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May 07, 2014

Discovery Communications Ride Gets Even Bumpier

Discovery Communications (DISCK) reported a slightly disappointing March quarter results. Most of the miss was not at the domestic or international cable networks. However, investors are treating the stock harshly even after poor year-to-date performance. In hindsight, I should have sold DISCK when the company went on its European acquisition spree as it was out of character with the historic corporate strategy as the company entered free-to-air, sports networks, and fiction programming. I put too much stock in the excellent management team and accepted its judgment that strategically the acquisitions made sense to support and extend the company’s long-term growth profile.

Earnings estimates have been coming down for DISCK and are being taken down another notch today. Management guidance suggests one more tough quarter followed by acceleration in revenue, cash flow, and earnings growth. With the stock down 20% year-to-date and now trading at a discount to its peers, I think the shares are pretty washed out. It has been a painful four months but I think the best course of action is to sit tight and look to the next quarterly report to as a catalyst for renewed appreciation potential.
Looking more carefully at the quarter, U.S. ad revenue fell a little short of estimates, growing 5%. Affiliate fees grew as expected, leading to U.S. growth overall in themed single digits. International saw ad revenues grow 23% and affiliate fees up 10%, both in line with estimates. Higher corporate expenses were the primary culprit in the earnings and operating cash flow shortfall although international margins were a bit light.

Management maintained full year guidance but signaled that 2Q would be the toughest compare of the year due to a recent asset sale, the timing of content sales, and cancellation of an important TV series for Discovery Channel. If management is right, 2Q will see flat to low single digit decline in organic growth. In addition, the closure of more European acquisitions will dilute margins in international, something investors do not like, especially given my earlier comments about the shift in corporate strategy.

DISCK is now trading at less than 15 times 2014 earnings. If growth accelerates in 2H14, this will seem like a bargain. Placing well-earned trust in management, I choose to believe and sit tight for another quarter.

DISCK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov.

Posted by Steve Birenberg at May 7, 2014 01:32 PM in DISCA