MoffettNathanson disses Discovery with ratings downgrade to neutral

Discovery+
MoffettNathanson predicted that the combined Discovery/WarnerMedia would face non-trivial post-merger indigestion. (Discovery Inc.)

The research firm MoffettNathanson slapped a warning label on the WarnerMedia-Discovery deal, lowering its rating for Discovery from Buy to Neutral and slashing its target price from $51 to $37.

In a note posted Monday, MoffettNathanson predicted that the combined firm would face non-trivial post-merger indigestion.

“The deal will go down as personal career highlights for Discovery’s management, board and advisors, but we think the near-term impact on shareholders is likely to be more muted,” the note said.

It blames part of that on the combined firm no longer having a single direct-to-consumer offering and part of it on the debt incurred in the $43 billion deal Discovery and AT&T announced May 17.

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The latter will push the merged company’s pro forma gross debt to $58.2 billion at the close of the deal, more than five times its estimated 2022 earnings before interest, taxes, depreciation and amortization.

The note’s glum assessment: “As it stands now, the new company will be a highly leveraged play on the domestic cable networks model with options on two DTC pivots – HBO Max and discovery+.”

MoffettNathanson had been more bullish on Discovery before the news that AT&T would unwind its media strategy and sell WarnerMedia to Discovery. In January, it had raised its rating of Discovery to Buy in a belief in the prospects of the new Discovery+ streaming service.

Monday’s note raises doubts about how well Discovery can either combine Discovery+ and HBO Max or at least cost-optimize their international rollouts. It also notes how Discovery’s stock sagged after its 2018 purchase of Scripps Networks Interactive.

The report does, however, note one upside: better bargaining power with traditional distributors that Discovery CEO David Zaslav has publicly complained pay affiliate fees that don’t reflect the value Discovery’s channels bring to cable and satellite services.

“No other company will have as much national viewing share as Discovery + WarnerMedia, which should give them greater leverage in negotiations with distributors to drive affiliate fees going forward,” it says. That should help even as cord cutting chews through the traditional video business.

MoffettNathanson’s headline description of Discovery as “Stuck In A Moment” — an apparent reference to the U2 song “Stuck In A Moment You Can’t Get Out Of” — does leave a little room for longer-term optimism, given sufficient investor patience.

As it concludes: “We do expect the new combined company to drive higher revenue and cost synergies, but this will take some time, which pushes us to the sidelines.”