Is Discovery Networks a Streaming Gold Mine or Out on Its ‘OWN’?

Discovery Networks (NASDAQ:DISCA) stock is being pumped by streaming’s promise. Since the start of 2021, the value of DISCA stock has more than doubled.

Shares that traded at under $31 in early January are set to open above $65 a piece this morning. That affords the company an almost-$29 billion market capitalization on 2020 revenues of about $10 billion. It’s a price-to-earnings multiple of more than 46x.

For a collection of cable networks focused on reality, science, and cooking, that’s a nosebleed valuation. For a streaming service, however, analysts feel it’s just right. Out of 15 analysts following the stock as tracked by Tipranks, only two say sell. This despite the average price target being 28% below where it’s currently trading.

Is Discovery a long-term winner, or is it being pumped by hope only to be dumped by reality?

The Hope Fueling DISCA Stock

The hope fueling DISCA stock was in Discovery’s Feb. 22 earnings release. CEO David Zaslav said the Discovery+ streaming service had 11 million subscribers and promised 12 million by the end of the month. This was no surprise given the company’s big investments “in content, beloved personalities and brands with huge consumer appeal, supported by industry-leading (direct to consumer) DTC capabilities.”

So, where’s the growth? Fact is, there is none. As fast as consumers are buying Discovery+, they’re dumping the cable networks on which it’s based. For the fourth quarter, Discovery said it had adjusted net income of 76 cents per share on revenue of nearly $2.9 billion. Sounds good, except a year ago it had adjusted net income of 98 cents on revenue of $2.87 billion, and it was trading at $30.

Discovery+ combines the libraries of over a dozen cable channels, including those bought with Scripps Networks in 2018 for $14.6 billion. As with ViacomCBS (NASDAQ:VIAC), investors are chasing the bright, shiny object of streaming and ignoring the cable cash flow left behind. 

The Reality Facing Investors

The reality facing investors is summed up in a corner of a page listing networks being bundled into Discovery+. It’s the logo of OWN, the Oprah Winfrey Network.

Winfrey sold her eponymous network to Discovery over time. A 2017 deal gave Discovery 24.5% of the network for $70 million of stock. In late 2020, Discovery bought another 23%, increasing its stake in OWN to 95%, for $35 million.

Ms. Winfrey didn’t become a billionaire by being stupid. Cable assets are rapidly depreciating. For nearly every streaming customer paying $5 a month for Discovery+, there’s a cable subscriber who cut the cord and cost Discovery that much, or more, from a cable operator.

Interest in lifestyle, niche streaming is growing, analysts say. Discovery doesn’t break out its $5 a month ad-supported subs from its $7 a month ad-free ones. Which begs another question. Is advertising for a month on the equivalent of 10 cable channels worth just $2 a month to Discovery?

Investors Paying 2x More for Streaming Revenue

Discovery is buying market share with low prices that let it break even on the top line as consumers move from one to the other.

The bottom line isn’t as good. Discovery’s net income for 2020 was 43% below 2019. The release obscures this with the term “Operating Income Before Depreciation and Amortization (OIBDA).” This is a non-GAAP measure of income which replaces net income in the EBITDA calculation with operating income. OIBDA was down only 9% year-over-year.

It’s reasonable to expect non-recurring expenses when your business model shifts from wholesale to retail. But there are also going to be more costs, like bookkeeping, customer service, and direct to consumer marketing.

The bottom line is that investors are paying twice as much for Discovery’s streaming revenue as they once did for its cable revenue. Oprah didn’t see this as a good deal as she sold down OWN for lower prices. That’s not the way I see it either.

At the time of publication, Dana Blankenhorn owned shares, directly or indirectly, in any company mentioned in this article.

Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, available at the Amazon Kindle store. Write him at danablankenhorn@gmail.com, tweet him at @danablankenhorn, or subscribe to his Substack https://danafblankenhorn.substack.com/.