Discovery Deal Still Expected

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The two-year anniversary of Liberty Media's spinoff of its 50% interest in Discovery Communications has come and gone, but that hasn't dampened analysts' enthusiasm that a deal to take full control of the cable networks could happen soon.

Liberty spun its interest into Discovery Holding Co. (DISCA) — including its 50% of DCI and its 100% interest in Ascent Media — on July 21, 2005. It was believed at the time that Liberty would be able to acquire the remaining 50% of the networks, owned equally by Advance/Newhouse Communications and Cox Communications, shortly afterward. But problems concerning possible tax implications prevented a deal from happening.

Since that time, though, Cox Communications sold its 25% interest in Discovery back to Liberty and Advance/Newhouse — increasing their stakes in DCI to 66% and 33%, respectively — for $1.3 billion in cash, the Travel Channel and a related Web site in May. In addition, Advance/Newhouse signed off on a plan in 2005 that would tie compensation of Discovery employees to the performance of the DISCA stock — a move that many analysts believed would not happen unless a consolidation of ownership were anticipated.

The two-year anniversary of the spinoff is significant in that many believe that is the timeframe that would allow Liberty to alter its structure without having to take a big tax hit.

Pali Capital analyst Richard Greenfield, who in June wrote a report outlining the possibility of a consolidation of the Advance/Newhouse stake, still believes that a deal could be done in the near future.

“We stick to our comments that we believe before year-end, something is going to happen,” Greenfield said in an interview last week. “I believe that Discovery Holding, DCI and Newhouse are in active dialogue and on record we would expect something to happen in terms of a consolidation before year-end 2007, if not substantially sooner.”

Discovery Holding stock has been on a tear in the past few weeks, most likely in anticipation of a deal. The stock was up more than 10% ($2.37 per share) in the first three weeks of July rising from $23.05 each on July 2 to $25.42 on July 23. The stock closed at $24.83 per share on July 24, down 59 cents each.

Greenfield, in his June note estimated that Advance/Newhouse could trade its stake in privately held Discovery Communications for Discovery Holding stock at a 15%-20% premium, which would value their interest at between $28.55 and $29.80 each, based on the July 24 close.

Owning 100% of Discovery Communications would allow the holding company to fully consolidate DCI's considerable cash flow (about $722 million in 2006) on its balance sheet.

Miller Tabak analyst David Joyce said an Advance/Newhouse deal makes sense, but Advance/Newhouse itself may be the main roadblock to a transaction.

“Some people that I have talked to in the industry indicate that Advance/Newhouse tends to be kind of stubborn in attempts to get anything done,” Joyce said, adding that Newhouse also is not weighed down by the incremental leverage Cox was as part of its privatization deal a few years ago.

“So they don't have that sort of an impetus to need to sell,” Joyce said. “There are some countervailing factors that might still be holding them back from doing something.”

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