Why I Swapped Discovery Share Classes

Includes: DISCA, DISCK
by: Steve Birenberg, CFA

On March 1st, all Northlake client positions in Discovery Communications voting shares (NASDAQ:DISCA) were swapped to Discovery Communications non-voting shares (NASDAQ:DISCK) on a dollar for dollar basis.

DISCA shares were added to the S&P 500 as of the close of trading on February 26th. The non-voting DISCK shares are not being added to the S&P. Several other companies with multiple classes of stock also have only their voting shares in the S&P 500.

The addition of DISCA to the S&P 500 caused the shares to spike relative to DISCK as index funds had to buy DISCA. What had been about a $3 premium expanded to over $4. The swap was completed at $4.23.

An added wrinkle in Discovery's share structure is that a third class of high voting shares (10 votes per share) exists and are completely controlled by insiders. As a result, the one vote per share "A" shares offer little value over the no vote "K" shares. After all, the A shares can't override the wishes of the insiders. All other aspects of the A and K shares are equal so there really is no reason for the A shares to trade at a significant premium.

I think the premium should be less than $2. It was headed steadily in that direction prior to the S&P move, having fallen from $4.50 since December. Other similar situations in News Corporation (NWS/NWSA), Comcast (CMCSK/CMCSA) and Liberty Global (LBTYK/LBTYA) all have spreads of less than $1 or less than 10% on a percentage basis.

Disclosure: DISCK is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. The Entermedia Funds are net long DISCK, NWSA, CMCSK, LBTYK, and LBTYA. Pair trades on NWS/NWSA and DISCA/DISCK are held in the Entermedia Funds. Steve Birenberg is co-manager of the Entermedia Funds, owns a portion of the Funds' investment management company, and has personal monies invested in the Funds.

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