EUR 850.00 For Business Accounts Only

Morningstar | Discovery Reports Strong 3Q EBITDA; Noncore Networks Continue to Bleed Subscribers

Discovery posted slightly better-than-expected third-quarter results as revenue came in line with consensus expectations and adjusted EBITDA beat Street projections. The integration of Scripps Networks appears to be moving faster than expected, as EBITDA margins expanded in the quarter despite continued investments in next-generation distribution platforms and new business. Despite the positive news about Scripps, the firm continues to lose subscribers with a 5% decline year over year, mostly at its smaller networks. We are maintaining our narrow economic moat rating and our $31 fair value estimate. With the shares trading in 3-star territory, we would wait for a pullback before starting a new position in this high-uncertainty name.

Overall revenue was up 57% year over year (2% on a pro forma basis) to $2.592 billion. For the U.S. segment, revenue increased 88% (up 4% on a pro forma basis) to $823 million, driven by growth in distribution and advertising. On a pro forma basis, distribution revenue was flat despite a 5% decline in subs. Affiliate fee rate growth offset the loss in subs and the subscription video on demand revenue.  Pro forma advertising revenue in the United States grew 5% as better monetization of digital content and better pricing more than offset lower delivery across all of the traditional linear channels. While ad revenue growth for the quarter was impressive, we remain concerned about the firm’s increased dependence on U.S. advertising after the Scripps acquisition. Despite the 60% growth in domestic affiliate revenue versus the same period last year, ad revenue was over 59% of U.S. revenue in the quarter, up from over 49% in the third quarter of 2017.

International revenue on a pro forma basis improved 2% year over year on continued affiliate fee expansion and advertising growth. Distribution revenue expanded 3% as Europe continued to grow due to digital revenue from Eurosport Player. However, rate declines continued in Asia as the firm’s offerings for the region lack sports content. Due to the revenue growth, adjusted EBITDA margin for the firm improved 500 basis points to 40.3% as Discovery also benefited from cost reductions from the merger.

While overall domestic subs fell 5%, the core networks were only down 2% as the smaller networks suffered mid- to single-digit losses due to continued cord-shaving. We still believe that the Scripps portfolio has a similar issue as the Discovery channels in that the three large networks (HGTV, Food Network, and Travel Channel) have better success at remaining or gaining carriage in the base packages at traditional and over-the-top pay-TV distributors than the more niche channels. As a result, we think the firm may be forced to rationalize its channel lineup as more consumers migrate toward the skinnier bundles on the OTT platforms.