DISCA/DISCK - Discovery Communications

[jtvalue]

I saw that DISCK was just written up on SumZero.  Anyone have access and care to share?

[Philip Morris IV]

The key here IMO is what is the debt trading for.  For many of these media names the debt is trading in the BBB/BB range & the reason for the spread is the fear of substitution.  Substitution will happen bu the question will the incumbents have enough time to react (ala fixed-line & cellular) or not (newspapers & internet).  I am of the opinion that there is enough time to react to the substitution will be adopted by the incumbents before the disruptors can cause much damage.  This is what the bond market is saying also & I also believe the bond marker before the stock market anyway.

 

Packer

 

What's the maturity on the debt you're looking at?  If the concern is that these businesses might really start to decline 7-15 years from now (which would greatly affect the equity), how much does the yield on 5-year debt tell you?

 

From what I can see today, 6-9yr debt for DISC is trading around 3.3-3.8% and 23-26yr debt is trading around 5.2%.  Still looks like a decent debt/FCFE yield spread even on the long end.

[KJP]

The key here IMO is what is the debt trading for.  For many of these media names the debt is trading in the BBB/BB range & the reason for the spread is the fear of substitution.  Substitution will happen bu the question will the incumbents have enough time to react (ala fixed-line & cellular) or not (newspapers & internet).  I am of the opinion that there is enough time to react to the substitution will be adopted by the incumbents before the disruptors can cause much damage.  This is what the bond market is saying also & I also believe the bond marker before the stock market anyway.

 

Packer

 

What's the maturity on the debt you're looking at?  If the concern is that these businesses might really start to decline 7-15 years from now (which would greatly affect the equity), how much does the yield on 5-year debt tell you?

 

From what I can see today, 6-9yr debt for DISC is trading around 3.3-3.8% and 23-26yr debt is trading around 5.2%.  Still looks like a decent debt/FCFE yield spread even on the long end.

 

Yes, I know about the current yields on Discovery's long-term debt and agree about the spread.

 

I was asking about the other "media names" with debt "trading in the BBB/BB range" that Packer referred to in his post.  I assume he's talking about broadcasters like Sinclair and Nexstar that have shorter-term debt, but I could be wrong.

[dwy000]

"I believe the bond market before the stock market"

 

Never has a truer word been said.  The company just sold 7 year notes off the back of doubling down in the industry and they got priced to yield 2.5%.

[Spekulatius]

Couple anecdotal observations and thoughts:

 

- IMO, the world is awash in too much content. BTW, this is not just about DISCA. I have the same opinion about Netflix/Amazon/Disney/etc. Does not mean that content companies can't make gigabucks. Might mean that competition is bigger than people expect. DIS is making nature movies now too: DisneyNature Born in China.

- Non-fiction library value is less than fiction library value. DISCA might have brand, but while people rent and watch 10 year old movies, they don't much rent and watch 10 year old nature documentaries.

- I think DISCA is pushing a lot into international markets. This might still be somewhat of tailwind, but I can't quantify how much.

 

I still hold my shares. I also hold some LGFB. Liberty pieces that haven't gone up recently and might be somewhat cheap (for a reason).

 

The content inflation is real. Amazon and Netflix now produce a lot of content that competes with the existing players.  Scripted content >> non scripted content. For documentaries, I can pull all I want from YouTube for free or Amazone prime or Netflix. That is a big threat to Discovery, which has to compete and it’s is one reason why Discovery and similar channels go into scripted content. That however also begs the question how Discovery channel can differentiate itself.

 

Personally, I found that Fiscovery channel was not missed after cutting the cord and is easily replaced by YouTube or Amazon content. I never liked the scripted shows in Discovery channels to begin with l but I do know that some people do. These scripted shows don’t travel as well internationally though.

 

I wonder how much cost cutting can really be done between SNI and DISCK without loosing something too.  Generating content does not really seems to have much economies of scale and that is really where most of the operating cost is.

[morob]

I believe consolidation in content is not so much about cost synergies but more about the gain in distribution leverage. As the cable operators are consolidating, so rises the pressure for content producers to do the same, particularly the smaller ones that are subscale. In addition, if you want to compete with the Netflix and Amazons of the world, you need to gain global distribution capabilities. I think all of the above motivated the DISCA/SNI merger. Actually, Malone articulated this many times in the past. While there is certainly some overhead that can be reduced (conservatively 300m+ according to mgt), the real synergies are likely on the distribution side. Some of it is strategic/defensive (better negotiating position), others simply the distribution of SNI content through DISCAs global network. Currently SNI has a very small international business. Another positive is the excellent SNI ad sales team which could enhance DISCAs ad business. Disca is certainly not without its challenges, hence the merger which was at least partially of defensive nature. It is also interesting that through this merger three of the most formidable US media investors/families have teamed up - Malone, Newhouse and Scripps. I wouldn't count them out of the race yet. The stock looks very inexpensive given the decent probability that some of the upside scenarios will materialize. Right now it is all about cord cutting, a sense that they overpaid for a slowing SNI and a potential doubling down on the cord cutting risk with the acquisition of SNI. On top you have merger arb dynamics and a suspension of buybacks. Come next year and it will become clearer how fast they are able to delever and potentially already show a path for some revenue synergies.

[Spekulatius]

I believe consolidation in content is not so much about cost synergies but more about the gain in distribution leverage. As the cable operators are consolidating, so rises the pressure for content producers to do the same, particularly the smaller ones that are subscale. In addition, if you want to compete with the Netflix and Amazons of the world, you need to gain global distribution capabilities. I think all of the above motivated the DISCA/SNI merger. Actually, Malone articulated this many times in the past. While there is certainly some overhead that can be reduced (conservatively 300m+ according to mgt), the real synergies are likely on the distribution side. Some of it is strategic/defensive (better negotiating position), others simply the distribution of SNI content through DISCAs global network. Currently SNI has a very small international business. Another positive is the excellent SNI ad sales team which could enhance DISCAs ad business. Disca is certainly not without its challenges, hence the merger which was at least partially of defensive nature. It is also interesting that through this merger three of the most formidable US media investors/families have teamed up - Malone, Newhouse and Scripps. I wouldn't count them out of the race yet. The stock looks very inexpensive given the decent probability that some of the upside scenarios will materialize. Right now it is all about cord cutting, a sense that they overpaid for a slowing SNI and a potential doubling down on the cord cutting risk with the acquisition of SNI. On top you have merger arb dynamics and a suspension of buybacks. Come next year and it will become clearer how fast they are able to delever and potentially already show a path for some revenue synergies.

 

Yes, the distribution angle makes a lot of sense, since DISCA and SNI are both fairly small compared to other media companies and the cable operators in the US.

[reader]

I'm a fan of Dr. Malone but maybe we're heading to a CWC like value destruction?

 

https://www.bloomberg.com/gadfly/articles/2017-11-03/discovery-shareholders-take-heart-john-malone-knows-deals

 

[HalfMeasure]

I'm a fan of Dr. Malone but maybe we're heading to a CWC like value destruction?

 

https://www.bloomberg.com/gadfly/articles/2017-11-03/discovery-shareholders-take-heart-john-malone-knows-deals

 

Different scenario as he was on both sides of the CWC transaction.

[thefatbaboon]

Dont have a great deal to add,  but to say wow, if this thing doesn’t melt this has a 20% FCF yield and is really really cheap.

[Broeb22]

What is difficult for me about Discovery is that broadcasters are trading at similar levels. I used to own DISCK because I thought it could grow internationally while maintaining a relatively flat domestic business. 3 years later, I believe I was proven wrong, and the unusual things DISCK is doing to meet its earnings targets (such as tax credit investments) is troubling. I know John Malone's reputation for intelligent tax manuevers, but when the company would otherwise be missing its long-term FCF targets, tax credit investments seem like putting lipstick on a pig.

 

As I researched the broadcasters (NXST, SBGI, TGNA, etc.), I found higher FCF yields than DISCK (at the time) but arguably stronger business positions because they were being included on skinny bundles and net retransmission revenue was actually growing.

 

Both broadcasters and DISCK are being traded like melting ice cubes. My assessment was that DISCK is melting faster, so I'd rather own TV broadcasters for similar yields.

 

I've had similar thoughts about radio. Entercomm is doing a huge deal for CBS Radio that will result in a company trading at 20% FCF yield (pro forma for synergies), and 5.5 EV/EBITDA after synergies when iHeart Radio and Cumulus Media both trade for 11x EBITDA and are highly levered.

 

In other words, there are some other relative values that could be even better than DISCK.

[thefatbaboon]

I agree with your points regarding the relative value offered by the broadcasters. And I like those businesses. The risk there is the affiliate relationship with CBS, NBC etc. Probably they have the bargaining position to get increasing amount of reverse retrans out of the local broadcastersc. Plus Tegna has some big markets that look juicy and could get could get picked off. Also the threatened  FOX/ION partnership seems to have some plausibility, a risk for Sinclair/tribune. GTN seems to have quite a robust position. Also what is the long term position for the national networks? Do cbs and nbc keep winning sports rights?  I guess the local broadcasters have a different set of risks to Discovery. 

 

I’m not sure your original logic to buy disck is disproven. They have more than held US flat and they have had to deal with some tough x rates abroad, a recession in lat am and the loss of Russia.  I think the jury is out still as to longer term prospects but so far DISCK seems to be doing fine fundamentally speaking. 

 

Thanks for the radio idea. Need to have a look at that CBS/entercom. But unlikely  I get over what will likely be zero growth and absence of sub/affiliate/retrans. Even if it’s one or two turn cheaper than an sbgi or disck.

[Broeb22]

Yeah, I view the radio situation as more of a special situation. I believe there may be some serious forced selling from CBS shareholders/arbs around the time the deal completes. Arbs are buying CBS now and shorting ETM because CBS is offering a 1.08 exchange ratio to CBS shareholders to exchange into ETM. So when that all reverses, there is going to be some interesting trading right after the merger completes later this month.

[thefatbaboon]

One positive thing I like to keep in mind with discovery (and scripps) is that their content commitments are short term. They can and do adjust costs quickly to protect margins. I think this is important when evaluating a business that might be a melting ice cube as negative operating leverage on some ice cubes can be horrible.

 

In other news Wargo bought 100,000 shares over the last couple days and Gunnar added 15,000.

[UK]

https://www.cnbc.com/2017/11/16/cnbc-exclusive-cnbc-transcript-liberty-media-chairman-john-malone-speaks-with-cnbcs-david-faber-today.html

 

DAVID FABER: So what do you do-- I mean, let's bring it back to a company that you own a significant economic stake in and a larger control stake, Discovery. What do you do if you're Discovery? You do the Scripps deal. You--

 

JOHN MALONE: Well-- that--

 

DAVID FABER: you expand domestically, but-- are you still--

 

JOHN MALONE: Well, first--

 

DAVID FABER: --at that scale disadvantage, or not 'cause you're global?

 

JOHN MALONE: Well, yes. I think Discovery-- did two things that most other guys in the space didn't do. First of all, they went global, big time. More than half their revenue is offshore. And they're in, I don't know, 1.2 billion households watching their stuff. They have good brand recognition globally. Number two, they're not really in the middle of what I would call the scripted programming food fight, right? Where-- the costs are going through the roof-- where the number of scripted television shows, movies is going through the roof. It's very tough in that space to be financially successful, and particularly up against the guys who are now becoming so large. Discovery's more over here in the non-scripted programming, reality programming, documentary programming-- personality driven. And so David is not seeing his production cost, you know, going through the roof, A. And B, he owns all of his content. He doesn't just license it, he actually creates it, produces it and owns it, all rights in all markets.

 

DAVID FABER: And it's portable across borders, as he would say, many times.

 

JOHN MALONE: Correct. So if you look at Scripps-- first of all, big synergy. Second of all-- relatively cheap. Free cash flow engine. You know, if you buy-- post synergies, if you buy-- something that's generating a 12% cash return and you buy it with 3.5% money, right, it's-- it creates a lot of free cash flow, David, you know? And it gives you market power in the U.S., okay, with advertisers 'cause you now have a bigger percentage of the audience. Now, you have this attrition going on as the big bundle-- as people are "Cord cutting." But what they're really doing is going from the big bundle to buying connectivity services and going out and figuring out where else to get their content, right? And so, you know, as that process continues, Discovery needs to make sure they're in every small bundle. They have to make sure that they're in a position to transition to direct consumer platforms. Either their own-- which they would be the core of, or somebody else's. And that process is underway--

 

DAVID FABER: Is ongoing.

 

JOHN MALONE: It's an ongoing process. It's underway. And-- o, you know, I would look at the positive of Discovery is in their great position to go direct consumer on a global basis. Outside the U.S., they're in very good shape because you don't have this big bundle comin' apart phenomenon, you know? Video in Europe is cheap.

 

DAVID FABER: Right. Much cheaper—

 

JOHN MALONE: Compared to video—

 

DAVID FABER: --than it is here.

 

JOHN MALONE: --here. So you don't have that sports pricing pressure in Europe. And where-- even in the U.K., where sports is expensive, it's an a la carte service. It's not bundled in with basics. So you don't have people saying, "Oh, this is gettin' too expensive." If you don't want the sports, you don't buy the sports.

 

DAVID FABER: But John, the market has hated this deal. And the stock has just been—

 

JOHN MALONE: I'm look—

 

DAVID FABER: --gettin' crushed.

 

JOHN MALONE: David-- most of the money I've made in my life has been when other people don't like what's going on. When things are cheap, that's opportunity.

 

DAVID FABER: So what is the market—

 

JOHN MALONE: So I'm not—

 

DAVID FABER: --list here? What has-- I mean-- you know, the minute they announced the Scripps deal, that thing started goin' straight down.

 

JOHN MALONE: No, no, what you h—

 

DAVID FABER: It only exacerbated—

 

JOHN MALONE: Let me explain a little of short term market phenomenon. First of all-- in this world-- "What have you done for me lately," right? So when you get a whole bunch of investors where are dependent upon the company doing periodic buybacks in large volume and that becomes sort of an addiction and the investor, the guy, the young man who's makin' that decision turns to his boss and says, "We got no downside risk. The company's got a lot of free cash flow and they're soakin' up the stock, so how bad can it get," right?

 

DAVID FABER: Well, it can get bad 'cause you're not reinvesting in your business and you're buyin' your stock at highs that you shouldn't be.

 

JOHN MALONE: That's the long term view. I'm talkin' about short term mentality, right? So when a company like Discovery that's been on the track of massive stock buybacks with its free cash flow goes out and buys Scripps and part of the deal is we're gonna have to suspend the buybacks for a period of time because we want to borrow the money, it's a 70% debt deal, right, we wanna be able to borrow the money at investment grade rates, (which were very attractive. Sub 4%, long money. If we're gonna do that, and that's important, right-- we don't wanna junk the company. In other words, we don't wanna pay a lot more money for interest going forward. So we stay investment grade. The quid pro quo with the rating agencies is, okay, until your debt ratio drops below 3.5 let's say, you agree that you won't do any more buybacks, right? So all of a sudden, you got the investment community saying, "Oh my God, they're not gonna do any buybacks." Okay. So people who feel like they don't have that support, right--

 

DAVID FABER: So you don't think it's a function of investors in-- to our conversation about scale, feelin' like Scripps simply does not answer that question in terms of—

 

JOHN MALONE: No, no—

 

DAVID FABER: --scale domestically, and they won't be able to do a direct to consumer offering that really is robust enough?

 

JOHN MALONE: It depends on how you phrase the question. It gives 'em a great domestic scale, okay? In the-- ihistoric space, right? It gives 'em personalities, it gives 'em throwaway in the advertising community. It actually gives 'em leverage with their existing historic distributors, right? 'Cause now - well, you got 20% of your viewing audience is watchin' this stuff, and this stuff is cheap in terms of affiliate fee per eyeball. You know, those are all positive things. And Scripps is one of the cheaper historic services, affiliate fees. You got huge synergies in puttin' these companies together. So you're buyin' somethin' that already has a lot of free cash flow, okay? The synergies are gonna add a lot more free cash flow. If Trump's tax thing gets through, all of a sudden the tax..goes down.

 

DAVID FABER: Right, we'll talk about that.

 

JOHN MALONE: This thing becomes, on a run rate basis, a cash flow monster. A huge, free cash flow. So they would be able to get backto investment grade leverage quickly, okay? Some people are skeptical.

 

DAVID FABER: Some are skeptical—

 

JOHN MALONE: Okay? Now, you also look at it and say, outside the U.S., they grew almost 10% EBITDA this year. I don't see anything negative going on outside the U.S. Inside the U.S., I think they grew 5% this year. Better than any of their peers, right? So I look at it, you know, and to me, it looks cheap. It looks—

 

DAVID FABER: You wouldn't be buyin' more?

 

JOHN MALONE: Well, I would possibly buy more.

 

DAVID FABER: You would?

 

JOHN MALONE: Okay. Yeah. Now, keep in mind, when you're an insider, you have all these rules and windows and—

 

DAVID FABER: Understood, but you seem to certainly be articulating a point of view that says, "This is a time."

 

JOHN MALONE: For me, I'm always a long term guy. And I'm gonna bet that Discovery, with its ownership and control of its content, right, will be able to transition to direct consumer platforms in a reasonably efficient way, okay? And if they successfully do that, then they are dirt cheap right now. If--they can partly get there, they're still cheap. So-- and I-- you know, you know David quite well.

 

DAVID FABER: Yes.

 

JOHN MALONE: I have a lot of confidence in David and his team. And I think that they will figure this out. And I think Scripps is an important piece of that 'cause I don't think the scale throwaway of Discovery's content alone was sufficient. I think with Scripps, they're much closer to being the gravitational center of the non sports, independent content guys. And so, you know, I think they got a good shot. there is no guarantees in that—

 

DAVID FABER: There are never any guarantees. I wanna move onto some other-- since there're so many different companies to discuss. In fact, 13 different companies that you're deemed to have some level of control.

[peridotcapital]

I watched that interview without knowing that the stock had dropped as far as it had (the last I looked it was in the low to mid 20's post-Scripps announcement). Once I looked at the valuation at $15.75 for the Class C shares, I could not believe how cheap it was. This really does not seem like a melting ice cube. If that's true, the risk/reward in the teens is pretty astounding, at least to me.

[scorpioncapital]

Am I missing something or is this company earning like 2.3 billion in free after expense cashflow on a market cap of 6 billion for a whopping 38 percent initial yield. Or is the programming cost going to go up as programming gets older ? Amortization expense is huge. Even so what would be a reasonable fcf figure on average ?

 

I mean if it's a melting IBM style cube and stabilization at 600m it's still cheap but this would be a four times drop. And you'd still be earning 10 percent plus . Not to mention in 3 years your entire cash flow equals the market cap.

 

Another example:

TRIP - 4.2 b market cap, roughly 200m-250m FCF.

DISK - 6.4b market cap, roughly 2000-2300m FCF.

 

It's like one order of magnitude more for appx the same price :)

 

[prevalou]

Disck Market cap is not $ 6,4 B

[scorpioncapital]

I see now , there seems to be a large dilution due to a preferred stock issue.

"Following the exchange, the Series C-1 preferred stock may be converted into Series C common stock at a conversion rate of 19.3648 shares of Series C common stock for each shares of Series C-1 preferred stock."

 

However since the price is below $19.3, wouldn't it be anti-dilutive so that in the next quarterly report they would have to exclude these from the diluted calculation? In either case, it would have to get up to that figure to pack a punch?

 

570 diluted vs 380 basic.

 

Still I'm reading a 25% initial yield or 12% if cash-flow is cut in half.

After 4-5 years, your entire investment is returned.

The question is how fast will incomes drop off a cliff? Even IBM has had 3.5% revenue growth over 10 years and like -3.6% over 5 years. At this rate it would take 20 years to halve your income.

 

PS. Does anyone know how to find out digital content revenue of the US and international segments? The latest 10-Q doesn't seem to break this down yet, perhaps its still minor?

 

 

 

 

 

 

 

[no_free_lunch]

I see now , there seems to be a large dilution due to a preferred stock issue.

"Following the exchange, the Series C-1 preferred stock may be converted into Series C common stock at a conversion rate of 19.3648 shares of Series C common stock for each shares of Series C-1 preferred stock."

 

However since the price is below $19.3, wouldn't it be anti-dilutive so that in the next quarterly report they would have to exclude these from the diluted calculation? In either case, it would have to get up to that figure to pack a punch?

 

570 diluted vs 380 basic.

 

Still I'm reading a 25% initial yield or 12% if cash-flow is cut in half.

After 4-5 years, your entire investment is returned.

The question is how fast will incomes drop off a cliff? Even IBM has had 3.5% revenue growth over 10 years and like -3.6% over 5 years. At this rate it would take 20 years to halve your income.

 

PS. Does anyone know how to find out digital content revenue of the US and international segments? The latest 10-Q doesn't seem to break this down yet, perhaps its still minor?

 

I don't follow your logic.  They have been actively buying back the preferreds.  I assume they will continue to do so especially with a lower purchase price available.  As a result I do think that you need to include the diluted count.  I am new a bit new to this one so happy to be proven wrong.

[scorpioncapital]

Are they allowed to buy back preferrreds during the merger? I think Malone said something about the rating agencies requiring a stop to buybacks in exchange for letting them lever up and maintain a decent rating.

[KJP]

I see now , there seems to be a large dilution due to a preferred stock issue.

"Following the exchange, the Series C-1 preferred stock may be converted into Series C common stock at a conversion rate of 19.3648 shares of Series C common stock for each shares of Series C-1 preferred stock."

 

However since the price is below $19.3, wouldn't it be anti-dilutive so that in the next quarterly report they would have to exclude these from the diluted calculation? In either case, it would have to get up to that figure to pack a punch?

 

You've misread the conversion ratio as a conversion price.  There is no conversion price on the new Series A-1 and C-1 (just like there wasn't any on the old Series A and C).  Rather, they are convertible at the option of Advance/Newhouse into a fixed number of A and C common shares.  See the disclosure here:  https://www.sec.gov/Archives/edgar/data/1437107/000119312517241440/d433093d8k.htm

 

So, to get the proper number of common share equivalents, you need to convert the new A-1 and C-1 (or the old Series A and C at the old conversion ratios) and add that to the outstanding A, B, and C common.  The company also does that for you in its disclosures.   

[scorpioncapital]

Does anyone have any thoughts on the best strategy with DISCK/SNI? I have a little bit of both but have sold down SNI to just buy DISCK...I estimate there is somewhat of a discount in the arbitrage and also if you will elect 100% shares (does anyone have experience with pro-ration if you are ever likely to get 100% stock for every person that chooses 100% cash, since it wouldn't be a perfect balance?). Even if you get 100% shares, I estimate the discount to be say 6-10% range off just buying the DISCK shares themselves, but on the other hand DISCK shares have zoomed substantially more than the discount of buying SNI and getting a full conversion. Not sure if it's worth the bother if you think DISCK is cheap and plan to hold it anyway. There's also some immediate tax effects of the merger because it would seem to be taxable as capital gain on this difference of cost and market price, so it's even a smaller discount.

 

 

[CorpRaider]

Wow, I was kicking tires around 25% ago. 

[mwtorock]

i did that exact same thing ;)