Discovery Communications Inc. (DISCA) is a non-fiction media and entertainment company responsible for television networks like Discovery Channel, The Learning Channel, Animal Planet, Science Channel, Military Channel and Investigation Discovery. In total, the Maryland-based Discovery Communications owns and operates nine networks in the United States and its content is distributed across the world. The company's corporate website boasts over 1.7 billion cumulative subscribers to its content, which is broadcast in 45 different languages and available in 209 countries and territories.
The main focus of Discovery's programming is on science, the natural world and human beings' interactions with both. Their impressive television lineup includes hit shows like Deadliest Catch, Gold Rush, Dirty Jobs, Mythbusters, American Chopper and a myriad of popular survival shows like Survivorman, Dual Survivor and the now defunct Man Vs. Wild. In conjunction with the British Broadcasting Company Ltd, Discovery is also responsible for critically acclaimed documentary series like Planet Earth, Frozen Planet and Life.
Discovery Communications first came to my attention last year as I was looking for the best way to play the expanding mobile entertainment and video-on-demand segment. As digital content providers like Amazon.com (AMZN), Netflix Inc. (NFLX) and Apple Inc. (AAPL) rush to include the most popular content in their digital libraries, the companies responsible for creating and distributing that content benefit greatly.
My search started out simple enough: find a company with a proven track record of consistent growth and innovative programming expertise. The next logical question I had as an investor was, which company makes the best content?
What I mean by "best content" is simple: the ability to continuously create and film original content that viewers want to see, content that is both able to change to the tune of the viewer at a moment's notice and that isn't too expensive to create. I was certainly not interested in buying a media company producing a summer blockbuster movie here or a few hit television shows there, as that would make for a more unpredictable investment. I was looking for the steadily growing media play that seemed to have an audience no matter what the circumstances were, a company that was capable of remaining in my growth portfolio for years to come. I found it in Discovery Communications.
Discovery has all of the things that I need to see in a growth company: a brand name-competitive advantage, growing revenue and EPS, relatively solid business fundamentals and reasonable valuation.
The set of companies I initially researched aside from Discovery were AMC Networks Inc. (AMCX), The Walt Disney Company (DIS) and Viacom Inc. (VIAB). Besides these select few, there really aren't too many other ways to play this segment. I eliminated companies like Comcast Corp. (CMCSA) and Time Warner Inc. (TWX) because I wanted my focus to be on companies dedicated more to content creation/distribution and not so much to cable, telephone and Internet access. I chose to include Disney, even with its large parks and recreation business, because of the exceptionally high quality of its media and entertainment divisions.
Let's take a quick look at some of the fundamentals and growth rates of the four companies I chose:
Avg. Revenue growth (last 3 yrs)
Projected 2012 Revenue Growth
Projected Revenue Growth 2013
EPS Growth 2012
EPS Growth 2013
AMCX immediately stands out as being the best growth pick for 2013, with revenue and EPS projected to grow 9.4% and 33.5%, respectively. DISCA comes in second with respective projected revenue and EPS growth rates of 7.8% and 24.3% for 2013. AMCX is projected for better growth than DISCA and currently offers better valuation at a forward P/E of 15.98 compared with DISCA's 18.86, which is the most expensive out of all four companies. On the other hand, DISCA has the most impressive profit margins by far, almost 10% higher than any other company on the list.
Past performance is a big indicator for me and I like to see my growth companies display the ability to grow consistently. Both AMCX and DISCA have managed a 3-year average of around 10% revenue growth and are really the only two stocks out of the four that a growth investor could consider.
DIS and VIAB, although the two cheapest with regards to P/E, simply do not offer enough consistent growth for a true long-term growth portfolio. Note: I do own shares of Disney in my dividend-oriented portfolio.
To narrow the two media stocks I had left on my list, AMCX and DISCA, down to one, I took a look at each company's networks and programming lineups. Between the two, I feel Discovery is better able to deliver consistent quality programming.
During the most recent earnings call for AMCX, third-quarter revenue increased a healthy 17% over the same period last year. This has been the case more often than not for AMCX lately as growth has really taken off on the heels of very successful content creation and marketing. According to the Wall Street Journal, management stated the growth was due to high viewer demand for AMC's original content. When I read this statement I immediately thought of AMC's two popular drama series, Breaking Bad and The Walking Dead, both of which have achieved remarkable success, the latter across multiple media formats (video-games, books). However, with Breaking Bad having ended in September and The Walking Dead well into its third season, AMC could have trouble maintaining this level of popularity going forward. AMC's other big time drama series Mad Men, which is slated for a sixth season in 2013, is also growing long in the tooth.
As good as the recent surge in viewership has been for AMCX, I feel that the company's growth may be too dependent on the AMC channel's lineup of hit drama shows and I am unsure whether AMC can keep delivering the same high quality content that it currently has. AMC's shows, although wildly popular now, eventually will come to an end. When that happens I'm not sure the company will be able to replace them with equally appealing content. As a growth investor, it is imperative to always look forward and I don't think AMCX's future is as bright as its past.
While the company certainly appears to be a good investment, at least for the next year judging by the growth numbers, beyond that I have trouble seeing the company maintaining steady growth. In order to reduce my risk as much as possible I eliminated AMCX from consideration.
Discovery, on the other hand, has proven it can successfully and continually create new and exciting content. The company basically has a lock on the documentary-style nonfiction television show. When viewers want to watch programming about animals they will most likely tune in to Discovery's Animal Planet, where else can they go besides Nat Geo Wild? Similarly, when viewers want to watch programming about World War II they will turn to Discovery's Military Channel. The same goes for outdoor survival, health/fitness and true crime shows; the offerings are extremely limited outside Discovery's own programming.
The company's expanding channel lineup has consistently provided viewers with a broad spectrum of informative and entertaining shows, so much so that the networks' themselves have become synonymous with phrases like "nature channel," "health channel" and "animal channel," which is evidence of powerful brand-name recognition. Do a Google search for any of these phrases and see what pops up first (one of Discovery's channels is always the first or second hit). This is what makes Discovery Communications such an intriguing company; it has very distinct brand-name recognition and very few competitors, the essence of a moat.
Discovery is extremely efficient at creating new shows by building off of prior or existing shows' success, something that I am unsure AMCX or any other media company can do with such a high level of success. Take for instance the hit show Gold Rush, now in its third season, which manages to get better ratings as it moves along. According to results from Nielsen Ratings, for the two-week period starting November 30, Gold Rush has been the number 1 primetime broadcast on Friday among the key age group of persons aged 18-49. Perhaps more important is that Discovery follows up Gold Rush with the equally exciting Jungle Gold show, which just so happens to be the number 2 show on Friday among persons of the same age group. The Nielsen results also indicate that Discovery has a lock on male viewership as well on Fridays, both Gold Rush and Jungle Gold were ranked number 1 and 2, respectively, among men ages 25-54, beating every other broadcast network on the air. Discovery currently owns the male demographic on Fridays with these two shows alone.
Management's ability to compound the success of Gold Rush with the newer show Jungle Gold does two things: First, it increases ratings while keeping the majority of the male demographic tuned in for another hour and second, it acts as a failsafe if there were to be any problems with further production of Gold Rush. Many Gold Rush viewers are now fans of Jungle Gold and will likely remain so with or without Gold Rush's continued production. This is not the first time Discovery has employed this type of strategy; the company has successfully built two new, popular shows off of the Gold Rush platform already, Bering Sea Gold and Bering Sea Gold: Under the Ice, both of which have managed to gain top spots among key demographics.
Discovery has a long history of launching similarly themed shows off of successful predecessors and while it may be an easy formula to apply it is certainly difficult to master. Discovery seems to have done it and as long as there are new mysteries waiting to be unraveled in the world I see no end to Discovery's ability to capture them on film and turn them into gripping television.
Discovery has no need to mix things up too much as the company's primary programming model is one that can continue to work well into the future. The upcoming documentary series Africa, which was created by the same team responsible for Planet Earth and Life, is set to begin in two weeks and will start what looks to be a big calendar year for Discovery. Also set to air in January for its second season is Discovery's TLC channel hit show Here Comes Honey Boo Boo, which regularly airs to an average of 2.4 million viewers and has been getting stronger as it moves along, according to Nielsen Ratings. The TLC channel looks to continue to have a big 2013 with new releases like Starter Wives, Totally T-Boz and the recently premiered reality series Sin City Rules.
Even more encouraging is the company's success outside of the United States. According to CEO David Zaslav in the company's most recent corporate newsletter, Discovery Channel is among the top-5 pay-TV networks in all of Latin America, leading the factual network category in Mexico, Brazil and Columbia for the most recent third quarter. Discovery en Espanol recorded its best quarter ever, growing 19% over the same third-quarter period last year. Australia has also been a bright spot for the company as Bering Sea Gold and Deadliest Catch recently achieved the highest launch ratings ever in Discovery Channel Australia's seven-year lifetime.
I expect continued success from Discovery in all of its foreign ventures, including the recently announced acquisition of several German and French television networks. According to Reuters, in what would be Discovery's biggest acquisition yet the company announced plans to buy 12 Nordic television channels from German company ProSiebenSat. The deal is reportedly valued at close to $1.7 billion. Discovery also plans to take a 20% stake in the French network Eurosport worth $221.6 million. This is a major step for Discovery because it marks the first time the company will enter broadcasting outside of their usual non-fiction docudrama segment (ProSiebenSat's Nordic Channels are largely scripted drama and Eurosport is a French sports network). This latest group of deals will further expand Discovery's reach and revenue stream and give the company a foothold into programming areas it has never had before.
Even The Oprah Winfrey Network, which Discovery owns 50% of and which has been a thorn in the side of investors for some time, is finally offering positive news. The network signed a deal with Tyler Perry in October to become the only channel to broadcast all of his new projects. Two original scripted series are already planned for mid-2013. If Perry's past television performance is anything to go by, OWN could see a dramatic increase in ratings for 2013.
Discovery has been busy the last five years rebranding many of its networks to better cater to new viewers (Oprah Winfrey Network chief among them). This rebranding is starting to pay off and has positioned the company to best experience the next generation of growth through opportunistic expansion overseas. According to the most recent investor presentation on December 17, management anticipates better margins going forward through increased revenue and stable cost structure. Additionally, management has been busy returning capital to shareholders by stepping the company's existing stock repurchase plan up by an additional $1 billion.
Discovery has a lot more debt than I'd ever like to see. A metric that I often use to judge manageable debt levels is to make sure total debt is no more than three times free cash flow. Going by that metric, Discovery does not make the cut as it had $1.1 billion in free cash flow at the end of 2011 but over $4.2 billion in total long-term debt. What's worse is that debt has been increasing the last few years. Fast-forward to Q3 of 2012 and debt has increased by about $1 billion. This is something that needs to be monitored going forward.
Also, analysts expect revenue for the entire 2012-year to be $4.52 billion compared with 2011's total revenue of $4.23 billion, which is an increase of only about 7%, significantly less than the average of 10% that Discovery managed over the last three years. Additionally, analysts are projecting 2013 revenue to be $4.87 billion, which is an increase of around 8% from the company's expected 2012 revenue, again, less than the company's prior growth rates.
And finally, with the stock currently at $63, the forward P/E is right were it's most comfortable when viewed historically. Discovery's average P/E for the last three years is 19.3, which almost matches its current forward P/E of 18.86. However, that 3-year average P/E was when the company was experiencing 10% yearly growth. With around 7% growth for 2012 and 8% projected for 2013, the forward P/E of 18.86 is a little high.
I do think the positives outweigh the negatives for Discovery Communications going forward. Discovery has shown that it is capable of growing revenue consistently, although not tremendously. It is a nice, steady grower with relatively solid fundamentals and a great story. The company's recent international expansions will open up new markets, create additional revenue and should provide further growth for investors. I have been long DISCA since $45 and believe there is more upside going forward.