DISCA is trading well below corporate averages relative to Forward Adjusted Earnings
At these levels, markets are already pricing in a near-worst-case for the name
However, DISCA has fundamentally transformed their business in the last decade
The company continues to build an economic moat through their low-cost, niche programming and their recent acquisition of Scripps
When there is
negative sentiment surrounding an industry, it can be difficult to
look through the noise and focus on individual company performance.
Within the Communication Services industry, concerns surrounding the
cord-cutting movement have clouded investors’ judgment when
thinking of individual companies.
While a rising
tide indeed lifts all boats, should the inverse be true? While some
companies have floundered in the wake of rising costs and lower
demand driven by increased streaming competition, others have quietly
built a vault of high-quality assets and streamlined operations.
DISCA is one of these companies.
Discovery, Inc. (DISCA) is an example of the market failing to recognize operational differences between companies that will lead to vastly different performances facing cord-cutting headwinds. Additionally, the market is pricing in expectations for DISCA to see profitability fall to levels last seen prior to their spin-off of Ascent Media and transition towards pure-play content. As such, should DISCA maintain even the low end of their profitability over the last decade, there is room for material upside. Uniform Accounting helps us see this.
Valuations & Market Expectations
PVP chart below reflects the real economic performance and valuation
measures of Discovery, Inc. (DISCA) after making many major
adjustments to the as-reported financials. The rationale behind
Uniform Adjusted Financial Reporting Standards (UAFRS) or “Uniform
Accounting”, and theory supporting this model can
be found here.
four panels explain the company’s historical corporate performance
and valuation levels plus consensus estimates for forecast years as
well as what the market is currently pricing in, in terms of
expectations for profitability and growth.
apostrophe after ROA’, Asset’, V/A’, and V/E’ is the symbol for
“prime” which means “adjusted” under Uniform
Accounting, and these metrics will be referred to as “Uniform”
throughout this report. These calculations have been modified with
comprehensive adjustments to remove as-reported earnings, asset,
liability, and cash flow statement inconsistencies and distortions.
To better understand the PVP chart and the following discussion,
please refer to our guide here.
DISCA is trading at a 10.2x Uniform P/E (Fwd V/E’), at the low end of historical and peer valuations. DISCA and its peers like Viacom (VIAB) (13.1x Uniform P/E), CBS (CBS) (11.2x), AMC Networks (AMCX) (11.1x), and Tribune (TRCO) (14.2x), have all been punished related to cord cutting concerns. Specifically, as consumers continue to switch from cable subscriptions to online streaming subscriptions, traditional network companies are likely to see reduced demand.
these levels the market is pricing in expectations for DISCA to have
no real organic Uniform Asset (Asset’) growth going forward, toward
the lower end of historical Uniform Asset growth levels, with Uniform
ROA falling from current 88% levels to just 54% over the next several
looking at DISCA’s historical trend in Uniform ROA, the company has
seen profitability above 50% in each of the last 10 years following
their acquisition of assets from Advanced/Newhouse Communications,
indicating a fundamental transformation in their business. Moreover,
DISCA has seen profitability expand over the last four years, with
Uniform ROA rising from 60% in 2015 to peak 88% levels in 2018 due in
part to the strengthening of their content portfolio related to their
acquisition of Scripps. At current valuations, the market expects the
company to see profitability fall to levels associated with a
fundamentally different business.
DISCA had a transformational change in 2007 when they spun off the
legacy Ascent Media portion of their business and began efforts to
become a pure-play content provider, a far more profitable and asset
you look at DISCA’s margins, it is clear their transition away from
Ascent Media fundamentally changed their operations. Prior to 2008,
Uniform Earnings Margin was volatile, often negative, and never above
cost-of-capital levels. However, since shifting their focus entirely
to content production and network ownership, Uniform Margins
inflected positively and have ranged between 19% and 34% since 2008.
Even using as-reported EBITDA margin, this shift is evident.
said, using as-reported metrics only tell half of the story. Not only
has DISCA experience a substantial margin improvement, but they have
also seen a huge improvement in asset efficiency. Prior to the Ascent
Media spin-off, Uniform Asset Turns were fairly weak, ranging between
0.2x-1.3x. However, over the last 11 years, Uniform Turns have
consistently improved to current 2.7x levels, as the firm has focused
on streamlining their existing content while integrating new channels
like the Scripps portfolio. Using as-reported asset turns, DISCA
incorrectly appears to be an inefficient business, with turns never
reaching higher than 0.4x over the last 16 years.
current valuations, markets are pricing in expectations for a
reversal in recent trends to both Uniform Earnings Margin and Asset
Turns, which appears far too pessimistic when considering the
fundamental improvements the business has incorporated into their
Peer Analysis – Valuations Relative to Profitability
major benefit of adjusting as-reported financial statements is to
clear away accounting distortions to allow for more accurate
peer-to-peer comparisons. To this end, we have included a scatter
chart below that plots DISCA against its peers based on their Uniform
Value-to-Assets (P/B) and Uniform ROA.
across industries, markets, and time, there has been a strong
relationship between a company’s Uniform ROA relative to the
corporate average (~5%) Uniform ROA, and the multiple the market will
pay above the value of the company’s Uniform Asset base, in terms
of a Uniform V/A (P/B) multiple. A company that generates a 5%
Uniform ROA will tend to trade at a 1.0x Uniform P/B, and a company
that generates an 15% Uniform ROA will trade for a 3.0x Uniform P/B,
Relative to its peers, DISCA appears undervalued with its 9.1x Uniform P/B and 88% Uniform ROA. Most of DISCA’s peers, including CBS, AMCX, and TRCO, trade along the expected Uniform ROA and P/B relationship. However, DISCA trades between 1.5x-3.0x higher valuations compared to these names while having 3x-5x higher profitability. The market is pricing in expectations for the company to see profitability decline to levels not seen since their fundamental transformation, which appears unwarranted given the firm’s stable profitability over the last 10 years.
DISCA has fundamentally improved their business since 2008, the
market should not be pricing in expectations for profitability to
return to pre-2008 levels. Even with cord-cutting an ongoing concern,
DISCA has built a portfolio of content designed for sustainable
margins and ongoing improvements to efficiency.
In a scenario
where DISCA can sustain 50%+ Uniform ROA, and just keep from
shrinking their asset base, the firm is likely worth north of $40 per
share, 25%+ higher than current prices, and if they are able to
continue growing the business, the firm could be worth north of $60
per share, or 2x current prices.