Discovery Holding Co (DISCA)

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Spun off from Liberty Media (LCAPA) in 2005, Discovery is a holding company for two businesses: Ascent Media Group, which helps create and distribute television shows and films; and a 67% stake in Discovery Communications, which creates and distributes programming through cable channels such as Discovery Channel, Animal Planet and The Learning Channel. Since 2005, Discovery Communications has generated all of the company's positive net income (the company does not consolidate revenue and operating income for both businesses).

The Ascent business generated about half of its revenue in 2006 from television advertising, which has been in decline due to threats from the Internet channel and weakness in the U.S economy; the company also generates significant business in the U.K. In addition, cable companies have been consolidating (e.g. the joint acquisition of Adelphia by Comcast and Time Warner Cable), thus decreasing Discovery's negotiating power when distributing its programming.

Both of DISCA's businesses operate in a highly competitive environment: Ascent competes with many of the same motion picture studios which are its customers--including Walt Disney Company (DIS), News Corporation (NWS)'s Fox Studios--and smaller companies providing post-production services, while Discovery competes with other cable networks operators such as E.W. Scripps Company (SSP) and Viacom (VIA).

[edit] Business Overview

Discovery is a holding company for two businesses: Ascent Media Group, which helps create and distribute television shows and films, and Discovery Communications, which creates and distributes programming through various cable channels.

• Ascent Media serves large clients such as motion picture studios, independent producers, and broadcast networks; it provides creative services for the production of films and television shows as well as network services to facilitate the distribution of content on cable and broadcast networks.

• Discovery Communications creates and distributes programming through its flagship Discovery Channel and a host of other networks including Animal Planet and The Learning Channel; the group currently operates in over 170 countries and receives revenues from subscriptions and advertising.^[1]

[edit] Ascent Financial Results

DISCA owns 66.7% of Discovery Communications and does not consolidate its results into financial statements; consequently, revenues and operating income reflect Ascent's results alone.

Both revenues and operating income for Ascent have been rather volatile for the past five years. In 2006, revenues decreased slightly due to contract terminations as well as decreasing volume of DVD and traditional media content from major studios, resulting in a lesser need for the production and post-production services provided by Ascent. Increases in operating costs resulted in a negative operating income. Ascent Media also underwent two rounds of restructuring in 2006 and 2005 by closing facilities, eliminating positions, and streamlining its structure, resulting in one-time charges of $12 million and $4 million respectively.^[2]

^[3]

The majority of Ascent's revenues (61% in 2006) are derived from the Creative Services Segment, a proportion that has remained relatively constant over the past few years as revenues in both segments tend to rise and fall in tandem.

^[4]

[edit] Discovery Communication's Contribution to Net Income

Unlike Ascent, Discovery Communications has posted a positive operating income for the past few years. In 2006, revenue rose 13% and operating income rose 5%. Margins improved as a result of a restructuring effort in 2006, when they hired a new CEO; the company structure was streamlined and over 200 US jobs were cut. Because Discovery Communications is much larger than Ascent, DISCA's share of Discovery Communications' earnings provides a sizable boost to net income (see below). ^[5]

^[6]

[edit] Key Trends, Risks and Forces

• Impact of an Economic Slowdown on Advertising Spending: Spending on advertising is highly correlated with general economic growth, which makes such macro factors as oil prices and the U.S. housing market key concerns for Discovery. Advertising spend in 2007 grew less than 1% over the previous year due to weakness in the housing market and growing fears of a recession. With the effects of the subprime crisis continuing to spread, 2008 may be another weak year. ^[7] Advertising is a key component of DISCA's business, accounting for 45% of 2006 revenues; continued weakness in advertising spending may have a strong negative effect on profitability.^[8]

• Consolidation in the Cable/Satellite Television Industries: Discovery Communications must negotiate with cable and satellite television companies for placement of its programming on cable and satellite channels. Consolidation in these industries (such as the 2006 purchase of bankrupt Adelphia by Comcast (CMCSA) and Time Warner Cable) reduces the number of distribution channels available to Discovery. Such consolidation raises cable companies' bargaining power at the expense of Discovery's; additionally, per-subscriber license fees paid to Discovery may be subject to volume discounts.^[9]

• Increasing Fragmentation of Television Audiences: With the proliferation of cable, broadcast, and satellite channels, video-on-demand, and various digital video recording devices such as TiVo (TIVO), cable audiences are becoming increasingly fragmented, with fewer viewers watching each program. Such fragmentation can decrease the amount of original entertainment content needed by any one entity and, consequently, the demand for Ascent Media's services, which aid in the production of such content.^[10] Discovery Communications' advertising revenues are also threatened by audience fragmentation. If the number of viewers watching Discovery's programming decreases, so will the value of the advertising the company sells. The increasingly frequent tendency of viewers to fast forward through advertisements further aggravates this decrease in value.^[11] Thus, fragmentation of television audiences is likely to have a negative impact on DISCA's profitability.

• General Economic Conditions in the UK: Ascent Media receives nearly 19% of total revenues from the United Kingdom;^[12] Discovery Communications is also quite active in the British market and has a longstanding relationship with the BBC, with which it partners for many of its international ventures.^[13] Hence, both general economic conditions in the UK and the state of the cable and satellite television industries there are important for DISCA; a positive environment can counterbalance weakness in the US economy, while recessionary conditions can drag down results.

[edit] Competition

 Discovery Holding Co

	Select All  |  Select None Metrics Revenue by Geography - International Revenue by Geography - Europe Revenue by Geography - Asia Revenue by Geography - Africa Revenue by Geography - South America Net Income Operating Income Revenue Revenue by Geography - United States Gross Profit Number of Viewers Average Revenue per Subscriber Cancel

	Select All  |  Select None Companies Crown Media Holdings (CRWN) Discovery Holding Co (DISCA) Liberty Media (LMDIA) Liberty Media (LCAPA) LodgeNet Entertainment (LNET) NDS Group (NNDS) Speedus (SPDE) Cancel

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Company	Data From	Average Revenue per Subscriber	Gross Profit	Revenue	Number of Viewers	Revenue by Geography - United States
Discovery Holding Co (DISCA)	2007	$0.476[14]	$216M[15]	$707M[16]	1.49B[17]	$562M[18]
Liberty Media (LCAPA)	2007	Add	$2.1B[19]	$9.42B[20]	Add	$7.18B[21]
Liberty Media (LMDIA)	2007	Add	$4.5B[22]	$9.42B[23]	Add	$7.18B[24]
LodgeNet Entertainment (LNET)	2007	Add	$232M[25]	$486M[25]	Add	$454M[26]
Speedus (SPDE)	2007	Add	$436K[27]	$733K[27]	Add	$733K[27]

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[edit] Ascent Media

Many major motion picture studios (Walt Disney Company (DIS), Paramount Pictures, etc) can provide the same services as Ascent in-house, which makes them both customers and competitors of the company. Other competitors include:

• Thomson: A global company whose brands include Technicolor and RCA, Thomson provides a variety of services to customers in the media, entertainment, and communications industries. Thomson has grown at a steady 8.3% over the past few years. ^[28]
• Eastman Kodak Company (EK): Kodak is a leading imaging products and services company, with revenues of $133 billion in 2006. Its Laser Pacific division, acquired in 2003, provides many of the same services as Ascent, as do the Cinesite production facilities in Los Angeles and London. ^[29]

[edit] Discovery Communications

Discovery competes with other networks for viewers, both for absolute numbers and narrower demographic categories; because the company acquires some of its programming from third party sources, it competes with other networks to acquire the best programming.^[30]

• Viacom (VIA): Viacom owns the MTV Networks (137 channels including MTV, Nickelodeon, Comedy Central, etc.) and the BET Networks. With $11.5 billion in revenue, the company is much larger than Discovery. It has a smaller exposure to international markets, which have lower margins (15% vs. Discovery's 33%); furthermore, many of Viacom's reality shows are cheaper to produce than Discovery's programming. As a result, Viacom has posted higher gross margins, reaching nearly 44% in 2006 as compared to Discovery's 30%.^[31]
• E.W. Scripps Company (SSP): Scripps operates in the newspaper, broadcast and cable television, and Internet segments of the media industry; its cable channels include Food network, Do it yourself and Fine living. Due to virtually no international exposure and lower costs of producing home improvement/cooking shows, Scripps' margins are higher than Discovery's, reaching 49% in 2006.^[32]

[edit] Competitive Advantage

DISCA benefits from Discovery Communications' Discovery, TLC and Animal Planet brands, recognized worldwide. The company also owns one of the largest libraries of nonfiction video content in the world; the nature of its nonfiction programming is such that it appeals to universal audiences and is simple to adapt to international markets (by dubbing over narration into foreign languages.) ^[33]

[edit] Footnotes

1. ↑ DISCA 2006 10-K Item 1 Business p.I-1
2. ↑ DISCA 2006 10-K Item 7 Management's Discussion and Analysis p.II-5
3. ↑ DISCA 2006 10-K Item 1 Business p.II-2
4. ↑ DISCA 2006 10-K Item 1 Business p.II-19
5. ↑ DISCA 2006 10-K Item 1 Business p.II-9-11
6. ↑ DISCA 2006 10-K Item 1 Business p.II-2
7. ↑ Joshua Chaffin. "US advertising faces 'another poor year'." Financial Times (FT.Com) December 4, 2007.
8. ↑ DISCA 2006 10-K Item 1 Business p.I-15
9. ↑ DISCA 2006 10-K Item 1 Business p.II-11
10. ↑ DISCA 2006 10-K Item 1 Business p.I-14
11. ↑ DISCA 2006 10-K Item 1 Business p.I-15
12. ↑ DISCA 2006 10-K Item 1 Business p.II-37
13. ↑ DISCA 2006 10-K Item 1 Business p.I-8
14. ↑ DISCA,2007 10-k,Item 1,PG-II-12,17
15. ↑ DISCA,2007 10-k,Item 9B,PG-II-30
16. ↑ DISCA,2007 10-k,Item 6,PG-II-3
17. ↑ DISCA,2007 10-k,Item 1,PG-I-12,17
18. ↑ DISCA,2007 10-k,Item 9B,PG-II-53
19. ↑ LCAPA 2007 10-k,item-9B, PG-II-65
20. ↑ LCAPA,2007 10-k,item-6, PG-II-3
21. ↑ LCAPA,2007 10-k,item-9B,PG-II-86
22. ↑ LMDIA, 2007 10-k,Item 9b, PG-II 21
23. ↑ LMDIA, 2007 10-k,Item 9b, PG-II 21
24. ↑ LMDIA, 10-k,2007,Item 9B, PG-II 62
25. ↑ ^{25.0 25.1} LNET,2007 10-K,Item 6,PG-26
26. ↑ LNET,2007 10-K,Item 15,PG-F30
27. ↑ ^{27.0 27.1 27.2} SPDE,2007 10-K,item-15,PG-33
28. ↑ Thomson Corporate Website www.thomson.net
29. ↑ Kodak Corporate Website www.kodak.com
30. ↑ DISCA 2006 10-K Item 1 Business p.I-16
31. ↑ Viacom Corporate Website www.viacom.com
32. ↑ Scripps Corporate Website www.scripps.com
33. ↑ DISCA 2006 10-K Item 1 Business p.I-7