Investors are ultimately responsible for their own investing decisions, but that doesn't mean they can't steal from the greats. One investing great -- especially when it comes to the media space -- is cable legend John Malone, who was profiled in William Thorndike's book on great CEOs, The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, and has an estimated net worth of $8 billion. Currently, Malone owns large parts of many different cable and media properties, from Charter Communications, to Liberty Media, and much, much more.
One of Malone's smaller positions is in Discovery Communications (NASDAQ:DISCA) (NASDAQ:DISCK), and over December 13-14, Malone upped his Discovery stake by about $8 million, almost doubling his position, according to SEC filings. While that is still not a huge percentage of the company (though Malone does control over 20% of the voting power), or a lot of money for Malone, it's interesting he is doubling down on Discovery now. As of mid-December, the stock had fallen about 25% year to date. So clearly Malone thinks the stock has overshot to the downside. Here's why that makes sense.
Merger in the works
Discovery is currently in the midst of buying Scripps Networks Interactive (NASDAQ:SNI) for about 70% cash and 30% stock, at an enterprise value of $14.6 billion. The acquisition has not been looked on favorably by investors, as Discovery shares have continued falling since July's announcement.
Both companies are in the media industry, of course, which has been roiled by cord-cutting, so some may be skeptical the merger will alter that bleak reality. In addition, Discovery will take on significant debt to acquire Scripps, and will halt its share repurchase program until its debt ratios are back down to a lower level.
While investors are clearly wary of that combination, Malone, Discovery, and Scripps management think differently. Here's the positive thesis on the merger.
When the deal closes, Discovery and Scripps will own a large percentage of major non-fiction cable content. Discovery owns channels such as The Discovery Channel, The Learning Channel, Animal Planet, and Oprah Winfrey's OWN network. Scripps owns popular lifestyle brands like HGTV, The Food Network, and The Travel Channel.
In fact, post-merger, Discovery-Scripps will own 20% of the prime-time ad-supported cable audience, and the largest portion of the women's ad demographic. That should give the combined company bargaining power with both distributors as well as advertisers.
In addition, these channels are relatively low-cost to distributors when compared to scripted channels and live sports, which should allow the combined company to maintain, or even raise, affiliate fees. Discovery-Scripps should also be relatively protected from the rising costs of scripted content. Discovery CEO David Zaslov said in a recent CNBC interview that non-scripted programming costs are only about 10% of scripted costs.
Finally, the companies estimate should generate about $350 million in cost synergies, and will generate substantial free cash flow. " ... if you look at Scripps-- first of all, big synergy. Second of all -- relatively cheap. Free cash flow engine. You know, if you buy -- post synergies, if you buy -- something that's generating a 12% cash return and you buy it with 3.5% money, right, it's -- it creates a lot of free cash flow," Malone said in a November interview with CNBC.
But there are risks
There are, of course, valid reasons why Discovery's stock price has declined. In the third quarter, Discovery's U.S. segment saw 5% subscriber declines. Scripps, for its part, also posted modest subscriber and advertising losses. Still, both companies reported overall growth, due to higher affiliate fees, as well as international growth. In addition, the combined company's debt ratio will be over 4.8 times EBITDA, which is relatively high.
The big question is if the current media industry transition will be severe or gradual. If the transition is smooth, Discovery looks like a promising value. While streaming and Silicon Valley giants garner most of the attention in media these days, niche companies such as Discovery could actually be the interesting media stocks to watch in 2018. So tagging along with this billionaire could make sense.
Billy Duberstein owns shares of AT&T and Discovery Communications. The Motley Fool owns shares of and recommends Discovery Communications. The Motley Fool recommends Scripps Networks Interactive. The Motley Fool has a disclosure policy.