Discovery Shares Poised for Gains After Rough 2021

(Bloomberg Opinion) -- Entertainment companies with digital streaming ambitions had it rough in 2021 as subscriber growth slowed and investors started paying closer attention to the bottomless money pit that is video content creation. While big names from Walt Disney Co. to ViacomCBS Inc. underperformed the S&P 500 Index’s 27% gain last year, none suffered quite as much as Discovery Inc. The company, owner of cable channels such as HGTV and Animal Planet, launched streaming service Discovery+ last year, a few months before its proposed merger with AT&T’s WarnerMedia business was unveiled. The 22% drop in Discovery’s stock price in 2021 made it one of the bottom 10 performers of the S&P 500.

Disappointing subscriber numbers for the company’s nascent streaming service were part of the reason for the poor showing, but its shares were especially battered by investment fund Archegos Capital Management’s forced liquidation of its equity positions, which erased nearly half of Discovery’s market value.

This year is off to a slightly better start, and investors shouldn't be so quick to write off Discovery.

AT&T Inc. reported last week that HBO and HBO Max subscriber numbers topped the high end of the company’s forecast at 73.8 million. For Discovery shareholders, the pending deal with the WarnerMedia business, which includes HBO, is starting to look more promising.

Wall Street seems to be warming to the idea. Discovery shares surged 33% last week, the biggest weekly increase in more than 13 years. The jump was driven largely by Bank of America analyst Jessica Reif Ehrlich’s upgrade of the shares, partly on the grounds that the newly merged business would be ripe for cost-cutting. Optimism that the merger might soon clear regulatory review also probably helped. 

No one should get too excited: Discovery shares are trading a whopping 63% below the $77.27 high they notched last March. And the shares gave up some of last week’s gains this week, shedding 4.2% in the first three trading days to $28.79 as of Wednesday's close.

The bull case for the stock is straightforward: Assuming the deal to merge AT&T’s WarnerMedia business with Discovery clears regulatory hurdles, the company will bring together Discovery’s global reach and hit reality shows with Warner’s deep, high-quality library, helping the company compete with streaming giants such as Netflix and Disney.

In 2023, for comparison’s sake, Netflix and WarnerMedia-Discovery are each expected to spend close to $20 billion on content, while Disney is expected to outspend them by a few billion dollars, according to Wells Fargo forecasts. (The figures exclude sports but include spending on programming that may not immediately be available for streaming.)

There could be more room for gains. Based on one metric, comparing enterprise value with future earnings before interest, taxes, depreciation, and amortization, or Ebitda, Wells Fargo’s Steven Cahall calculates that WarnerMedia-Discovery is trading at a significant discount to Disney or Netflix.

Integrating Discovery with WarnerMedia will be a challenge and might be one reason the market is still a little wary of the combined company’s prospects. Another concern is that many AT&T investors, who are set to receive shares in the merged company, will immediately sell the stock, preferring to unload equities that don’t pay dividends. 

For investors willing to brave some uncertainty as the deal takes shape, though, it looks as if Discovery has put its worst days behind it.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

David Wainer is a Bloomberg Opinion columnist covering the business of entertainment and telecommunications. He has covered markets, health care, economics and international affairs for Bloomberg News.

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