Discovery 3Q21 Earnings Analysis


Discovery Stock Analysis

Business Description:

  • 800 million monthly unique viewers globally

  • 250 million hours viewed daily

  • Operates under 2 segments: US Networks and International Networks, each divided into advertising and distribution subsegments

  • 65% of revenues in 2020 came from US Networks, 38% Advertising and 27% Distribution

  • 35% of revenues in 2020 came from International Networks, 15% Advertising and 19% Distribution

  • Since shows are factual, expenses are limited compared to competitors with 2020 operating margins of 25% vs 18% for Viacom and Netflix and 2% for Disney (20% in 2019)

  • Stock crashed by 60% after a margin call from Archegos Capital



Merger with AT&T’s (NYSE:T) WarnerMedia

  • Structured as Reverse Morris Trust Transaction, whereby AT&T will spin off Warner Media which will then merge with Discovery

  • Discovery shareholders will own 29% of the new company

  • AT&T will receive $43 billion in a combination of cash, debt securities, and Warner’s retention of certain debt


Catalysts:

  • Recovery from pandemic

  • Content creation/acquisition is less expensive compared to competitors

  • Discovery+ ARPU expected to 3-4X US Networks Linear

  • Deal willl make Discovery more competitive with non-factual networks


Risks:

  • Streaming business is very competitive with Netflix, Disney+, Amazon Prime, Apple TV+ and others

  • Streaming business might be a cash flow drain in initial years

  • Cable Networks businesses are in decline

  • Concentrated business

  • Will no longer be a fully factual network

  • Synergy costs might be bigger than expected

  • Will take some of the debt of AT&T on balance sheet

  • AT&T shareholders unhappy about the dividend cut from the company


Financial Analysis:



Discovery Stock Analysis

Valuations:

  • My personal Biases:

  • 4.0% of my portfolio

  • Assumptions for base case:

  • WarnerMedia was acquired by AT&T in 2018 for $85 billion

  • Below are the pro-forma financial estimates of WarnerMedia+Discovery for the last five years

Discovery Stock Analysis

  • Revenues in 2021 will slightly exceed 2019 level

  • US Network Revenues will grow by 12% annually from 2021-2025 (17% in the last five years) with operating margins of 35% (average of 45% in last five years)

  • International Network Revenues will grow by 4% annually from 2021-2025 (4% in the last five years) with operating margins of 10% (average of 12% in last five years)

  • 4% of annual growth of WarnerMedia revenues

  • Operating margin of 25% for WarnerMedia

  • 80% of operating income conversion in FCF


Discovery Stock Analysis

  • Discount rate of 15%

  • Terminal growth rate of 3%

Discovery Stock Analysis

  • Use P/FCF as exit multiples for 2025 (range of 5-33 in last 5 years)

  • Bull case 15% more than in base case and bear case 15% less

  • Shares outstanding doesn’t change

  • We will consider only prices for shares of Discovery, ignoring the new company (since we don’t know anything about pricing yet)


Discovery Stock Analysis

Conclusion

  • An intrinsic value of $78.3 billion for the new company means $22.7 billion for Discovery today

  • Undervalued with a market cap of $13.2 Billion for $22.7 Billion in intrinsic value in a conservative analysis

  • With a margin of safety, a fair value would be $20 billion

  • Exit multiples analysis shows an expected returns of 24% per year with limited downside of 20% and possible reward of over 400% in bull case

Full Research and Analysis: https://ishfaaqpeerally.teachable.com/courses/662813/lectures/31950949

Discovery Stock Analysis

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