online meetings - whenever there are connectivity issues, blaming on their cable provider, and waiting to jump ship as soon as another option is available. 

Edited May 21, 2021 by LearningMachine

[peridotcapital]

24 minutes ago, LearningMachine said:

Thanks @peridotcapitalfor sharing that history.  

I had to go back and confirm, and you're right

 

Any thoughts on why stock was trading below $20 for so long?  Fear of cord cutting, Amazon/Apple getting into streaming, or more? 

Yeah, the narrative has been that cord cutting will continue at current rates unabated and they could not compete in streaming, so why not just buy Netflix stock? Of course, their customers love their cheap to produce non-fiction content and thus the content has remained valuable and generated ever increasing FCF per share. Adding HBO and Warner to that mix can only help. Similar story at AMCX, which is crazy cheap.

[peridotcapital]

12 minutes ago, LearningMachine said:

In the exurbs in Pacific Northwest, where there was no other competitor until now. 

That's very interesting. Here in Seattle you can get internet only from them, but it's like $90. For $110-$120 you can get cable too, so the bundle is actually a good deal (my wife and I still watch plenty of cable). And then we add Xfinity Mobile for cell service on top of that and the value improves further.

We end up paying Comcast about $160/month for cable, 400 mbps internet, and cell service on 2 smartphones. I can't find a materially better value anywhere else and the service has been problem-free across the board. But... I don't know anyone else who is doing the same thing so maybe we are their dream customer, but the exception.

[Jurgis]

2 hours ago, peridotcapital said:

Discovery FCF:

2010: $0.72 per share

2020: $3.48 per share

Yes, the stock has not mirrored that growth (multiple has gone from 25x to 8x) but I don't think you can argue that management has failed shareholders with respect to value creation. They can't control the multiple. It is entirely possible that 2025 FCF is $5 per share.

Yep. Let's ignore the cash spent on acquisitions when calculating FCF. It's the win.

[KJP]

1 hour ago, LearningMachine said:

 

Any thoughts on why stock was trading below $20 for so long?  Fear of cord cutting, Amazon/Apple getting into streaming, or more? 

I hesitate to opine on why the market does what it does, but personally it's the potential loss of revenue from the slow (and perhaps accelerating) demise of the cable bundle combined with the leverage.  Running constant leverage at rising OIBDA is great because buybacks = FCF + (leverage ratio * (change in OIBDA)).  With falling OIBDA, that magic obviously reverses and true FCF starts to looks like reported FCF - (leverage ratio * (change in OIBDA)).  That type of structure can go from a 10% cash return to shareholders to a 3-4% cash return to shareholders rather quickly.  Whether it will or won't happen for Discovery is too hard for me to say.

 

[peridotcapital]

14 minutes ago, Jurgis said:

Yep. Let's ignore the cash spent on acquisitions when calculating FCF. It's the win.

Not sure I follow... the interest on incremental debt funding of M&A shows up in the numerator and any equity issued to fund M&A shows up in the denominator.

[Jurgis]

Just now, peridotcapital said:

Not sure I follow... the interest on incremental debt funding of M&A shows up in the numerator and any equity issued to fund M&A shows up in the denominator.

You are ignoring the fact that DISCA spent $2B cash in 2013 and $8.5B cash in 2018.

Is there a difference between the following two scenarios:

1. Company A has FCF growth you showed with no acquisitions and no extraordinary cash outlays

2. Company B has FCF growth you showed with $10B spent in the meantime

And if there is a difference, then is it OK for you to not mention the 10B cash outflow when you present the FCF growth?

[adhital]

Zaslav options are currently trading out of the money with about half of them vesting in May 2026 and in 2027. It need to rise above $36/share for him to make money.

Regarding valuation, Netflix has compounded revenue by over 25% since past 10 years and trading at around 8x revenue. Is it expensive? I don’t know but it's not cheap either. 

Discovery has compounded revenue by just over 12% during the same time frame. So they’ve created value but I don’t think trading it just around 1.5x is fair. 

If the merger goes through and if they can improve the revenue growth and margin expansion in par with netflix, this should get rerated substantially.  $3B synergy can go towards content spending. FCF may not be way to value this going forward given the capex it needs to invest on contents. Netflix is spending $18B just this year with $25 annual revenue. Discovery/TW likely will spend on the same ballpark.

If they can pull off the margin expansion, smart capex spend and gain market share , its not very hard to imagine the combined company to trade at least 2x forward revenue, if not more. Just based on this simple math, 2023 fair equity value can be > $100B or 30B for Discovery shareholder. We can discount back to PV using whatever discount rate we like to use, but the current share price cheap. It’s at least double from here in next 5 years Or, could go much much higher. Taking debt improvs the ROE too. I sold it a while back and have started buying.  downside is not much either if the merger don't go through..

 

[mwtorock]

If it is really cheap, Malone should buy more. If he does not, it is not really cheap. 

Sorry, that is a silly short cut valuation.

[adhital]

4 minutes ago, mwtorock said:

If it is really cheap, Malone should buy more. If he does not, it is not really cheap. 

 Sorry that’s a silly argument  

[walkie518]

unfortunately, I think it's likely that there will now be an overhang on DISCA/K until a month or so after the deal closes  

I have trouble seeing how T shareholders will want to hold the Warner/Discovery assets? 

[LearningMachine]

1 minute ago, walkie518 said:

unfortunately, I think it's likely that there will now be an overhang on DISCA/K until a month or so after the deal closes  

I have trouble seeing how T shareholders will want to hold the Warner/Discovery assets? 

That makes sense.  That said, the deal won't close until 2022. So, lots of time for all kinds of things to happen. 

[walkie518]

valuation does look good though have owned DISCK since $17/sh and perhaps should've sold prior to Archegos ... then again, I am happy to own Warner/Discovery

today, shorting DISCA and buying an equal amount of DISCK seems like a reasonable play to trap value

a lot of activity in Lions Gate...must be related to speculators thinking LGF will do the same thing 

curious when anti-trust starts to care? or maybe businesses trading at 5x EBIT get a pass?

[wabuffo]

That said, the deal won't close until 2022. So, lots of time for all kinds of things to happen.

The stock will be under pressure after that, too.  For a couple of reasons:

1) the overhang of the T shareholders, many of whom will be selling after the close.  They are dividend "digesters" (LOL) and there will never be any here for perhaps ever.

2) The dashed expectations of former Discovery shareholders who expect continuous large buybacks.  I'm almost certain that there will be a suspension of all capital returns for 1-2 years in order to pay down debt after the merger.

The same thing happened after the Discovery- Scripps Network merger.  Discovery had to suspend its prodigious buybacks in order to pay down debt from the merger.  The stock tanked.   So much so, that Malone had to go on CNBC during a Liberty Investor Day and proclaim that the stock was cheap and he was thinking of buying it in the open market (which he did after the public statement on CNBC).

So this stock could be under pressure for awhile.  I own a ton, but I am in no hurry to buy more - though I will if it falls enough over the next 2-3 years.

wabuffo