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Clear Sailing for Discovery Communications

Patricio Kehoe

Patricio Kehoe

7 followers

That the media and cable landscape is changing is admittedly nothing new, with mergers and licensing agreements occurring among industry giants like Time Warner Cable Inc. (TWC), Comcast Corporation (CMCSA) and Twenty-First Century Fox Inc. (FOXA). However, it’s not only the industry giants that are scaling their options to continue gaining profits. The somewhat smaller, niche content pay TV player Discovery Communications (DISCA) has also displayed several changes over the past quarter and they seem to have been successful, as earnings per share saw a solid increase, closing the fiscal year at $2.97, up 25.6% year over year. So with investment gurus like Caxton Associates (Trades, Portfolio) and Louis Moore Bacon (Trades, Portfolio) buying shares, let’s take a look at the most recent developments and future outlook.

International Expansion Remains a Key Growth Driver

In my last article on Discovery I focused on its competitive advantage as a niche network, via its flagship channels TLC, Animal Planet and Discovery, as well as its children’s network The Hub (joint venture with Hasbro Inc. (HAS)). I also mentioned that future growth would be driven by possible content licensing agreements with Netflix Inc. (NFLX) or Amazon.com Inc. (AMZN), but while these deals are still to be announced, I believe 2014’s growth will be outlined by international expansion. Apart from the recent acquisition of Prosieben’s SBS Nordic assets, via which the company now airs its original content in 217 countries, Discovery is set on increasing its 20% stake in TF1’s Eurosport until fully acquiring the sports channel. These acquisitions are expected to bring an 18% increase in revenue growth for 2014, adding on to 2013’s reported 21.10% growth rate.

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Moreover, while there were talks in December about the firm possibly acquiring Scripps Networks Interactive Inc. (SNI), these were put to a halt and replaced by a new deal. Instead, the company announced last week that it would be buying Channel 5, with BskyB for $590 million, thereby adding on to its international expansion strategy. However, Discovery hasn’t only been expanding its cable network, but also relocating its assets in order to focus operations on the television business. Thus, the company will be selling off its website HowStuffWorks.com to the Internet service company Blucora Inc. (BCOR) for $45 million, and although the sales price definitely won’t benefit Discovery (as they originally purchased the website for $250 million in 2007), the visitor declines indicate that this is a smart move to avoid future losses.

A Positive Outlook

Overall, I stick by my recommendation to invest in Discovery, as the company seems to be moving in the right direction with its acquisition strategy and reached analysts’ estimate of $5.5 billion for revenue in fiscal 2013. Furthermore, revenue will continue to grow at an average annual rate of 9% for the next five years, fueled by 14% growth in international sales and 5% growth on the domestic front. And while the current 36% operating margin is below the 2010 to 2012 average of 45%, due to the SBS Nordic purchase, this metric will recover to an average 42% by 2019, way above the industry median of 10.1%.

The firm’s earnings trend is also looking healthy and is expected to hit the $3.96 mark by the end of fiscal 2014, in line with the current returns on equity of 17.35%. Moreover, the stock’s trading price has declined slightly and is now trading at a 39% price premium (compared to last quarter’s 42% premium) relative to the industry average of 18.3x, making it a more profitable buy for shareholders.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

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