Discovery (DISCA) – Forced Sell-Off – 20% Upside

Current Price: $42.30

Target Price: $51

Upside: 20%

Expiration date: TBD

This idea was shared by Andrius.

 

This is a speculative and timely idea mostly based on technical sell-off from the forced hedge fund liquidation.

Last week share price of multiple well-known large caps, including $DISCA, $VIAC and several US-listed Chinese conglomerates ($BIDU, $RLX, $GSX, etc.) crashed eliminating hundreds of billions worth of market value.

$DISCA fell -47% from the recent all-time high. 10x the usual volume was traded on Friday and 5-6x on Monday (yesterday):

Apparently, at least part of this sell-off was driven by the liquidation of a major hedge fund Archegos ($30bn AUM), forcing investment banks to block-sell Archegos positions in the open market and thereby pushing the above-mentioned stocks to free-fall. Archegos was run by former Tiger Asia manager Bill Hwang, which in 2012 was found guilty of insider trading. Hwang used Archegos as its family office managing $10bn of Hwang's family assets. However, on top of that, it is reported that the fund used a substantial amount of leverage (apparently 3 to 1) inflating the AUM to $30bn. Reportedly, Archegos held concentrated positions, including a mix of stock and swaps.

It was reported that Archegos related sell-off started on Friday - Goldman Sachs alone sold 30m shares of VIAC during midday trading, while Morgan Stanley sold 15m shares of DISCA. However, the downtrend started a few days earlier (mid-week) than the news Archegos liquidation appeared.

WSJ reported that sales connected to Archegos were continuing on Monday (yesterday) and there are rumors that it could continue for several more days this week due to further additional liquidations of other affected hedge funds. Most of the sold-off stocks continued to be volatile yesterday with the trading volumes being significantly elevated.

 

The rebound?

Given the magnitude of the sell-off (47% drop from its recent all-time highs), the current situation could provide an interesting play on the potential DISCA share price rebound after the forced selling and market panic are over. However, DISCA share price has now settled at the February'21 levels and the main question here is which price is a better reference point of DISCA fundamental valuation - recent all-time high of $77 or February levels around $40/share. I believe the answer lies somewhere in the middle as at least some part of the recent month's price surge is justified by very favorable developments, which got the market excited.

DISCA annual results were announced on the 22nd of Feb. These showed modest top/bottom-line performance (revenues down -4.2% YoY, net income -41% YoY) due to COVID-19 related disruptions for advertising business and disruption in the European sports schedule. Despite that, the major positive catalyst was the unexpected success of DISCA's new streaming service. Discovery+ was launched in January and in less than 2 months managed to attract almost 6m subscribers. As stated on the conference call, company's direct-to-consumer segment subscribers have increased from 5.2m in Dec'20 (pre-launch) to 11m in February and are forecasted to reach 12m by the end of that month (the call was held on the 22nd of Feb). From the call:

Discovery+ is off to a fantastic start, and we couldn't be more encouraged by all the early metrics. After 7 weeks since launching here in the US, we have over 11 million paying direct-to-consumer subscribers across our entire portfolio, and we will hit 12 million by the end of this month of February, an increase of 7 million net adds, as compared to 5 million subs, we reported in December. The vast majority of this increase is attributable to Discovery+.

The company also intends to expand the service globally during the next 18 months. Outlook for 2021 was not shared, however, the company stated that it expects 50% growth in next-gen revenue (streaming services, which is not reported as a separate segment) in Q1'21 with further acceleration in the following quarters:

We see both a very strong start to next-gen revenue growth in 2021 with Q1 poised to grow around 50% with meaningful acceleration in the quarters, thereafter, and a much more attractive investment opportunity around subscriber growth.

Another big catalyst could be the Olympic games this year. Discovery+, in advertising partnership with Snapchat, will be an exclusive streaming home platform for the European markets (in my understanding - the only streaming service to broadcast the Olympics in Europe). The company expects the Olympics to substantially catalyze the international expansion:

As we come out of the Olympics and go into the second half of the year, that's when you're going to see the acceleration of the international rollouts.

Next-gen revenue was about $850m in 2020 (8% of total revenues). Assuming the company can double it this year, just the streaming services alone would grow total revenues by 8% YoY. On top of that, the legacy advertising business is also expected to recover with the ongoing vaccine roll-out.

On top of all these positive expectations, DISCA is cheap. The company currently trades at 8% FCF yield ($2.3bn FCF in 2020 vs $3.1bn in 2019), which by itself seems quite attractive.

Overall, given the success/growth potential of the new streaming service and expected recovery of the legacy media/advertising business with the vaccine rollout and post-COVID recovery. I think it's fair to assume that at least some of the run-up since February was justified. Once the sell-off is over, I expect the stock to rebound to some extent. 8% FCF yield should act as downside protection at current share price levels.

 

WSB

This event has caught the attention of WSB and there are multiple posts now covering the situation. WSB jumping on the "dip" might act as an additional catalyst for the rebound. Keep in mind that this is pure speculation, however, given the recent events of the year, WSB involvement could be an impactful factor here (even if negative sentiment seems to be higher than the positive one, whatever that might mean)

DISCA popularity on WSB:

5 COMMENTS

  1. ijw

    I looked at this when it was trading in the 20’s, and couldn’t get comfortable with low barriers of entry. I get pretty much all my infotainment off YouTube these days and it is far superior than anything you can get on most of DISCA’s channels. And I think YouTube is only getting started.

    DISCA is basically competing with loads of random people who are willing to do it for free at first aided by YouTube’s algorithms that are getting better and better at letting people discover new content they like. And producing good infotainment these days often takes very little budget with the advanced tools that are now available to regular people. That didn’t seem like a good business to me. But maybe my fears are overblown and I am just bitter I missed out on a double here 🙂 .

    1
  2. Alex

    There is $1.4 billion remaining under the authorization as of December 31, 2020. For the full year 2020, the Company repurchased 41.6 million Series C common shares for $965 million at an average price of $23.18 per share. The Free Cashflow will probably be used to buy back shares, which will support the share price. It will be interesting to see if they stepped up the buyback after the big drop.

  3. dt

    Rumors out on mega business merger between Discovery and AT&T. Transaction details are expected within a week.

    AT&T close to deal to combine media empire with Discovery-reports

    U.S. telecoms giant AT&T Inc (T.N) is nearing a deal to combine its media assets, including CNN and HBO, with Discovery Inc (DISCA.O), the owner of lifestyle TV networks such as HGTV and TLC, according to news reports citing unnamed sources.

    The deal would mark the unwinding of AT&T’s $108.7 billion acquisition of U.S. media conglomerate Time Warner in 2018, and it would underscore its recognition that TV viewership has moved to streaming, where scale is required to take on the likes of Netflix Inc (NFLX.O) and Walt Disney Co (NFLX.O).

    The combination would create a new company separate from AT&T that could be valued at $150 billion, including debt, the Financial Times reported. Discovery currently has a market value including debt of about $30 billion.

    A deal could be announced later this week, according to Bloomberg News, which first reported the news.

    https://www.reuters.com/business/media-telecom/att-discovery-talks-combine-content-assets-bloomberg-news-2021-05-16/

  4. snowball

    DISCA’s lack of recovery after the forced sell-off is intriguing. Price has now returned to January level (YTD return flat, 60% off from March 19 high of $77.27).

    Either DISCA is significantly undervalued now, or the spectacular 150% run-up in price during the first three months of 2021 was single-handedly orchestrated by Bill Huang’s short squeeze.

  5. Ilja

    The rebound thesis has fallen flat and we are closing this idea with 24% loss in 2 months. However, the WarnerMedia acquisition seems interesting with both businesses being highly synergistic and complementary. DISCA currently trades at just 6x pro-forma 2020 adj. EBITDA and 5.1x E2023 adj. EBITDA and seems quite attractive for a longer term investing.

    Merger presentation – https://s27.q4cdn.com/187472364/files/doc_presentations/2021/ATT-Discovery-WM-05172021-FINAL.pdf

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