- A conservative valuation points to some upside.
- This is an investment for the patient investor.
- Do not underestimate the creator of the 90 Day Fiancé.
- WarnerMedia and Discovery have some of the best assets in its class.
- The future company will be a juggernaut in the DTC streaming space.
I bought Discovery Inc. (NASDAQ:DISCA) back on March 29 at $41.50 following the Archegos meltdown. For a stock that was once trading at $77 back in March, it felt like I was getting a bargain. When somebody, in this case Archegos, is dumping shares of a good company at bargain prices, I’m a buyer. When somebody is in a desperate situation, and needs to sell, the buyer is in a good position. I’ve been following the company for years and an opportunity presented itself. There was “blood on the street” as we say and I moved in. But short-term noise took over the narrative. DISCA fell, and fell, came back for a bit, and then fell off a cliff. At this moment DISCA is trading around $25 despite being a good company.
Discovery is my worst investment in a long time. Of course nobody bats 1.000. They can’t all be winners. I bought companies in the past that fell 10% after I bought them. It happens and it mostly works out. DISCA sticks out like a sore thumb. I’m down 38% in almost seven months. Simple arithmetic says that’s a big hole to come back from. Losing money hurts. It double hurts when everything else I could have bought is going up. It triple hurts when you are public about the purchase (previously documented on the blog). You don’t want people to lose money. But again let me reiterate that this is not investment advice and you should do your own research.
The languishing stock price warrants some reviewing. Why is it that I do my best research after a stock is down a lot? I need to ask questions and to be honest with myself. Was this a mistake? Am I trying to make the story work? If so, when is the story going to work? Do I sell? If this is truly a bargain, should I buy more? If I liked it at $41, wouldn’t I love it at $25?
What do investors see?
I can’t predict the future, but I can try predicting the present. So what do investors see?
- The turning point seems to be the WarnerMedia merger. After the Archegos selloff, DISCA bounced back near my break-even point of $41.50. But following the merger announcement, the market reacted negatively. A lot of debt, deal complexity, and uncertainty clouds the story.
- DISCA is getting kicked around. Sentiment is negative. Sometimes the reason for a lower stock price is a low stock price.
- A complex deal to buy WarnerMedia weighs heavily. We still don’t know how it’s going to be structured. Is the Reverse Morris trust structure going to be a dividend or an exchange offer for AT&T holders? Details remain scarce.
- We don’t know how the streaming services will be rolled out and priced. Well they know but won’t tell us. This is a nightmare if you are a Wall-Street analyst that needs key numbers to plug in the financial model.
- Discovery has three classes of shares trading at three different levels. It’s not efficient.
- The overhang from AT&T shareholders selling post the deal close. Most T shareholders are in for the dividend. Warner Bros. Discovery (Newco) won’t distribute a dividend.
- Cable TV is bleeding subscribers. There’s a lot of FCF in that segment but there’s no growth and Wall-Street cares about growth.
- A crowded streaming space that’s getting more crowded. Growth in streaming is slowing.
- The deal won’t close until mid-2022 or later, if they get the regulatory green light. That’s another ~nine months? That’s an eternity for today’s investment timeframe.
- Warner Bros. Discovery will have a lot of debt, ~$55b.
- HBO is the best, but they have made missteps under AT&T ownership.
- Some are doubtful that Discovery can achieve $3b a year in synergies. That’s a big number. That’s $30b in value at 10x multiple. Great if they achieve it but remains to be seen.
Combine all of this and you have dead money. This means DISCA won’t likely significantly move until we have better visibility, more certainty on the deal. However, having said that, I had success with stocks in “purgatory”. It’s the place stocks go when they fall out of an orbit. They are in the “nobody cares about them” bucket. They stay in that zone for a while until some event push brings them back. This is where Discovery is. You can value Discovery as a stand-alone business, but we lack crucial details on the merging entity. A stock in “purgatory” can present an opportunity. It’s an uncrowded fishing pond. This means you can take advantage of this opportunity to build a position. If you have an investment horizon a little longer than the average investor you can do well in that space.