Discovery Communications is my latest, which I found while combing through a local asset manager’s portfolio here in Pittsburgh. They are a global media company that provides content in 223 countries and 45 languages with a product portfolio that includes the Discovery Channel, Animal Planet, and TLC. They operate production studios, websites, and curriculum-based educational programs.
The reason I believe they are undervalued is their aggressive share repurchase activity: the share price has not moved, but the underlying growth in value per share has been dramatic. The business has grown its top line and bottom line by 10.5% and 16.4% annually, respectively, since 2008. Additionally, they have repurchased 23.6% of shares outstanding since 2010, after adjusting for stock splits. With a slight decline in the share price over the past 12-18 months, the business looks very appealing to me today.
Shown below are their financial results since 2008:
What should emerge as highly relevant is the large increase in ROE. This is the result of an increase in leverage, as margins, sales turnover, and asset turnover have remained largely constant. The leverage today is at a healthy 3.5x operating income and 6.0x net income, with borrowing costs at 4.7%.
Additionally interesting is the aforementioned growth in the business, which appears to have slowed for TTM Q3 2015. This is the result of a strong dollar, as underlying sales volumes still have increased between 8-11% each quarter in 2015. This growth is primarily the result of their international expansion, which has been very aggressive and is now 50% of sales, as well as the rise of a number of content distribution businesses like Netflix, Hulu, and Amazon. With more companies vying for Discovery’s content, the amount they can charge increases.
Valuation is also highly appealing at $12.3 billion today. This indicates a P/E of 10.5x and price-to-book of 2.2x. For a business growing 8-11% per year with such a high ROE, low capital costs, and a lot of excess cash flow that is all used for share repurchases, I would be willing to sell around $17-21 billion, or roughly at a 16.5x multiple to earning power. And because this business is growing, there is a buffer to the ultimate value realization, where today’s investor is paid to hold onto their shares.