Discovery Q2 up 10% on International
Discovery Communications’ Q2 revenues were $1.610 billion, up $143 million, or 10%, over Q2 2013, as 23% growth at International Networks was partially offset by a 2% decline at U.S. Networks–primarily due to additional revenues from licensing agreements in the prior year. Excluding the impact of the Eurosport transaction, foreign currency fluctuations and licensing agreements, total revenues increased 9% and Adjusted OIBDA increased 11%.
Q2 net income available to Discovery Communications, Inc. of $379 million ($1.09 per diluted share) increased $79 million, or 26%, compared to $300 million ($0.82 per diluted share) for the second quarter a year ago, primarily due to the strong operating performance in the current quarter.
The current quarter results also reflect a $31 million gain associated with the sale of HowStuffWorks, a $29 million gain associated with the consolidation of Eurosport and a $15 million increase in equity earnings.
Adjusted EPS, which excludes the impact of the amortization of acquisition related intangible assets, was $1.16 per diluted share in the second quarter of this year compared with $0.91 per diluted share in the same period a year ago. For the last twelve months, Adjusted EPS was $3.62, up 35% compared with $2.69 in the prior twelve months.
Said David Zaslav, Discovery CEO: “The operating strength across Discovery’s organic businesses, along with increased contributions from strategic acquisitions, led to sustained financial momentum during the second quarter. Our persistent focus on building a broad and deep content portfolio to leverage the opportunities across our unique distribution platform is driving viewership and revenue growth worldwide as pay-tv continues to evolve. Going forward, investing in compelling programing remains a priority as we integrate our recent acquisitions and build new avenues of growth so we can deliver additional long term value to our shareholders.”
Noted Brian Wieser, Senior Research Analyst, Pivotal Research Group: “Discovery Communications reported 2Q14 earnings that delivered 4.7% domestic ad revenue growth for the quarter, continued internationally expansion and a narrowed range of revenue growth and profitability for the year, very much in line with our expectations. Results paired with commentary around taxes suggest that our long-term expectations around tax rates have probably been too conservative, and such a consideration should add to the company’s value. With these and other tweaks to our model, we now value Discovery at $78 on a YE2014 basis vs. $74 previously and continue to rate it a Hold.
2Q14 domestic ad revenues at +4.7% were slightly better than we expected, similar to 1Q14’s +4.8%. This is consistent with commentary we have heard from much of the national TV buying community, with spending trends not meaningfully changed between the quarters. Discovery’s commentary about 3Q14 conveyed expectations for mid-single digit growth, consistent with our model’s 5.0% forecast. International trends were solid again, although slightly harder to parse given the inclusion of the free-to-air incumbent Nordic networks in last year’s baseline figures. We can derive an estimate for growth for “legacy” Discovery international advertising activity as falling in the low 20% range – still very solid, considering that the company has posted better than 20% year over year advertising growth in that legacy business for six quarters running. New free-to-air networks have proven to be significant contributors to this result.
Distribution revenues were constrained in the United States due to a licensing agreement with Netflix in 2Q13, yielding -8% growth in domestic licensing. The company did generate underlying growth of 6%, which falls in line with the company’s expectations for the remainder of the year, excluding any new distribution deals that get signed and excluding some revenue booked during the second half of last year in association with such licensing agreements.
The cleanest like-for-like margin figures reported were domestic activities, which were flat at 59.4% vs. 59.5% in the year ago period and 60.9% two years earlier. Margins would have been negatively impacted by the absence of Netflix revenues this quarter, although presumably were positively impacted by the disposition of Howstuffworks.com, which was sold in April. Across the company as a whole, OIBDA margins were 42.1% vs. 45.5% reflecting the lower margin nature of the company’s recent acquisitions.
Updated guidance for the remainder of the year indicated expectations on the lower end of the previously provided range, consistent with our expectations. FX headwinds, a delayed close on Eurosport and weaker US advertising market were cited in association with the adjustments. New guidance calls for revenue of $6.45-$6.525bn vs. our forecast for $6.445bn. Adjusted OBITDA guidance is for $2.6-$2.65bn, vs. our forecast of $2.59bn. The company’s adjusted net income forecast was for $1.34bn to $1.4bn, although our forecast is presently at $1.33bn.
One particular positive from the call related to taxes, which came in at 35.1% for 2Q13, vs. 37.6% in 2Q13. Comments indicated that investors “will continue to see that reduction in effective tax rate throughout 2014 and you will see that accelerating in 2015.” The company is engaging in a range of ongoing efforts to help bring down its effective tax rates, which are now more appropriately incorporated into our model as well.
We continue to view Discovery’s business through a positive lens, considering its international expansion very favorably. However, underlying value of the company, even if impacted positively by incorporating a lower long-term tax rate along with other modifications and updates to our model lead us to a $78 vs. $74 previously. We continue to rate the stock Hold.
RISKS. Discovery investors face risks from 1) the company’s reliance on a handful of core network brands 2) misguided perceptions by many investors and industry participants regarding the “death of TV advertising”, and 3) deceleration in pay TV subscription growth levels or reduced ARPUs around the world may diminish growth in distribution fees.
VALUATION: We value Discovery using a DCF, using a near-term discount rate of 5.7%, a long-term discount rate of 11.2% and a long-term growth rate of 5.5%. Current P/E equates to 21x 2014 earnings.”
Noted Sterne Agee analyst, Vasily Karasyov, who adjusted estimates for Discovery: “We are sticking with our Buy rating of DISCA shares and raising our 12-month target price to $99 from $87. We think that acceleration in US advertising revenue growth that we expect starting in 4QFY14 should support the multiple.
• Valuation has been helped by the recent M&A speculations in the sector but may need support from US advertising revenue trajectory. We think that the multiple could contract in the mid-term if US advertising revenue growth doesn’t improve. The comps, however, will get easier: from +12% in 3Q to mid-single digits in 4Q and beyond.
• We are adjusting estimates to reflect updated guidance. For 3Q, we expect U.S. Networks ad revenue growth of 5% vs. 8% prior, affiliate revenue to contract 4%, and adjusted OIBDA of $414 mln (down $17 mln). Our International Networks estimates are $354 mln of ad revenue (unchanged), $475 mln of affiliate revenue, and $313 mln of adjusted OIBDA (-$12 mln). We expect total adjusted OIBDA of $666 mln (down $30 mln) for 2Q and $2.65 bln (down $49 mln) for FY14. Our 3Q, FY14, and FY15 EPS estimates are $0.88, $3.67, and $4.50.
• 2QFY14 total adjusted OIBDA was $694 mln, 3% above our model; diluted EPS was $1.09 while we expected $0.92. U.S. Networks revenue of $777 mln came in $7 mln below, with ad and distribution revenue in line but Other revenue softer than expected; adjusted OIBDA was $27 mln higher than our forecast at $466 mln. International Networks revenue of $802 mln was $38 mln above our model but adjusted OIBDA was $18 mln lower at $297 mln.
• Our revised 12-month target price is $99 and reflects recent P/E multiple expansion and is based on a FY16E P/E of 19x.”