Imperial Capital Says Patience Will Pay Off For Discovery Communications Investors

Discovery Communications Inc. DISCA shareholders who are focusing on domestic cord-cutting concerns are overlooking the company's future potential, according to Imperial Capital.

The Analyst

Imperial Capital's David Miller initiated coverage of Discovery with an Outperform rating and $32 price target.

The Thesis

Discovery not only acquired Scripps for a "relatively low" price, but gained the company's expertise in over-the-top skinny bundles — which is needed given Discovery's poor performance in that area, Miller said in the initiation note.

Scripps "somewhat surprisingly" transformed its Food and HGTV channels into "fairly popular networks" in skinny-bundle offerings, while Discover fell behind in doing the same with its multiple channels, the analyst said. 

Encouragingly, the acquisition of Scripps will generate an "immense amount" of scale in the linear cable networks space that will support future negotiations with distributors, particularly overseas, Miller said. The companies complement each other, as Scripps' business lacks international exposure and Discovery has seen success outside of the U.S., he said. 

Discovery is likely to allocate its 2018 and 2019 free cash flowto lowering the debt load used to complete the Scripps acquisition, Miller said. The combined company should end 2018 with a net debt/EBITDA ratio of four times, a figure the analyst expects to improve to 3.25 times at the end of 2019 — which is only 1.25 turns higher than the true capital efficiency ratio of 2.5 times, he said. 

Discovery is making the right moves to give shareholders an opportunity to generate a profit, but only for investors with patience, according to Imperial Capital. 

Price Action

Discovery shares were trading down 0.89 percent at the time of publication Tuesday morning. 

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