Discovery Grows Earnings Despite Streaming Investments, Eyes $1B in "Next-Gen" Revenue

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Discovery CEO David Zaslav

The company grows U.S. advertising and distribution revenue, reached $700 million in "next-gen" and direct-to-consumer revenue, talks up the Magnolia network and discusses the Olympics amid the coronavirus threat.

Discovery on Thursday reported higher fourth-quarter earnings despite lower ratings, continued cord-cutting and investments in its direct-to-consumer business as the bottom line result exceeded Wall Street expectations.

Discovery CEO David Zaslav on the earnings conference call said the company recorded more than $700 million of "next-gen and direct-to-consumer revenue" in 2019 and was "well on our way" to exceed the milestone of $1 billion in 2020.

The company will reach peak spending on next-gen and direct-to-consumer (DTC) initiatives in 2020 or 2021, CFO Gunnar Wiedenfels signaled, adding that it doesn't take a huge amount of subscribers for the business to be profitable. 

Zaslav said the company continues to "evaluate the possibility of offering an aggregated platform of all of our channels, brands and personality, quite possibly in partnership with the help of any number of distribution partners" in the U.S. and abroad. "Our aggregate content is very strong on a standalone basis and in addition would be a great complement to the many other scripted and AVOD/SVOD platforms" that often "look alike," he added.  

Zaslav late last year had first said that Discovery was "starting to explore a new opportunity" in the U.S. that would aggregate all of the firm's programming in a female-skewing streaming service. "You have some of these platforms launching with eight series, 10 series or a bunch of movies and series to come," he said. "We have hundreds of thousands of hours that people grew up on. ... We are looking now at whether we should just aggregate … all of our content in the U.S. and having something that looks very different, is very deep, has great personalities, great brands to curate through."

Zaslav described the effort as "stepping up" to launch "a full attack" on those who are not pay TV subscribers with the company's content that he said differentiates the firm from the scripted space, highlighting that Discovery owns and controls all its content globally and adds about 8,000 hours of original programming per year.

On Thursday, the CEO said that "we are positioned to create dual-revenue stream direct-to-consumer platforms" while "being mindful of the balance and importance of the linear pay TV business." He said his team was focusing on DTC models that are "scaleable, sustainable economically and rational from a cost perspective as we expand and complement the linear ecosystem."

Discovery early on Thursday posted fourth-quarter earnings of $476 million for the period, or 67 cents per share, compared with $269 million, or 38 cents a share, in the year-ago period. Adjusted OIBDA, another profit metric, fell 8 percent though.

Selling, general and administrative (SG&A) expenses increased 6 percent at Discovery's U.S. unit "primarily due to higher marketing and personnel expenses to support our direct-to-consumer initiatives." At its international networks, SG&A increased 15 percent "primarily due to investments in technology and personnel, as well as higher marketing expenses driven by subscriber acquisition costs for our direct-to-consumer initiatives," it said.

Discovery, which in 2018 closed its $14.6 billion acquisition of Scripps Networks Interactive, posted a 2 percent revenue gain, or 4 percent when adjusted for currency fluctuations, for the fourth quarter to $2.9 billion, including higher U.S. distribution and advertising revenue despite lower ratings. 

U.S. ad growth of 1 percent was "primarily driven by increases in pricing and, to a lesser extent, the continued monetization of our digital content offerings and inventory, partially offset by lower overall ratings and secular declines in the pay TV ecosystem." Distribution revenue rose 5 percent in the latest period, driven by higher affiliate rates and additional carriage on virtual platforms, partially offset by a decline in linear subscribers. "Total portfolio subscribers for December 2019 were 5 percent lower than December 2018, while subscribers to the fully distributed networks were 3 percent lower," Discovery said in an update on how cord-cutting has affected its business.

Discovery's international advertising and distribution revenues increased 5 percent and 10 percent, respectively, excluding foreign-exchange impacts.

The company has been building out its direct-to-consumer streaming business, including via partnerships with European broadcasters, such as ProSiebenSat.1 in Germany for streamer Joyn and Poland's Cyfrowy Polsat.

Wiedenfels had on the third-quarter earnings call said that the company expects "the impact from direct-to-consumer investments on full year 2019 adjusted operating income before depreciation and amortization to be at the lower end of the $300 million to $400 million range we have previously discussed. ... The expected ramp in our digital investment spending will flow through more meaningfully in the fourth quarter."

Discovery last year also struck a deal with the BBC for natural history and other factual programming, which will help power a new global subscription VOD service set to launch this year, after signing a strategic alliance with the PGA Tour to create a global home for golf fans, which includes video streaming service GolfTV. Zaslav said Thursday that the company was in the process of determining whether to go global with the service as a separate offering or put it together with other Discovery offerings, with a decision expected soon. 

Zaslav also got a question on the status of the planned Magnolia network with Chip and Jo Gaines and a related DTC offering. He said decisions will be made soon, adding that the team is "getting on terrifically well," "a ton of content" has been greenlit, and it "looks great."

Discovery's management team previously touted that the company in 2019 exceeded its target of reaching $3 billion in free cash flow after the acquisition of Scripps, hitting that goal ahead of schedule. Zaslav has described Discovery as a "free cash flow machine." On Thursday, it shared the exact figure for the full year: $3.1 billion.

Discovery also unveiled a new $2 billion stock buyback authorization, which one analyst said investors will likely see as a bullish sign. After selling his remaining stake in Lionsgate last year, billionaire investor and media mogul John Malone acquired $75 million more stock of Discovery in one of his largest open-market purchases of the stock ever.

"2019 was a year of promises made and promises delivered," Zaslav said in the earnings report. "Our differentiated local content strategy and global scale, coupled with our unique free cash flow conversion profile, provide distinct financial flexibility that allows us to adapt to changing media consumption habits."

Zaslav also used the "promises made, promises delivered" phrase several times on the earnings call, which ran past the usual hour mark by about 15 minutes. 

Asked about Discovery's plans for the Summer Olympics in Tokyo, to which it has the rights in international markets, amid the coronavirus  threat, Zaslav said "we are monitoring it closely." But management said it expects no "adverse impact" on Discovery's financials given it has insurance for the case the Games do not happen.