Discovery-Scripps: What Wall Street Is Saying About a Possible Combination

David Zaslav - Publicity - P 2016
Courtesy of Discovery Communications

One analyst calls it "the most logical" deal in media, citing scale, cost cutting and international upside as opportunities, while another one argues that it wouldn't "fundamentally alter" things for the companies.

Wall Street analysts have started discussing the benefits and risks of a possible combination of Discovery Communications and Scripps Networks Interactive after a Wall Street Journal report said that the two TV networks companies were once again talking about a deal.

Financial details of the conversations weren't immediately clear. Discovery, which operates the Discovery Channel, TLC, Animal Planet and OWN, has a $15 billion market capitalization, while HGTV, Travel Channel and Food Network owner Scripps has a market value of $9 billion.

"We view the deal as among the most logical in media," RBC Capital Markets analyst Steven Cahall said in a report. "Both are somewhat relatively sub-scale when dealing with distributors, and while their combination may not put them on equal footing with a broadcast network or major sports rights owner, scale matters and should improve network carriage and affiliate negotiations." He also highlighted: "Investors have viewed consolidation among smaller players as an eventual inevitability."

The analyst also argued that Discovery "is perhaps the best cost manager in media and can drive meaningful cost synergy (potentially both overhead and programming)." And third, he highlighted that "Scripps is in the early innings of establishing an international distribution footprint," while Discovery "has a massive international platform with an average of more than 10 networks in well over 100 countries." Concluded Cahall: "We'd expect significant revenue synergies as Scripps content is distributed globally." Cahall also suggested that the combined company could reach $250 million in cost synergies in the first year.

MoffettNathanson analyst Michael Nathanson, meanwhile, was less bullish on a possible deal. "While there will likely be 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," he said.  

"With ongoing [pay TV distributor] consolidation and wave after wave of negative pressures hitting pure-play cable network stocks, there is sound industrial logic for M&A on the network side," he highlighted though.  

He also looked at the potential financial benefits. “We project Discovery’s 2017 U.S. cable networks earnings before interest, taxes, depreciation and amortization (EBITDA) margins to be close to 60 percent (which is an industry record) versus Scripps’ domestic margins of approximately 50 percent,” wrote Nathanson.

Getting Scripps to the same level alone would generate incremental earnings EBITDA of roughly $300 million, he said, concluding: “We think maybe signing up for half the upside, or $150 million, makes sense.” 

Jefferies analyst John Janedis, meanwhile, described the possible deal as more of a mixed bag. "While the combo would be a clear leader in the female demo, we would argue that the content is quite different, with Scripps' being more advertiser friendly, and the move would appear to be more defensive," he wrote.

As key pros, he highlighted that a merged company would have more leverage in future negotiations with pay TV distributors and could reduce costs and expand the international reach of Scripps' content. "The deal could provide earnings per share accretion of at least 15 percent for Discovery," he concluded.

But Janedis also mentioned some cons. "While largely reality programming, the genres/content are different," he wrote, also mentioning "differences in pay scale/cultures" and ratings issues. "Finally, it may not solve the skinny bundle challenge," he said.

The deal talks report could provide support for entertainment stocks, according to Cahall. "This deal will undoubtedly spur debate around further consolidation both intra-media and inter-media," he said. "M&A as a theme is likely to provide upside and/or limit downside to the sector."