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Why Discovery Stock Is Soaring Today

By James Brumley – Jan 7, 2022 at 8:18AM

Key Points

  • The combination of AT&T's WarnerMedia and Discovery will create a streaming powerhouse.
  • Shares of Discovery are undervalued relative to the sort of income the combined entity is expected to produce.
  • Interested investors may want to wait for the stock's price to settle from its current volatility before buying in.

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An upgrade only pointed out an obvious reality that actually came back into view late Wednesday.

What happened

It took a day and a nudge from Bank of America to get the ball rolling, but the ball is rolling in a big way now. BofA upgraded cable television content maker Discovery (DISC.A) (DISCK), (DISC.B) to a buy today following encouraging comments made by AT&T (T 0.89%) CEO John Stankey late Wednesday regarding the impending merger of Discovery and AT&T's WarnerMedia arm. All share classes of the cable television content maker are trading sharply higher, though its widely owned Class A shares are leading the way with a gain of 16.4% as of 12:43 p.m. ET Friday.

So what

Bank of America's upgrade may have been the prompt. Given the sheer scope of Friday's rally and BofA's relatively tempered explanation, though, beaten-down Discovery shares appeared primed for a rally long before today. As of Thursday's close the stock was down 67% from March's peak, with no significant advances being made during that stretch. Today's gain carries Discovery shares to a six-month high.

And yet, Bank of America analyst Jessica Reif Ehrlich is only voicing the (mostly) obvious in pointing out that AT&T's WarnerMedia -- which includes HBO -- and Discovery are "highly complementary assets."

HBO and its streaming offshoot, HBO Max, ended 2021 with 73.8 million worldwide subscribers, according to comments made by Stankey at Citigroup's AppsEconomy Conference on Wednesday. Meanwhile, despite not having any splashy television or movie titles of its own, Discovery says it was serving 20 million direct-to-consumer customers at the end of September. Ehrlich points out that the combination of Warner's hit movie franchises like The Matrix paired with Discovery's popular lifestyle-oriented television channels (which include Food Network and Animal Planet) will be powerful, in that the combined companies will be able to jointly offer some of the best entertainment options in homes as well as in theaters.

Rising bar chart with a blow arrowed trend line.

Image source: Getty Images.

AT&T's Stankey agrees, suggesting at Citi's recent conference that once WarnerMedia's chief Jason Kilar "can start to bring in the strength of what Discovery does so well into that portfolio, it's going to be unstoppable."

It should also be more profitable. The official announcement of the deal made by AT&T in May of last year indicates the pairing of Discovery and WarnerMedia will create a company poised to do $52 billion worth of business in 2023. Of that, $14 billion is expected to be converted into earnings before interest, taxes, depreciation, and amortization (EBITDA), with a total of $3 billion in annual cost synergies anticipated. Bank of America's Ehrlich highlights the fact that Discovery's stock is now priced at less than eight times next year's expected pre-depreciation operating income, making the risk/reward ratio on owning the stock "extremely favorable."

The pairing of Warner and Discovery is still on pace to be completed around the middle of this year, having just won a favorable ruling from the Internal Revenue Service that indicates the deal won't create a tax liability for shareholders.

Now what

Friday's enormous gain will be a tough act to follow -- at least right away. In fact, the fact that the stock jumped so much at the open above and beyond Thursday's highest price sets the stage for short-term profit-taking that will likely drag Discovery shares lower from here. At the very least this sort of extreme volatility makes entering such a stock a tricky affair.

By and large though, BofA's assessment of Discovery's potential once joined with Warner is on target. So is the analyst community's assessment of the stock's value. Ehrlich's price target of $45 is well above the current consensus target of $38.94, but even the lower of those two figures is 30% higher than today's dramatically increased actual price. The tricky part is being patient enough to let the current volatility run its full course before stepping in.

Citigroup is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. James Brumley owns AT&T. The Motley Fool recommends Discovery (C shares). The Motley Fool has a disclosure policy.

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