Discovery (DISC.A)(DISCK) just reported its final quarter of a most difficult year. Fourth-quarter 2020 revenue was flat from a year ago, leaving the full-year total down 4% year over year to $10.7 billion -- which includes the deep advertising freeze last spring at the start of the pandemic lockdown. At the very least, ad activity has rallied to pre-pandemic levels, helping offset the slow but steady decline of cable TV subscribers.
But the real news here was of course the long-awaited launch of the streaming service discovery+. And just seven weeks after its U.S. launch, discovery+ has accumulated over 11 million subscribers worldwide and will surpass 12 million by the end of February. Profitability is going to take a hit this year as the media company props up its marquee service of the future, but this remains one cheap stock if the streaming service continues to pick up subscribers at a rapid pace.
Forget about profits for now
As expected, Discovery's free cash flow took a hit at the end of the year. The total in Q4 was $441 million, a 61% dive compared to $1.13 billion the same time last year. However, Discovery is a highly profitable media company. Even with the hit the bottom line took, free cash flow margin was a healthy 15% during the final months of 2020.
Not that shareholders should fret too much about this metric. At this point, it's all about picking up new discovery+ subscribers as quickly as possible. After all, cable TV is steadily bleeding out as the cord-cutting movement continues unabated. Discovery management expects spending to peak in 2021 as it supports its new streaming property (and the rebranding of Dplay in some international markets to discovery+). Adding 7 million net subs since the last update in December is solid progress, and there are new market launches on the way in the coming year and a half.
In the year ahead, Discovery said it will be putting share repurchases on the back burner and instead deploying its cash to maximize discovery+'s potential. With $2.38 billion in free cash flow generated in full-year 2020, the company certainly has liquidity at its disposal to foster growth.
Laying a solid foundation for the future
There will eventually be payoff for this transition from cable TV (which includes popular Discovery stations like its namesake channel, Food Network, HGTV, and Animal Planet) to streaming. The ad-supported tier of discovery+ (the majority of subs to this point) is just $4.99 a month, but it's really all about the advertising potential. CEO David Zaslav explained the difference between linear (cable) and streaming TV ads on the earnings call:
We are already an industry leader when it comes to time spent with our linear portfolio, yet watch time on discovery+ in the U.S. is nearly twice that. This naturally has been extremely well received by our advertising and brand partners, which coupled with initial signs that discovery+ extends effective reach to non-pay TV viewers gives us even more conviction and confidence in the long-term ARPU [average revenue per user] trajectory. In fact, our ad-light ARPU in the U.S. is already above linear and we are just getting started. As we scale and usage continues, we are confident our ARPU will grow meaningfully.
Put another way, the quality of advertising dollars spent on discovery+ is already exceeding that of traditional cable. Marketers have more flexibility in choosing an ad slot, can target audiences better, and can track effectiveness of ads better. Discovery said it will be rolling out new tools for marketers later this year like keyword targeting and interactive advertising.
And don't forget there are other positive catalysts coming later in the year for Discovery. In European markets, discovery+ will be the home of the Tokyo Summer Olympics this year and the Winter Olympics in Beijing next year. Paired with its extensive reality TV and non-fiction content, this is an enviable library of entertainment in the U.S. and abroad. The recent pace of subscriber additions should continue for a while.
The metric will no doubt get worse this year as Discovery funnels cash into discovery+, but class A and C shares trading for a respective 11 and 9.6 times trailing-12-month free cash flow seem like a pretty good deal to me. This is a highly profitable media business taking great strides to update itself for the new digital era.