DISCA/DISCK - Discovery Communications

[LearningMachine]

1 hour ago, Jurgis said:

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?

What if Company A retains earnings and spends $10B on internal projects, and grows FCF, e.g. like Berkshire Hathaway Energy?

[Jurgis]

1 minute ago, LearningMachine said:

What if Company A retains earnings and spends $10B on internal projects, and grows FCF, e.g. like Berkshire Hathaway Energy?

Is it spending on internal projects every year? Then that's reflected in FCF yearly.

Is it spending it via huge outlays every Xth year? Then you should somehow adjust FCF on the years when it does not have the outlays.

How would you value the following:

Scenario 1. Year 1-10: $1B OCF 0.5B capex 0.5B FCF

vs

Scenario 2. Year 1-8 and year 10: 1B OCF, 0 capex, 1B FCF. Year 9: 1B OCF 5B capex -4B FCF

Is scenario 2 worth 2x scenario 1 because it has 2x higher FCF in year 10?

 

[vince]

I haven't read any other posts after this one yet but will say that the following post is a fantastic (yet basic if you call yourself an investor) rebuttal to Spec's post.  This is exactly what I wanted to write but am tired of wasting my time repeating what I thought was understood when I wrote my original post.  I stand by exactly what I wrote and Spec's writings continue to inform me more about his abilities rather than providing anything of value about the businesses in question

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.

[adhital]

21 minutes ago, walkie518 said:

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

based on this chart, looks like shorting DISCK and buying DISCA is better buy

[peridotcapital]

2 hours ago, Jurgis said:

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?

I think current FCF/share is real, no matter how they got there. And I think the multiple one assigns to it today should reflect the future growth outlook for said cash flow. If you are arguing that we should pay a lower multiple today because they have grown via M&A in the past (and are trying to do so in the future), okay fine, but there are plenty of companies that are serial acquirers and FCF per share stays stagnant deal after deal after deal (AT&T anyone?). If management is growing per-share FCF, I consider that real value creation regardless of method. Investors still have to pay an appropriate price for that value creation to make money on the investment. If adding HBO and Warner Bros makes their offerings more valuable to the consumer, I will gladly have Zaslav grow FCF per share via M&A over the next 5 years, and folks buying at 8x FCF should make nice money as a result. For those who paid 25x FCF in 2010 for a cable content company, well, their poor returns should have been expected.

[walkie518]

23 minutes ago, adhital said:

based on this chart, looks like shorting DISCK and buying DISCA is better buy

I see DISCA trading at $31.60 and DISCK trading at $29.20 ... they are going to collapse into one share class upon consummation ... maybe your chart is set to % change? 

Since announcement of the deal, pricing has started to rationalize and it's likely there will be some vol given others who see the overhang 

 

[walkie518]

2 minutes ago, peridotcapital said:

I think current FCF/share is real, no matter how they got there. And I think the multiple one assigns to it today should reflect the future growth outlook for said cash flow. If you are arguing that we should pay a lower multiple today because they have grown via M&A in the past (and are trying to do so in the future), okay fine, but there are plenty of companies that are serial acquirers and FCF per share stays stagnant deal after deal after deal (AT&T anyone?). If management is growing per-share FCF, I consider that real value creation regardless of method. Investors still have to pay an appropriate price for that value creation to make money on the investment. If adding HBO and Warner Bros makes their offerings more valuable to the consumer, I will gladly have Zaslav grow FCF per share via M&A over the next 5 years, and folks buying at 8x FCF should make nice money as a result. For those who paid 25x FCF in 2010 for a cable content company, well, their poor returns should have been expected.

scripps + discovery was a good merger at great pricing, but both companies were two-sides of the same coin

discovery + warner will be another doubling cash flow, but both companies are more complementary whereas scripps fortified a niche in content 

on cash flow, warner is still overpriced, but the IP does change the dynamic of the company and calling Guy Fieri "Batman" doesn't really work

[dwy000]

36 minutes ago, peridotcapital said:

I think current FCF/share is real, no matter how they got there. And I think the multiple one assigns to it today should reflect the future growth outlook for said cash flow. If you are arguing that we should pay a lower multiple today because they have grown via M&A in the past (and are trying to do so in the future), okay fine, but there are plenty of companies that are serial acquirers and FCF per share stays stagnant deal after deal after deal (AT&T anyone?). If management is growing per-share FCF, I consider that real value creation regardless of method. Investors still have to pay an appropriate price for that value creation to make money on the investment. If adding HBO and Warner Bros makes their offerings more valuable to the consumer, I will gladly have Zaslav grow FCF per share via M&A over the next 5 years, and folks buying at 8x FCF should make nice money as a result. For those who paid 25x FCF in 2010 for a cable content company, well, their poor returns should have been expected.

Its a question of how you use the FCF (i.e. is it really "free cash").  If you spend it on capex you have lower FCF (and FCF/share) than if you have acquisition spend every 5-10 years that you pay for with debt.  But if all that extra FCF in the acquisition scenario has to be used to repay the debt incurred it's not apples to oranges.  If you want to look at it equally, you need to factor in the cash flow required to equalize the debt level.

Otherwise you could just keep using more and more debt to buy back stock.  Your FCF/share would go way up even though FCF might have declined.  If you equalize for net debt it helps even it out.

[Spekulatius]

4 hours 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? 

Now do the debt and add back interest expense to the FCF to strip out the financial engineering. The way the numbers are achieved matters. DISCK started as a high single digit organic grower in 2010 with a pretty clean balance sheet and it ended up as a melting icecube with a rather iffy balance sheet. That's why the multiple has collapsed. it's a buy if they can reverse the trend and it's not if they can't. The financial engineering is of lesser importance than the business performance and just enhances the trend in either direction.

 

Each of the Malone controlled business, that has been a melting icecube or lacked organic growth has failed to create shareholder value (LILA, LBYTA, DISCA)

[CorpRaider]

3 hours ago, wabuffo said:

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

Good stuff. 

I also have always had a problem rolling with Zaslav. 

Whoever asked about the termination fee, it is discussed in Section 10.5 of the merger agreement filed with an 8K yesterday.  I think a simpler explanation of the mechanics was also in the original 8k.

 

Edited May 21, 2021 by CorpRaider
I read the merger dox

[LearningMachine]

50 minutes ago, Spekulatius said:

Now do the debt and add back interest expense to the FCF to strip out the financial engineering. The way the numbers are achieved matters. DISCK started as a high single digit organic grower in 2010 with a pretty clean balance sheet and it ended up as a melting icecube with a rather iffy balance sheet. That's why the multiple has collapsed. it's a buy if they can reverse the trend and it's not if they can't. The financial engineering is of lesser importance than the business performance and just enhances the trend in either direction.

 

Each of the Malone controlled business, that has been a melting icecube or lacked organic growth has failed to create shareholder value (LILA, LBYTA, DISCA)

Here is how it looks with debt added in.  Debt has been growing in line with FCF, just a little faster.   Because interest rates have been going down so far, interest expense per share probably hasn't been growing that much.  Risky if interest rates start to go up, but if interest rates stay low, and they can pay back more debt that they are gonna take with the merger, could become less risky.

 

I have been burnt by LBTYA and LILA as well in the past - so, trying to look at it objectively as the merger does change the economic power.  In other words, two shitcos merging does provide a chance to get scale, which can be beneficial for a direct brand for streaming. 

After getting burnt by LBTYA and LILA, and seeing Discovery didn't have market power, I stayed away, but what caught my attention was that Mr. Market was not recognizing the change in economic power due to the merger.  It might have been overpriced before the merger, but the merger itself should result in more economic power. 

However, given my long-term principle to price things as if interest rates could hit 10% any day, looks like I need to get out of it at the next profitable opportunity even though I just bought the dip today :-).  How did I get so excited that I forgot about my principle :-).

Edited May 21, 2021 by LearningMachine

[Spekulatius]

@LearningMachine thanks for putting up the table, it is very helpful for perspective. I have been invested in DISCA and SNI (Scripps)  from ~2015 to 2017 and made some money (mostly on the Scripps side) and have played this game too, with some success but not really a great IRR.

I am not convinced that scale is the solution to DISCK problem and I know that Malones does, hence the support for a merger.

 

A few thought that are loosely related tp each other:

1) DISCA‘ content is a commodity. Many of their channel have lost relevancy (the former Scripps channels are actually amongst the better ones) as there are ready replacement with YouTube and Netflix

2) DISCA‘s true competitors aren’t other cable channels any more, they are Facebook, YouTube /Google, Netflix, Amazon Prime, Disney. Compared to those, DISCA looks like the patsy on the table. Some of these play and entirely different Metagame and seem to be winning (Netflix, Amazon). DISCA plays the cash flow game, but seems to be losing. Now we can say the market got it all wrong, but this has been going on for 10 years now at least. Mr Market very rarely is wrong for 10 years.

3) Mega mergers are hard, especially on a business like Media, where people really matter. This is not two companies that make plastic containers in difference Geographie margin (Berry) which is something that almost always works. Most large mergers fail to create shareholder value and I think base rates matter.

4) Even if you think the merger is ultimately a good idea, the timing to invest seems early. lots of folks are probably eager to dump their stock. ATT is likely a structural seller in the long run. No buybacks for a while to delever. Think CVS - Aetna (different industry, same setup) and how long it took for the shares to move.

 

Anyways, those are just my thoughts, all of which are qualitative. Tables and spreadsheet are useful but only get you as far as getting a sanity checks. You have got to be right about analysing the business and in that regard, the current setup looks anything but a one foot hurdle to me. 
 

If I am wrong, so be it, it’s a no called strike for me. Hope everyone here makes money by the boat load.

Edited May 21, 2021 by Spekulatius

[adhital]

@Spekulatius how much would you be willing to pay (or ditch Netflix) for TW/Discovery contents? ad-free and ad supported versions for example? 

Don’t  know how to setup a poll here but would be interesting to know

[LearningMachine]

6 minutes ago, adhital said:

@Spekulatius how much would you be willing to pay (or ditch Netflix) for TW/Discovery contents? ad-free and ad supported versions for example? 

Don’t  know how to setup a poll here but would be interesting to know

I used to like Discovery channels a lot 20 years ago.  I am still interested in those subject areas. Even then, I wouldn't be willing to pay anything for it today.  What I would be willing to pay for though is YouTube, only if free version wasn't available.  Too bad, Mr. Market is pricing it all in for GOOGL :-(.

[Spekulatius]

30 minutes ago, adhital said:

@Spekulatius how much would you be willing to pay (or ditch Netflix) for TW/Discovery contents? ad-free and ad supported versions for example? 

Don’t  know how to setup a poll here but would be interesting to know

Easy answer - zero.

I have Netflix, Amazon Prime, Hulu (because cheap for $2.99/ month for one year) , Apple TV (free, because of iphone purchase) and Peacock ( free Version).

 

Quite frankly, I can live well with Netflix and Amazon Prime alone. I cut the cable years ago and never looked back.

[adhital]

19 minutes ago, LearningMachine said:

I used to like Discovery channels a lot 20 years ago.  I am still interested in those subject areas. Even then, I wouldn't be willing to pay anything for it today.  What I would be willing to pay for though is YouTube, only if free version wasn't available.  Too bad, Mr. Market is pricing it all in for GOOGL :-(.

Yes, I’ll pay for YouTube as well. But, HBO is not bad too.. I’ve both Netflix and hbo and I think I spend equal time watching both but I think I like hbo better though.. and now Combined with news, TLC, food etc.. I think the package would be compelling for someone to switch.. that’s why poll would be interesting. Twitter might be of help here  

[vince]

4 hours ago, peridotcapital said:

I think current FCF/share is real, no matter how they got there. And I think the multiple one assigns to it today should reflect the future growth outlook for said cash flow. If you are arguing that we should pay a lower multiple today because they have grown via M&A in the past (and are trying to do so in the future), okay fine, but there are plenty of companies that are serial acquirers and FCF per share stays stagnant deal after deal after deal (AT&T anyone?). If management is growing per-share FCF, I consider that real value creation regardless of method. Investors still have to pay an appropriate price for that value creation to make money on the investment. If adding HBO and Warner Bros makes their offerings more valuable to the consumer, I will gladly have Zaslav grow FCF per share via M&A over the next 5 years, and folks buying at 8x FCF should make nice money as a result. For those who paid 25x FCF in 2010 for a cable content company, well, their poor returns should have been expected.

I think that the fcf per share that Peridotcapital references is distinguished from fcf growth, and I believe that's what he was trying to say with this post......."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".  This goes a long way in determining whether the cash flow growth is adding to value.  Jurgis is right to say that just because earnings are growing doesn't mean value has been created as Buffett has said before that even a savings account will kick out ever greater earnings by just retaining earnings annually.  The true way to make the determination is to look at incremental and/or total returns on invested/tangible capital.   If the returns on incremental capital (including debt capital) are north of say 10% then the best possible thing Malone can do is borrow at low rates to make acquisitions (assuming the debt ratios stay within reason or come back down when they go over that desired ratio) and use free cash flow to buy back as many shares as he can ESPECIALLY when the free cash flow yield is 10-12% on the buyback. Picture a bank that borrows at 4-5% and lends out at 12%.  Malone is not perfect but his long term value creation record is phenomenal.

[Spekulatius]

3 minutes ago, adhital said:

Yes, I’ll pay for YouTube as well. But, HBO is not bad too.. I’ve both Netflix and hbo and I think I spend equal time watching both but I think I like hbo better though.. and now Combined with news, TLC, food etc.. I think the package would be compelling for someone to switch.. that’s why poll would be interesting. Twitter might be of help here  

HBO would be an interesting asset by itself and wish ATT would have spun it off. I think they didn’t because they needed to structure a deal so they could get cash out.

HBO by itself would need to invest heavily and cannot support a debt burden, but it would be an unique asset, if they concentrate on high quality content and play a different game. Maybe ATT has damaged it already too much, that’s hard for me to judge.

[adhital]

 

14 minutes ago, Spekulatius said:

HBO would be an interesting asset by itself and wish ATT would have spun it off. I think they didn’t because they needed to structure a deal so they could get cash out.

HBO by itself would need to invest heavily and cannot support a debt burden, but it would be an unique asset, if they concentrate on high quality content and play a different game. Maybe ATT has damaged it already too much, that’s hard for me to judge.

I think at the end of the day, TW/D is competing with Netflix audience ultimately. No one is going to switch prime, that’s for sure. Disney is on its own. I won’t be paying for both as well given YouTube and prime options. 

I read it somewhere that GOT is getting renewed for few seasons. Also, WB pictures likely to be played on this platform pre-release...

If they offer, say, $15/month for whole package plus additional income from cable advertising, I think they’ve a shot.. 

 

Edited May 22, 2021 by adhital

[vince]

The true value of Discovery to HBO is their globality.  Anything less than global scale in this game will fail so the survival strategy is to get it as soon as possible.  Netflix will soon be spending 20 billion on content (rising annually). So if your business does not allow you to get somewhere near that number, you are toast eventually.  And you will not get there with a u.s. business.  And the longer it takes for you to get there the harder it gets.  

[adhital]

3 minutes ago, vince said:

The true value of Discovery to HBO is their globality.  Anything less than global scale in this game will fail so the survival strategy is to get it as soon as possible.  Netflix will soon be spending 20 billion on content (rising annually). So if your business does not allow you to get somewhere near that number, you are toast eventually.  And you will not get there with a u.s. business.  And the longer it takes for you to get there the harder it gets.  

Their yearly combined revenue is almost twice that of Netflix and all the $$ they are now spending on buyback and dividend payout plus $3B cost savings will go towards contents. So they’ve the fire power. May be they should start bundling it now rather then waiting for official merger next year.. who knows they might announce something soon 

[vince]

Another topic that I think is grossly misunderstood is "financial engineering".  I have listened to close friends criticize executives that use debt, buybacks, recaps, spinoffs etc, claiming that these things couldn't possibly increase the stock price.  I have seen countless talking heads on CNBC do the same thing.  Mary Barra ran around the world and worked her ass off trying to apply her magic touch to operations and with a ton of excess cash sitting there that did no work at all.  Imagine how many shares she could have repurchased at 30 bucks (and even less) and what the equity would be trading at now that the market has realized the business is more valuable than originally thought.  And by the way, it took roughly 10 years for the market to realize.  If you read the book "Outsiders" you will see that the CEO's profiled created just as much value with the balance sheet as they did with operations.  That's how they achieved the magic 20% over long periods.  Obviously, just putting lipstick on a pig is not going to produce superior returns.  But when you have a decent business I think a CEO (with his 20 million dollar pay) is REQUIRED to use financial engineering (I call it financial basics) to maximize returns to shareholders.  

[Spekulatius]

I read Outsiders too and I think most people have the wrong takeaway from this book, namely that capital allocation is the most important thing for a CEO.

While I think it is extremely important, I think reads may be missing how good most of those CEO‘ in Outsiders were operationally. Singleton, for example was an exemplary operator and that’s what really enabled his capital allocations moves.

If you look at great capital allocators today (example Transdigm), they are great operators and food industries. My take is that industry and operational Skills matter much more than their Capital allocation moves. Looking at Transdigm, Heico is similar in term of industry and operational prowess without any of the financial engineering and they do quite well. Even TDY ( Teledyne - Singleton‘s vehicle) has done great long after Singleton was gone, because they are great operators.

My simple take is that operational prowess and industry matters much more that capital allocation and the same moves done without a solid foundation in terms of operations most likely lead to disaster rather than outsized returns.

Another note - why didn’t DISCA raise some funds with a secondary like VIAC did early this year? Seems to me that if capital allocation is such a core competence, selling overvalued stock should be part of the equation. It was for Singleton and even these chumps at VIAC ran the cash register.

[wabuffo]

why didn’t DISCA raise some funds with a secondary like VIAC did early this year? 
I think they were in negotiations with T and couldn’t do a secondary without disclosing the MNPI.  Knowing Malone, the overvalued Discovery stock would’ve been an extra motivation to pursue the merger.  It will be interesting to read the proxy on the deal to see how both sides dealt with/reacted to the sharp drop in price after Archegos blew up in the middle of their negotiations.

wabuffo

Edited May 23, 2021 by wabuffo

[vince]

3 hours ago, Spekulatius said:

I read Outsiders too and I think most people have the wrong takeaway from this book, namely that capital allocation is the most important thing for a CEO.

While I think it is extremely important, I think reads may be missing how good most of those CEO‘ in Outsiders were operationally. Singleton, for example was an exemplary operator and that’s what really enabled his capital allocations moves.

If you look at great capital allocators today (example Transdigm), they are great operators and food industries. My take is that industry and operational Skills matter much more than their Capital allocation moves. Looking at Transdigm, Heico is similar in term of industry and operational prowess without any of the financial engineering and they do quite well. Even TDY ( Teledyne - Singleton‘s vehicle) has done great long after Singleton was gone, because they are great operators.

My simple take is that operational prowess and industry matters much more that capital allocation and the same moves done without a solid foundation in terms of operations most likely lead to disaster rather than outsized returns.

Another note - why didn’t DISCA raise some funds with a secondary like VIAC did early this year? Seems to me that if capital allocation is such a core competence, selling overvalued stock should be part of the equation. It was for Singleton and even these chumps at VIAC ran the cash register.

I think it's silly to imply that I downplayed operations.  Obviously a well operating business is what feeds the capital allocation function.  But change is constant and capital allocation is what saves the day when you inevitably find your business will soon be obsolete.  On discovery specifically..... their industry is being disrupted by a different model.  Something that you think makes them a sh@tco.  They are trying to make the transition and I would argue it's their capital allocation skills that have increased the odds dramatically that they will thrive.  Instead of blurting out sh@tco, show the board how they underperformed their peers using the "operational" metrics that are within their control. Enlighten us with your analysis of their capital allocation, I know how hard that is when looking backwards. Grading Discovery by comparing their stock price to AT&T is outrageous.