If you are a nature or animal lover, it is likely that you have watched programs produced by Discovery Communications Inc. (NASDAQ:DISCA), the global leader in nonfiction media content with brands such as Discovery Channel and Animal Planet. Unlike television dramas and movies, whose popularity depend on a host of unknown factors, Discovery Communications Inc. (NASDAQ:DISCA)’s programs have far more stable viewership ratings and customer loyalty for its brands. However, Discovery Communications Inc. (NASDAQ:DISCA) is fairly valued at 1.0 times PEG, and I will advise investors to wait for a more attractive entry price.
Nonfiction’s edge over fiction
I prefer to invest in producers of nonfiction content like Discovery Communications Inc. (NASDAQ:DISCA), rather than those churning out fiction. Popular actors and actresses, award winning scriptwriters and directors, and a big budget devoted to the state-of-the-art special effects are no guarantee for high ratings. In fiction media content, you are as good as your last show. That means that investors in fiction content are essentially buying into unknowns.
In contrast, the elements of a good nonfiction program are easily replicated across multiple shows, resulting in more consistent quality. Furthermore, nonfiction media consumption has a stronger association with brands and content creators. As a result, nature lovers and animal lovers have a higher chance of staying with the programs produced by Discovery Communications Inc. (NASDAQ:DISCA).
Does customer loyalty still exist?
Discovery Channel, Discovery Communications Inc. (NASDAQ:DISCA)’s flagship television brand, was named by U.S. viewers as their favorite cable network for the 20th consecutive year, according to a 2013 study by BETA Research. Discovery Communications’ brands have also unparalleled reach, with its channels distributed to more than 300 million households across over 200 countries.
Despite its incumbency status, Discovery Communications also managed to build six new brands in the past five years. Among these new brands, Investigation Discovery, which offers crime and mystery related documentaries, is now among its top five networks in terms of U.S. subscriber base with more than 80 million subscribers.
Diversified revenue streams provide stability
Discovery Communications generates about half of its revenue from distribution, and the remaining half from advertising. It is intuitive that when the economy is in a downturn, consumers have a lower propensity to spend, leading to decreased advertising spending. On the other hand, there is need for television stations to fill up the time slots with content, notwithstanding the state of the economy. Moreover, advertising contracts are usually shorter in tenure of a year or less; in contrast, Discovery Communications signs multi-year agreements with its distributors. With a longer lock-up period, distribution contracts provide an element of stability for Discovery Communications’ earnings, partially offsetting the cyclicality of advertising revenues.
Discovery Communications also derives more than one-third of revenues outside the U.S., further reducing its reliance on the domestic advertising market.
Discovery Communications’ peers include Scripps Networks Interactive, Inc. (NYSE:SNI) and Viacom, Inc. (NASDAQ:VIAB).
I am negative on Viacom, Inc. (NASDAQ:VIAB) for a two reasons. First, it has a substantial movie business, which are basically binary outcomes of hits or misses. Second, Viacom saw ratings for its Nickelodeon channel fall last year, as viewers turned to old episodes of the show available on Netflix, Inc. (NASDAQ:NFLX). The new deal with Amazon.com, Inc. (NASDAQ:AMZN) does not change the fact that digital distribution deals will not be as lucrative as advertising revenues from traditional channels. One bright spot for Viacom shareholders is the continued return of capital through share repurchases. Viacom spent about $700 million buying back approximately 11.7 million shares, and still has $2.6 billion remaining from its share repurchase authorization as at end of April 2013.
Like Discovery Communications, Scripps Networks Interactive, Inc. (NYSE:SNI) has its own unique niches. While Discovery Communications focuses on content related to nature, Scripps Networks Interactive, Inc. (NYSE:SNI) has a strong lifestyle emphasis, with channels such as Food Network and Travel Channel. Like its peers, Scripps Networks Interactive, Inc. (NYSE:SNI) generates substantial free cash flows and capital allocation is a big driver of value. I am concerned if its internal expansion strategy through M&A and potential acquisition of Tribune’s 31.3% stake in Food Network will divert cash away from its current share repurchases. Scripps Networks Interactive, Inc. (NYSE:SNI) has $750 million remaining from its current share buyback authorization as at the end of the first quarter of fiscal 2013.
I like Discovery Communications for its focus on nonfiction media content, strong brands and diversified revenue streams. However, I only invest in good companies at attractive valuations. While it does not pay a dividend like its peers, it has a disciplined capital return policy, with about $1.4 billion remaining from its current share repurchase authorization as at end of April 2013. At 1.0 times PEG, valuations are reasonable, but the margin of safety is insufficient for me. Investors should consider accumulating this stock, when the stock price falls below 1.0 times PEG.
The article Rediscover this Leader in Nonfiction Media Content originally appeared on Fool.com and is written by Mark Lin.
Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Scripps Networks Interactive. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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