Discovery Communications is doing something other major cable networks aren’t during these difficult economic times: growing channels that will strengthen its brand in an expanding digital market.
While MTV Networks, ESPN, Turner Networks and other major cable content players are posting revenue and earnings growth this year, spurred by their dual advertising and subscription revenue streams, none has successfully forged a new string of developing channels off a relatively low-cost content base.
Discovery has matched its core Discovery Channel, The Learning Channel, Animal Planet and Travel Channel with the domestic and international rollout of the fledgling Discovery Health, BBC America and its suite of Digital Networks, which includes branded science, kids, home and leisure, civilization, Spanish-language and aerospace channels.
The developing services have had such a good initial run that UBS Warburg analyst Christopher Dixon estimates Discovery’s developing assets are worth about $1.5 billion, or nearly one-third of the estimated $6 billion assigned to Liberty Media Corp.’s 49 percent stake in the company.
The goal is to create more $2 billion franchises such as Discovery Channel and The Learning Channel, the company’s cash cows.
Many on Wall Street expect Liberty to monetize in an improved stock market and economy in which quality branded content is in high demand.
“The goal is to understand what we have enough [of]to exploit it. Whatever we do, we need scale and lots of strategic alliances,” Liberty Chairman John Malone told investors at an annual conference in New York in September.
Even now, it wouldn’t take much to reignite Liberty’s past talks with the likes of USA Networks, AOL Time Warner, Viacom and General Electric Co.’s NBC about a strategic alliance, spinoff or buyout that would make Discovery’s unique stable part of a larger content platform.
For instance, NBC’s National Geographic specials, which air on MSNBC and CNBC, would be a great fit for Discovery.
Peter Minsky, an analyst at SG Cowen, says spinning off or selling its stake in Discovery is one of the few remaining ways Liberty can create significant value from the investment. “The key is feeding and protecting the brand. I don’t know how many more channels they can create from the library they own,” Mr. Minsky said. “It’s one of the ways of creating shareholder value that would be instantly understood and accepted by investors.”
In fact, Liberty has frequently monetized its minority stakes in other companies, swapping them for a lesser minority interest in a larger company, such as News Corp., Viacom or AOL Time Warner, where it can capitalize on its connections and exercise its influence. Such trading pieces have included BET and Gemstar.
A more likely scenario is that in better times, Liberty could spin off Discovery, creating a publicly traded stock that could be used as acquisition securities. Discovery is the largest piece of Liberty’s $27 billion private portfolio, which also includes a 43 percent stake in QVC, 100 percent ownership of Starz!-Encore and various international businesses.
Lehman Bros. analyst Stuart Linde believes Liberty will retain its current Discovery stake to comply with its goal of keeping 60 percent of its vast and varied holdings in operating companies.
“It fills a huge void and maintains 50 percent-plus margins because of the relatively low-cost programming involved,” Mr. Linde said. Liberty Media can now offer the company a dominant distribution platform in countries such as Japan and Germany, where Liberty has been acquiring and constructing cable systems.
Growth and declines
Overall, Discovery, which is valued at about $15 billion, is supported by advertising revenues (which comprise slightly more than 40 percent of its total revenues), affiliate fees and licensing fees. “The current advertising environment illustrates the importance of Discovery’s second revenue stream and its international diversification,” said Liberty Executive VP Gary Howard.
While it has suffered a decline in ad revenues like other media concerns, Discovery has advanced its subscriber growth across its developing and international networks, contributing to an 8 percent rise in third-quarter revenues and narrowing its start-up losses.
Discovery’s international developing channels, which are expected to turn cash-flow-positive next year, posted a 28 percent rise in third-quarter revenues, beating analyst estimates by $11 million, although losses were worse than expected at $117 million before interest, taxes, depreciation and amortization. Aggregate gains bringing the international subscriber count to 144 million were driven by the rollout of Sky Digital, Discovery India and the growth of Discovery Health and Discovery Channel in places like Europe and Latin America.
All of Discovery’s developing assets will be profitable by 2004.
While Discovery’s financial picture looks increasingly bright, its lesser owners also will have something to say about the company’s future. They include Cox Communications, the Advance/Newhouse partnership and John Hendricks-Discovery’s founding chairman and chief executive.
Mr. Hendricks told me Discovery will continue to grow organically and through select acquisitions, such as buying The Health Network from Fox Entertainment for $155 million several months ago. He also means to leverage the fact that Discovery has become the world’s most widely distributed television brand, with 650 million subscribers in 155 countries.
Discovery has begun challenging the bigger, more conventional media outlets with what Mr. Hendricks calls the “Discovery power block roadblock,” allowing advertisers to buy one 30-second spot that airs twice across 10 demographically cohesive channels and Web outlets.
“We’re taking dead aim at the advertising dollars of the broadcast networks,” Mr. Hendricks said.
Before the advertising recessions worsened earlier this year, Discovery had achieved 112 percent growth in ad revenues in the first quarter from a year earlier based on ratings growth. In early September, Discovery’s channels generated an average 5.6 rating compared with 5.5 for Fox, 7.6 for ABC, 7.9 for CBS and 7.4 for NBC. That’s a far cry from the 1995-96 season, when Discovery averaged a 1.5 rating compared with 6.4 for Fox, 8.8 for CBS, 9.5 for ABC and 11.6 for NBC.
Although Discovery’s recent upfront ad sales managed to match those of the prior year, its pricing was down to low to mid-teens to support an overall projected 4 percent revenue growth rate in 2001. There is nagging concern that a prolonged economic slump will cost the company and its services more ad dollars and subscribers.
“There is certainly some concern if you have two consecutive years where you have the market going down 6 [percent] or 8 percent to close to 10 percent, depending on whose numbers you look at,” said Gregory Durig, executive VP and chief financial officer of Discovery Communications.
“Obviously that’s a big hole when your business plans are based on 10 [percent] or 15 percent growth. It does make it difficult to get back to the numbers. … Our Discovery and Learning [costs per thousand] have held a little stronger, so hopefully it will be less of a hurdle for our larger networks. But all of our international and domestic developing channels will begin contributing significantly to cash flow once they reach critical mass.”
That will happen quickly over the next several years despite the current economic downturn, since Discovery’s program services are proving to be more universal and less susceptible to fragmentation and advertising pullback than anyone imagined.
With prime-time audience growth for its core channels up 12 percent from the second quarter and 14 percent from a year ago, affiliate revenues up 11 percent and subscriber growth up 13 percent, a 4 percent rise in advertising revenues doesn’t look so bad.
In the meantime, Discovery is building value at a relatively low cost at a time when other companies are
bemoaning the loss of ad dollars, viewers and revenues. It is playing into an increasingly fragmented global television market to win.