The following segment was excerpted from this fund letter.
Discovery Communications (DISCK)
Discovery Communications thesis has been tracking well. The company has de-levered its balance sheet and brought leverage below its target levels. Organic sales growth has been low single digits or higher consistently, in stark contrast to the market fears of an inevitable decline. Free cash flow has been prodigious, rising to ~ $3B in 2019. The company has begun to buy back its shares, using $650M of cash for that purpose in 2019, or over 3% of the market capitalization. Yet, the stock continues to trade at less than 8x times profits and free cash flow as the market worries about declining TV ratings, the threat to the cable bundle and the implications for the company's terminal value.
When I increased the position size to a large position with the stock in the mid-teens in 2017, I hedged that with January 2020 put options. The main reason for the hedge was the finite-duration risks of an over-levered balance sheet and integration risks post the Scripps acquisition. These risks are now behind us with the company navigating them well, and the stock is almost double the price it was at the time when I made it a larger position. Continuing to hedge the position doesn't make sense as 1) it is too expensive to continuously hedge with put options and 2) there are now no finite duration specific risks that would justify a one-time hedge. As such, I let the last put options expire in January.
Without the hedge, the position would have been 24% of the partnership's assets. That is too high given the downside to the worst case, as it would have caused Portfolio at Risk (PaR), which I define as Position Size x Downside to Worst Case, to exceed my maximum of 10%. Therefore, I somewhat reduced the position to under 20%, so that when the hedge expired our PaR would stay under the 10% maximum. Discovery is our largest position and I strongly believe that I am right. I also know that I am fallible and can be wrong, and the last thing I want is for the partnership to become overly dependent on any one judgment. Over time, it is my disciplined execution of the process that should aid us in compounding our capital rather than any one success.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.