Discovery Communications Aims to Supercharge Growth With a Pricey Acquisition

8/2/17

By Demitrios Kalogeropoulos, MotleyFool

Discovery (NASDAQ:DISCK) shocked Wall Street this week by announcing it will purchase pay-TV rival Scripps Networks (NASDAQ:SNI) in a $15 billion megadeal aimed at securing growth despite an ever-shrinking pool of cable subscribers. As part of the announcement, the network operator posted its business results for its fiscal second quarter.

Here's a look at how the headline numbers compared to the prior-year period:

Metric

Q2 2017

Q2 2016

Year-Over-Year Change

Revenue$1.75 billion$1.71 billion2%
Net income$380 million$415 million(8%)
EPS$0.64$0.66(3%)

DATA SOURCE: DISCOVERY'S FINANCIAL FILINGS.

What happened this quarter?

Sales growth slowed to 2% from 3% in the prior quarter on continued weakness in Discovery's advertising business.

A man holding a TV remote and looking forward.

IMAGE SOURCE: GETTY IMAGES.

Here are the key highlights of the quarter:

  • U.S. network revenue ticked up by 2% thanks entirely to the increased fees that the company charges its distributors. Discovery managed zero growth in the advertising segment for the quarter and that division is also flat over the past six months.
  • Subscriber numbers dipped, which pushed advertising volumes lower. That slump was mostly offset by rising licensing revenue, including from the company's digital and on-demand broadcasting initiatives.
  • Discovery's international business expanded by 4% but saw adjusted earnings decline by the same percentage thanks to rising costs related to acquiring and producing sports content.
  • Cash flow dove 48% due to the combination of rising capital expenditures and shifts in working capital. Discovery still managed a slight uptick in its cash balance, though.
  • The company spent $300 million repurchasing its stock and the resulting decline in share count explains why per-share earnings fell just 3% even as overall net income dropped by 8%.

What management had to say

Executives focused their comments on the pending Scripps acquisition, which they explained will be funded by a mix of cash and stock. "This is an exciting new chapter for Discovery," CEO David Zaslav said in a press release. "We believe that by coming together with Scripps," he continued, "we will create a stronger, more flexible and more dynamic media company with a global content engine that can be fully optimized and monetized across our combined networks, products and services in every country around the world."

A graphic showing the popular content from both Discovery and Scripps, including "Shark Week" and "House Hunters."

IP = INTELLECTUAL PROPERTY. IMAGE SOURCE: DISCOVERY INVESTOR PRESENTATION.

The combined company will claim almost 20% of the ad-supported pay-TV audience in the U.S. with an especially strong share of the female demographic, management said. "Increased U.S. scale creates compelling opportunities for advertisers and distributors," executives noted in an investor presentation. With TLC, HGTV, Discovery, and Food Network all under one roof, the new entity will produce roughly 8,000 hours of original programming each year.

Looking forward

Set to close early next year, the merger will result in Discovery shareholders owning 80% of the combined entity while Scripps investors own the rest. Zaslav and his team predict that the acquisition will remove $350 million of costs, with about half that figure applying to the fiscal 2018 year.

The company believes the buyout will create attractive new growth opportunities in digital content and in extending the Scripps brands into international markets. Profitability should increase, too, they expect, as Discovery gains leverage in negotiations with advertisers and with distributors.

Over the short term, the company's debt load will balloon thanks to this purchase. But Discovery plans to suspend its share repurchase program and direct all excess cash toward paying down its liabilities so that its leverage falls back to historical levels by the end of 2019.

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