Discovery Communications shares are roaring higher on Friday, after an analyst upgraded the stock and issued a price target 75% above Thursday’s closing price in a 30-page report.
Discovery stock (ticker: DISCA) jumped 17% in Friday morning trading. That pop is worth some $1 a share to AT&T (T), which was also upgraded to the equivalent of Hold–from Sell–by Wells Fargo on Friday. AT&T stock rose 3% in morning trading Friday. Discovery’s voting shares (DISCK) also added 17%.
Reif Ehrlich upgraded Discovery shares to Buy, from Neutral, and lifted her price target to $45, from $34 previously. That compares with the stock’s $25.72 closing price on Thursday, and levels around $30 after Friday morning’s bump.
Last May, AT&T announced plans to spin off and merge WarnerMedia with Discovery in a transaction known as a Reverse Morris Trust. AT&T shareholders will own most of the combined media company–to be called Warner Bros. Discovery–while current Discovery CEO David Zaslav will lead the entity. The company’s U.S. cable networks will include Discovery Channel, Food Network, CNN, TNT, Cartoon Network, and more. Other assets include the Warner Bros. film studio and Discovery’s European networks. But its future will be focused on streaming: HBO Max and Discovery+ are the current offerings there.
Reif Ehrlich expects Warner Bros. Discovery will have sufficient content and financial scale to compete in the competitive global streaming market.
“It remains to be seen how many services consumers will ultimately subscribe to and how subscale providers will compete against behemoths…that are all accelerating content spending,” such as such as Netflix (NFLX), Dinsey (DIS), Amazon.com (AMZN), and Apple (AAPL), she wrote in a report published on Friday. “Ultimately, the magnitude of success will be predicated on the success of the combined entity’s global direct-to-consumer, or DTC, strategy. It is our view WBD will eventually combine to one service (vs. bundle) which enhances the depth and breadth of content offerings, reduces churn, increases [lifetime value,] and improves [go-to-market] efficiencies.”
The merger also promises to eliminate redundant costs, to the tune of $3 billion annually, according to management’s initial estimate (versus combined revenues of about $45 billion in 2021). Reif Ehrlich sees that target as conservative, and is bullish on management’s ability to squeeze more savings out. Discovery’s acquisition of Scripps, which closed in 2018, exceeded initial synergy forecasts.
Investors haven’t bought that thesis just yet. AT&T stock has lost 16%, after dividends, since the day the merger was announced, and Discovery stock has shed 28%. The deal is scheduled to close around the middle of 2022.
Reif Ehrlich’s new price target for Discovery stock is based on a sum-of-the-parts (SOTP) valuation of WBD’s future streaming business and its legacy TV and film businesses. She expects a total of 148 million streaming subscribers at the combined company at the end of 2024, versus an estimated 97 million today.
At Thursday’s close, Discovery stock was trading for less than eight times management’s target of $14 billion in 2023 operating income before depreciation and amortization, or Oibda, for the post-merger company. Reif Ehrlich values the DTC streaming business at 14 times her estimate of 2030 Oibda, implying a roughly four times Oibda multiple for the legacy businesses. That’s too cheap, she argues.
There’s still the merger overhang and execution risk, but this valuation presents an attractive risk/reward trade-off today, according to Reif Ehrlich. Her bull case scenario, which includes greater cost savings and faster streaming subscriber growth, has shares rising to $57. Her bear case–slower DTC growth, less synergies–yields a target of $25, or about where shares were trading on Thursday.
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