Discovery and Scripps Tune in to Global Media

12/05/2017 5:00 am EST

Focus: STOCKS

Azmath Rahiman

Chief Analyst, Cabot Benjamin Graham Value Investor

Our best wishes go out to Roy Ward who has retired as editor of Cabot Benjamin Graham Value Investor. We also offer our congratulations to Azmath Rahiman who has stepped in as the service's news editor. Here's his latest value idea.

Discovery Communications (DISCA) is a significantly undervalued stock with conservative growth prospects. The company is a global media company that provides contents such as Discovery, TLC, Animal Planet and The History Channel across multiple distribution platforms.

In 2016, revenue from U.S. networks and international networks were $3.28 billion and $3.04 billion, respectively. Discovery’s two main revenue streams are distribution revenue and advertising revenue.

The operating margin in the U.S has been around 50% to 60%, while the margin from international had dwindled from 40% in 2002 to 20% in 2016, primarily due to increasing sports content costs in Europe.

That said, I’m assuming a conservative 2%-3% long-term growth in Discovery’s earnings without accounting for the synergies that will be achieved by its acquisition of Scripps Networks Interactive.

Discovery will acquire Scripps Networks Interactive for $14.6 billion. Scripps provides lifestyle and interactive content on channels like Food Network, HGTV, Travel Channel, DIY Network, the Cooking Channel and Great American Country. Scripps’ annual revenue was $3.4 billion in 2016, with a net profit margin of around 20%.

Discovery and Scripps anticipate the merger to provide a $350 million in cost synergy and international exposure to Scripps’ female audience-targeted contents. The combined firm will also allow for better bargaining power with advertisers and distributors due to its sheer size.

I believe that Discovery’s $14.6 billion offer was at a considerable premium. However, the premium will be offset by the significant bargain in Discovery’s stock. The current market undervaluation of DISCA is a result of ongoing concerns on cord cutting and emerging competition from internet-based content providers.

Even after these considerations, Discovery is a bargain considering its stable and attractive free cash flow, and I foresee stable growth for the company and expect the market to appraise the stock at a reasonable valuation in the future. We rate the stock a buy.

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