It’s Time to Trim Down on Discovery Stock

June
2, 2021

5 min read

This story originally appeared on MarketBeat

Television networks media giant Discovery Networks (NASDAQ: DISCA) stock has been pummeled by two events in 2021 leading to shares falling more than (-50%) off their highs. The one-two punch drastically reversed sentiment from euphoric on the climb from $20s to $78s inside of four months to bearish on the collapse to $30s in the following two months. The first shoe to drop would be the Archegos Capital Management margin calls that collapsed shares from a high of $78.08 to a low of $34.60 in a single week in sympathy with ViacomCBS (NYSE: VIAC). The second shoe was the announcement of the merger spin-off of AT&T (NYSE: T) WarnerMedia unit with Discovery into a new unnamed company that would combine the media entertainment content into a supposed powerhouse player in the entertainment industry. While the sentiment may improve in the near term with reopenings to attempt the return to normal, the spin-off is may hamper its ability to compete with Disney’s (NYSE: DIS)  Marvel Cinematic Universe. Investors are confused in the uncertainty of the upside of this deal as Discovery will be adopting $43 billion of new debt in addition to its existing $15 billion of debt. Prudent investors may consider trimming down exposure in shares of Discovery as near-term bounces get absorbed by anxious sellers.

What is the WarnerMedia Discovery Deal?

The board-approved deal will enable AT&T to spin-off its WarnerMedia unit to merge with Discovery to combine the library of IPs. The new company will be 71% by AT&T and 29% by Discovery. AT&T offloads a large chunk of debt that Discovery will inherit. The deal combines over 100 brands including HBO, Warner Bros., DC Comics, CNN, Cartoon Network, Discovery, HGTV, Food Network, Turner Networks, TBT, TBS, Eurosport, Magnolia, TLC, Animal Planet, and ID. Once again, the spin-off will have a mountain of debt mostly from WarnerMedia of approximately $43 billion. The Company plans to spend $20 billion on new content annually, which even transcends Netflix’s (NASDAQ: NFLX) $17 billion annual budget. The company has ambitious goals of becoming the number one player in the streaming wars as be Discovery CEO David Zaslav, who will run the new company.

Q4 2020 Earnings Release Recap

Just to recap Discovery earnings on Feb. 24, 2021, Discovery Networks released Q4 2020 results for the quarter ending in December 2020. The Company reported earnings per share (EPS) of $0.76 excluding non-recurring items, beating consensus analyst estimates of $0.72, by $0.04. Revenues grew 0.3% year-over-year (YoY) to $2.88 billion, beating analyst estimates for $2.83 billion. Adjusted OIBDA fell (-9%) YoY to $1 billion. The Company finished 2020 with over $2.3 billion in free cash flow and a 56% adjusted-operating-income-before-depreciation-and-amortization (AOIBDA) to free cash flow conversion rate. The Company ended the quarter with $15 billion in debt. The new company will inherit a total of $58 billion in debt from the get-go.

Mismatched Synergies and Massive Debt

On paper, the spin-off combined company looks amazing at first glance combining a library of content arguably larger than Netflix. Discovery will contribute 100% of its businesses for 29% stake in the new combined company with WarnerMedia. Discovery CEO David Zaslav will operate the new company. In addition to the new $43 million in debt and $15 billion existing debt, they are also planning to spend $20 billion on content. The new company is expected to generate $39 billion in annual revenues with $12 billion in Adjusted EBITDA with leverage of 5X EBITDA. The new company expects “reinvest” the supposed $3 billion in cost synergies and expects to pay down debt to 3X EBITDA by 2023, approximately 24 months after closing. Just how this will be achieved is left to be seen. HBO Max subscribers may not be the target audience for Discovery’s slate of non-scripted reality dramas like 90 Day Fiancé or Guy’s Grocery Games. One would assume combination would derive either an expanded footprint into different demographics to gain more viewers or bundle services somehow at a discount. One is pure premium content (HBO Max) while Discovery is cable tv content. Two different products that don’t complement each other nor share the same end-user appeal seem like a mismatch from the get-go. Aside from the paper synergies, the reality is yet to be very convincing.

DISCA Opportunistic Exit Levels  

Using the rifle charts on the weekly and daily time frames enables a precision view of the playing field for DISCA stock. The weekly rifle chart has been in a downtrend with a falling 5-period simple moving average (MA) just below the $35.14 Fibonacci (fib) level. The weekly stochastic has a mini inverse pup under the 20-band which formed when shares rejected back down off the 5-period MA. The weekly lower Bollinger Bands (BBs) sit near the $12.32 fib. The daily rifle chart is attempting to bottom out with a rising 5-period MA at $31.68 with a stochastic cross up still beneath the 20-band. The daily market structure low (MSL) triggered on the breakout through $32.05. The weekly 15-period MA overlaps with the $33.60 fib which would be the channel tightening target on a 20-band stochastic test. Prudent investors can consider trimming down exposure on the daily MSL buy trigger into opportunistic exit levels ranging from the $32.05 to $36.35 range. The daily lower BBs sit at $28.40, but downside could fall to the low 20s. Keep an eye on T stock as both shares tend to move together after the deal announcement.    

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