Discovery Quarterly Earnings Fall Short on Currency Impact, Stock Drops

David M. Zaslav | Discovery Communications
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2010 Pay: $42.6 million (+264% from 2009)
Discovery stock change for fiscal year: +36%

CEO David Zaslav touts U.S. momentum, including a 5 percent ad gain and better-than-expected sub trends, and says the company would be happy to own a bigger stake in Oprah Winfrey joint venture network OWN.

Discovery Communications, the company behind such cable networks as Discovery Channel, TLC and OWN, on Thursday reported lower than expected fourth-quarter earnings as its international business was hit by foreign-exchange head wind and higher costs.

Like other entertainment biggies this earnings season, including Viacom and Time Warner, the company saw its stock drop in early trading as investors have focused on such challenges as cord cutting. As of 9:45 a.m. ET, Discovery's stock was down 6.3 percent at $25.02, near its recently set 52-week low of $23.74.

The company, led by CEO David Zaslav, reported quarterly earnings of $219 million, compared with $250 million in the year-ago period. Earnings per share came in at 34 cents, or 38 cents on an adjusted basis. That compared with 43 cents in the year-ago period. Wall Street had on average expected 41 cents per share.

The company said its lower quarterly earnings were "primarily due to foreign currency exchange rates, losses associated with the sale of businesses and higher net income attributable to non-controlling interests, partially offset by a decrease in restructuring costs and higher earnings related to equity-method instruments." Excluding currency effects, adjusted earnings per share increased 12 percent, it said.

Management also cited higher costs at its international networks, which came amid increased programming spending and personnel costs.

Like other entertainment giants, the company has been affected by foreign-currency fluctuations, but given that 50 percent of its revenue comes from outside the U.S., it has been hit harder than its peers. Amid a strong dollar, foreign results have translated into fewer dollars, impacting the financials of companies with strong operations abroad. But management on Thursday said that once currency trends reverse, the firm will see benefits.

On an earnings conference call, Zaslav touted the growth of such networks as OWN, the joint venture of Discovery with Oprah Winfrey, saying that "Oprah's magic continues to grow in a meaningful way." When asked about the channel by an analyst later, he added: "OWN is doing very, very well … Oprah is very engaged … I feel we are on a very strong trajectory." It is "making a lot of money," he noted. "We love the channel."

Asked about Winfrey's option to put part of her 50 percent stake to Discovery starting this year, Zaslav said both sides are very happy with the network. But if Discovery ended up owning more of the channel and consolidating its results, "that would be very favorable for us," he said.

Discovery said OWN in 2015 repaid Discovery $85 million based on its annual cash flow after getting a loan of more than $500 million early on in its life. OWN now owes the company $380 million, with Discovery on Thursday predicting that this would all be paid off over the coming years.

Discovery's fourth-quarter revenue decreased 2 percent to $1.65 billion as growth in the U.S. was more than offset by lower international results. "Our U.S. business now looks like a meaningful growth business," Zaslav said on the call.

Discovery management reaffirmed its 2015-2018 financial guidance. It also predicted low double-digit percentage growth in adjusted earnings per share in 2016. The foreign-exchange effect on revenue in 2016 will likely amount to $185 million-$195 million, the firm estimated. The company projected U.S. ad sales growth in the mid single-digit percentage range in the current quarter but more moderate growth beyond.

U.S. fourth-quarter revenue jumped 6 percent as advertising revenue rose 5 percent in the quarter, with U.S. distribution revenue growing 7 percent. "Distribution revenue growth was primarily driven by higher rates," Discovery said. Ad gains came "primarily due to higher pricing partially offset by lower delivery."

The company's international networks posted an 8 percent revenue drop driven by an 11 percent ad decline and a 2 percent distribution drop. For the full year 2015, international revenue fell 2 percent to $3.09 billion, dipping below the U.S. revenue of $3.13 billion, up 6 percent. In 2014, international revenue had overtaken U.S. revenue.

"At U.S. networks, Discovery and ID ratings were up in the fourth quarter, while TLC and Animal Planet suffered double-digit ratings declines," Guggenheim Securities analyst Michael Morris wrote in an earnings preview. "Trends are likely to remain fairly strong for domestic affiliate revenue — we estimate fourth-quarter growth of 7.3 percent as Discovery continues to benefit from last year's NCTC/Cablevision distribution renewals. In addition, the company's new agreement with Comcast is effective as of Jan. 1, 2016 and should support affiliate revenue growth in the "high single-digits" per company comments."

Discovery CFO Andy Warren said on the earnings call on Thursday that U.S. pay TV subscribers fell a bit more than 1 percent in 2015 but commented that subscriber trends have been better than expected when the company provided forecasts at its investor day in September. He also said the company should not see any major financial pressure from pay TV consolidation, such as Charter's plan to acquire Time Warner Cable.

When asked about cord cutting, Zaslav said that "most consumers seem to want the big bundle" in pay TV these days. If "skinny" pay TV bundles become a big business, "we would be well positioned," he stated, adding: "I don't believe it's going to."

Zaslav said: "In 2015, Discovery Communications continued to build momentum with our unmatched worldwide brands and leading multiplatform distribution network. We surpassed 3 billion cumulative viewers, launched more new networks and increased audience and market share, all of which helped to drive steady global growth and strong financial results."

He added: "Propelled by our category leadership, broad rights ownership and content and brand expansion across platforms, Discovery is well positioned to thrive in the rapidly evolving media landscape and to drive continued shareholder value in the years ahead."

On the company's earnings conference call, Zaslav said 2015 saw strong "secular and economic challenges around the world."

Discussing recently launched streaming video app Discovery Go, Zaslav said early usage is encouraging and ahead of expectations. "While the world is changing, we are changing with it," he stated. "I'd like over-the-top to happen in a meaningful way … but I think it's going to be a while."

Zaslav once again touted the outlook for the company's online streaming and other digital business, saying it is roughly breaking even and has strong growth projects.

And he explained that Discovery pulled its networks twice in international markets recently to get higher carriage fees from pay TV firms. Zaslav said that the company has made this a major focus over the past year, explaining that his team was looking for "more meaningful" fee hikes in Europe and Latin America where historically growth has mostly come only from subscriber increases.