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Investors Seem Underwhelmed By Discovery's Confirmation of Scripps Nets Acquisition

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Shark Week
Shark Week Credit: Discovery Channel
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Wall Street on Monday reacted to the news of Discovery Communications' proposed $14.6 billion acquisition of Scripps Networks Interactive with a raised eyebrow, as shares of the Silver Spring, Md.-based media company dropped 8.9% in late-afternoon trading to $24.44.

While there are obvious synergies to be explored in such a merger, the Discovery-SNI deal doesn't immediately address the headwinds that are buffeting the traditional cable TV model: subscriber churn and the steady divestment of the younger viewers who would otherwise assume their rightful place in the heart of the advertiser-coveted 18-to-49 demo.

Per terms of the agreement, which was announced today in a 10 a.m. EDT conference call, Discovery said it would buy SNI for $90 a share in a cash-and-stock deal that includes $2.7 billion in assumed debt. SNI shares this afternoon were up 0.69% to $87.50, and while that was a bit shy of the takeout price, it was also nearly 28% higher than the $68.47 price SNI fetched at the beginning of the month.

Discovery owns its eponymous flagship network, as well as top-tier outlets such as Animal Planet, TLC and OWN. SNI is the home to a suite of lifestyle channels that includes Food Network, HGTV and Travel Channel, the last of which had been owned by Discovery for the better part of a decade. By consolidating the various media properties under one roof, Discovery will boast a 20% share of all women watching prime-time, ad-supported cable in the U.S.

In the second quarter of 2017, Discovery and SNI networks accounted for five of the top 25 most-watched cable channels in prime. HGTV was ranked No. 4, while the biggest draw among Discovery properties was ID: Investigation Discovery, which finished the quarter as the eighth most-watched ad-supported cable net.

Speaking to investors during this morning's conference call, Discovery CEO David Zaslav suggested that the merger could present an opportunity for the non-fiction nets to develop a standalone skinny bundle for consumers that would make them less dependent upon the rapidly-devolving traditional distribution scheme.

Skinny bundles are cheap ($30-$40), streamlined packages of cable channels that are increasingly being pitched as a viable alternative to the clunky, expensive traditional distribution model. But they're basically a la carte light -- not the grail of the theoretical pick-and-pay-for-only-what-channels-you want model, but a reasonable approximation thereof.

"We do think we have the makings ourselves for a very compelling core for a skinny bundle," Zaslav said, before adding that the combination of assets would open up any number of distribution avenues. "There are a lot of different ways to play it. We will be really listening to consumers. There is no question that there will be an evolution."

At present, Discovery is not particularly well-represented in the available skinny bundle packages. The company's biggest brands (Discovery Channel, ID, TLC, Animal Planet) are offered via DirecTV Now and PlayStation Vue, but are not found on the menu at YouTube TV, Sling TV or Hulu. For its part, SNI's leading nets are available on each of the top virtual MVPDs but YouTube TV.

Skinny bundles will be a crucial component of the cable model as cord-cutting/-shaving and an ongoing shift by younger consumers away from traditional TV puts the squeeze on the current distribution ecosystem. Per SNL Kagan and Nielsen estimates, the larger Discovery and SNI nets have lost around 5% of their respective subscriber bases since 2015, and there's no sign that the defections are going to decelerate. And while Discovery Channel boasts one of the highest affiliate fees for a non-sports network -- at an average monthly rate of $0.44 per sub per month and an estimated reach of 91.4 million homes, the flagship rakes in some $482.5 million per year from cable and satellite operators -- most of the other less-monolithic Discovery and SNI nets command between $0.10 and $0.15 a head every 30 days.

Both Discovery and SNI expect the deal to close in 2018. Not all of the extant brands are likely to continue on as linear-TV networks.

David Zaslav, president and chief executive officer of Discovery Communications.
David Zaslav, president and chief executive officer of Discovery Communications. Credit: David Paul Morris/Bloomberg

"We had started to move towards looking at our 12 channels in the U.S. and seeing that a strong eight may be the direction that the industry is going," Zaslav said. "We haven't got into it with [SNI CEO] Ken [Lowe] to try and get his best sense about whether all of [the Scripps nets] will be survivors…or whether some of them could be taken in a different way, to mobile or direct to consumers."

Reaction from analysts thus far has been mixed, with MoffettNathanson's Michael Nathanson providing one of the Street's more skeptical takes. In a note to investors, Nathanson said that while he anticipates the deal would pay off in "ample cost synergies, international revenue opportunities and improved relative scale, we don't think this merger will fundamentally alter the long-term prospects of these companies. … Without any material improvement to current ratings and subscriber trends, the timing and cost for Discovery to double down in the U.S. will likely look foolish in hindsight."

At the same time Nathanson fired off his analysis, Wells Fargo analyst Marci Ryvicker flagged for investors the fact that April 1-June 30 revenues for both content mills came in below expectations in a report bearing the headline "Well, Good Thing They're Combining Because Q2 Results Were Underwhelming." (Ryvicker's takeaway: the merger on the heels of the results "suggests how tough the cable network business has become.")

Discovery this morning reported flat year-over-year ad sales revenue of $472 million and overall quarterly sales that were up 2% to $1.75 billion, trailing consensus estimates. SNI for its part lowered its calendar-year guidance to +4% (down from +6%) and reported second quarter ad sales growth of 2%.

Other analysts lauded Zaslav's proactive stance, opining that the deal was an other example of the CEO's decisive, take-the-long-view management approach.

The Discovery-SNI announcement arrives just days after Viacom elected to end its courtship of the HGTV/Food Network parent company. Viacom shares are down 2% since bowing out of the bidding.

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