Two reports last week say that Discovery is looking to buy Scripps Networks Interactive, first in the Wall Street Journal and then in Bloomberg. This has increased the market value of Scripps from $9 billion to over $10.5 billion.
Some media watchers have criticized the potential deal, saying that it's dumb for one of the most profitable cable networks to buy another string of profitable cable networks.
Here's media reporter Lucas Shaw of Bloomberg on the potential deal:
https://twitter.com/Lucas_Shaw/status/887475452226437120
And this follow-up:
https://twitter.com/Lucas_Shaw/status/887475614470557696
But here's the question: If Discovery CEO David Zaslav spent $3 billion building a new online service today, how long would it take for him to generate revenues from it and then how long would it take to get a meaningful bump in his stock price from it?
It's hard to think of any examples from the last three years where larger media companies have invested in online services with a big payoff. The only one I can think of that appears to be moving the needle is CBS with its CBS All Access, which it launched in October 2014.
Does CBS deserve credit for investing early in this business so they can learn from it and grow it? Yes.
Is CBS All Access increasing the value of CBS' stock? Probably not.
If this Variety article from earlier this year is right, CBS All Access is approaching 1.5 million subs. Let's say they're at that level now. At $6 a month, that means CBS is generating about $100 million a year in revenues from it. Profits? Who knows, but let's assume there's not much.
My point is that CBS started 3 years ago, and they're still small. They probably have spent far less than $3 billion on this so far. But even if they'd spent $3 billion, it's hard to see how they could've gotten $3 billion in added value in such a short period of time.
Now let's see what Discovery gets if they do buy Scripps:
- $3.44 billion in revenues (vs. $6.55 billion for Discovery today)
- $1.55 billion in EBITDA (vs. $2.47 billion for Discovery)
- $3 billion in debt (vs. $8 billion for Discovery)
- $1 billion in operating cash flow (vs. $1.57 billion for Discovery)
- Assuming you get a 10x multiple on that EBITDA, you get an asset worth about $15.5 billion in enterprise value
- Specialty channels HGTV, Travel Channel, Food Network and Cooking Channel — all of which lend themselves well to the most profitable niches in digital video at the moment
- Food Network and HGTV were in over 90 million households as of last year
- These popular networks give Discovery additional leverage in negotiating their networks' future inclusion in cable/satellite and skinny bundle negotiations which increase and lengthen the future value of the Discovery linear cable networks income stream
Let's assume you put Discovery and Scripps together and get a 10x enterprise value on their combined EBITDA of $4 billion. That's $40 billion. If you subtract out their combined debt loads of $11 billion, you get an implied market cap for the new company of $29 billion. Today, their standalone market caps total $26 billion. That means there's a potential increased market cap of another $3 billion from a combination — and that's before cost cuts. It's an accretive deal.
No wonder the stock prices of both Discovery and Scripps went up when news first leaked out on the deal.
Zaslav — or any other media executive in favor of combining forces with another popular set of cable networks — isn't ignoring the future with this deal. He's simply prioritizing.
Essentially, Zaslav is looking at the potential upside from combining assets now and saying that's a better use of shareholder money in the long run versus throwing a lot of money at a new streaming service today when there's not yet a large appetite for it.
It mirrors the criticism Bill Simmons made of ESPN management for not supporting his popular podcast the B.S. Report in 2015 by selling more ads on it. At the time, in 2015, the entire podcast industry had ad revenues of $34 million. Instead of spending time trying to get a fraction of that small pie, ESPN management was trying to negotiate large ad-revenue deals across its linear programming, website and podcasts to support ESPN's $14 billion-a-year business. Two years later, the podcast industry has matured, and who has the No. 1 sports podcast? ESPN, with its "30 for 30."
Like ESPN, Discovery's Zaslav isn't saying no to digital services by buying Scripps. He's betting he can get just as big a slice of the digital pie later as it grows — now with more enticing content. He's also betting that the additional content from Scripps will help lengthen the linear profit runway from his existing cable assets.
That's smart business — not ducking the future.
