In the media industry, a key factor for a company’s success is finding a market niche and exploiting it. Discovery Communications Inc. (DISCA) has followed that precise strategy and now owns several cable networks available in over 200 countries worldwide. The national and pan-regional networks, distributed through 130 feeds and in 40 languages, have established this media firm in virtually every market. So, let’s take a look at what might have encouraged investment gurus Ron Baron (Trades, Portfolio) and Lee Ainslie (Trades, Portfolio) to add more of this company’s shares to their portfolio.
Working Through the Niche
As the niche cable network provider in the media industry, Discovery’s flagship channel addresses topics like science, technology, history and exploration. With TLC, Animal Planet and Discovery as the three key domestic channels, the company reaches 100 million households, and despite the mature U.S. market, sales have grown 6% and revenue 10% in fiscal 2013. This is mainly due to the media giant’s unique content programming and line-up refreshments. Hit shows like Shark Week, for example, have become so popular through advertising that the network experienced in 2013 its all-time best viewership with over 50 million viewing rates during one episode. The men’s lifestyle cable network, Velocity, also experienced a 30% viewership increase in quarter four of 2013, and is now the fastest-growing network in that segment.
Furthermore, in addition to the namesake channels, Discovery also owns Investigation Discovery, The Learning Channel, a 50% stake in Oprah Winfrey’s new cable channel OWN, and The Hub, a children’s network created with Hasbro Inc. (HAS). The strong universal appeal of content which transcends cultures and languages, add a differential value to this company and has allowed international distribution across multiple media platforms. In fact, 100% content ownership gives this firm a competitive advantage, as it can seek benefits from non-traditional content distribution. With companies like Netflix Inc. (NFLX) or Amazon.com Inc. (AMZN) looking to push through their video on demand or SVOD services, Discovery is bound to benefit from licensing agreements in the future.
International Expansion Boosts Valuation
Discovery’s most recent acquisition of Prosieben’s SBS Nordic assets and a 20% stake in TF1’s Eurosport are strategically well-placed deals, given the company’s strong presence in the Western European market. This is reflected in the firm’s annual revenue growth of 13.2%, well above the industry average of 3.3%. For the next five years, revenue is expected to average an 11% growth rate, while the current 20% EBITDA growth margin is expected to reach a five-year average of 42%. These margin boosts will be the consequence of the company’s international expansion, where a 59% revenue increase closed the fiscal 2013 metrics at $4.5 billion.
Although advertising represents 50% of Discovery’s revenue income, which could be problematic in the case of a recession, I believe this company’s business model and 41% operating margins will solidly balance out headwinds. Furthermore, the outstanding 185.10% returns on capital (ROC - Greenblatt), as well as the strong 24% EPS growth rate, leave me feeling very bullish about this media giant's future. In fact, earnings per share will progressively grow from $2.50 in 2013 to $3.96 in quarter four of 2015. And despite the stock’s trading price premium of 47% compared to the industry’s average of 19.2x, I think investors would benefit from entering the market now, given the growing price trend.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.