BOTTOM LINE: Discovery Communications reported results that we characterize as positive, if slightly below our expectations. The quarter still featured top-line improvements and reasons for optimism around overall progress in developing the cash-generating capacity and overall profitability of the business. We have updated our model and retained our $73 price target with a HOLD recommendation. Discovery is a standout business with attributes which are well-understood by investors, leading to a company with what we characterize as a generally fair, if often very highly valued stock. At current prices, Viacom remains our preferred stock in the sector given much more favorable cash yields (8% during 2014 on yesterday's close for Viacom vs. 4% for Discovery on the same basis). Further, despite Discovery's likely outperformance in revenue and cashflow generation over the next few years, even by 2017 Viacom will still be yielding more cash per share (10% by our estimates) than will Discovery (7%).
Highlights from the release and call include:
RISKS. Investors in Discovery will need to be conscious of 1) the company's reliance on a handful of core network brands which collectively account for small share of total TV viewing, 2) misguided perceptions by many investors and industry participants regarding the "death of TV advertising", and 3) slowdowns in pay TV subscription levels or reduced ARPUs around the world may diminish growth in distribution fees for Discovery.
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