Discovery, Scripps Deal a Sign of "How Tough Cable Net Business Has Become," Says Analyst

Kenneth W. Lowe, Chairman of the Board, President and CEO of Scripps Networks -Getty-H 2016
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As observers weigh in on the $14.6 billion transaction, activist shareholder Eric Jackson lauds its benefits for the cable networks groups, which both also reported their quarterly earnings on Monday.

The stocks of Discovery Communications and Scripps Networks Interactive went separate ways in early trading on Monday after Discovery unveiled a $14.6 billion deal to acquire Scripps, combining two cable networks groups known for non-scripted and lifestyle content.

As is often the case with deals, shares of the buyer, in this case Discovery, were trending about 1.7 percent lower, while the stock of the takeover target rose about 1 percent. 

Scripps, which operates such channels as HGTV, Travel Channel and Food Network, and Discovery, whose networks include Discovery Channel, Animal Planet, TLC and OWN, also reported their second-quarter financials on Monday, earlier than expected, and Wall Street started chiming in on all the news.

Amid cord-cutting, carriage fee showdowns with pay TV companies and ratings challenges that have hit cable networks groups, analysts said the deal will allow Discovery to cut costs, strengthen all the networks' positions in carriage talks and use Scripps' content more broadly across the world. But observers differed in their focus on how positive and forward-looking or defensive the combination is. 

Activist shareholder Eric Jackson, managing director of SpringOwl Asset Management, lauded the deal, and emphasized how Discovery's management is looking to proactively take on change in the industry, in a CNBC column under the headline: "Discovery's [CEO] David Zaslav isn't ducking the future by looking to buy Scripps — he's prioritizing."

But others had more of a mixed reaction. Jefferies analyst John Janedis highlighted both the positives and challenges of the Discovery-Scripps deal. "While it could be argued that the move is somewhat defensive by Discovery, scale for programmers will be increasingly important," he wrote in a report. And he argued: "While we believe the two companies are likely better positioned together, rather than apart, the longer-term issues facing the industry still remain."

Added Janedis: "1) Viewership on TV, and more so, cable networks continues to decline. 2) The combined company may not solve the skinny bundle challenge going to market with even more networks."

Meanwhile, Wells Fargo analyst Marci Ryvicker, highlighting that revenue for both firms came in below expectations and Scripps also lowered its full-year guidance, said the combination and the latest results showed the current challenges of the TV business more than anything. 

"Well, with second-quarter results like this, we could see why there's a deal," she wrote in a report entitled "Good Thing They're Combining Because Second-Quarter Results Were Underwhelming." "In all seriousness, this deal combined with second-quarter results suggests how tough the cable net business has become."

Scripps reported second-quarter earnings from operations before income taxes of $400.8 million, up 20.8 percent, but operating earnings only rose 0.3 percent to $374.1 million. Revenue rose 3.6 percent to $925 million. The main shortfall came in U.S. advertising revenue, which rose 2.2 percent, below Ryvicker's 5 percent estimate, while "distribution came in ahead (+8 percent versus +5 percent) and international was slightly better."

As a result of "the ratings and impression softness in the U.S. market," Scripps cut its full-year 2017 guidance for revenue growth to 4 percent from 6 percent and for segment profit to no change from 3 percent growth. 

Discovery, meanwhile, reported second-quarter earnings of $374 million, or 64 cents per share, down 8 percent from $408 million, or 66 cents per share, in the year-ago period and below Wall Street estimates. Quarterly revenue rose 2.3 percent to $1.75 billion. "International revenue came in much softer than U.S., although U.S. was softer in both advertising and distribution, but both beat on the bottom line," Ryvicker said.

In announcing the cash-and-stock deal early on Monday, the companies highlighted that they target $350 million in cost savings by bringing together a set of popular brands, including several networks targeting women, and see international opportunities for Scripps' business and upside in the area of digital and direct-to-consumer services.

Both companies' CEOs on a call with Wall Street also focused most of their time on the opportunities and benefits of the deal in various areas, such as scale, reach, digital, direct-to-consumer and global upside.