Discovery Shows Small Q2 Profit Gain

Content Company Reduces Full-Year Outlook

Discovery Communications reported a small increase in earnings in the second quarter despite a 30% jump in revenues.

Net income rose 2% to $300 million, or 82 cents per share, from $293 million, or 76 cents a share, a year ago.

Revenues rose 30% to $1.47 billion. Much of that increase came from acquisition in Scandanavia, which made smaller contributions to earnings. Without the acquisitions, the company said revenues rose about 10%.

The figures were below Wall Street expectations of $1.48 billion in revenue and $324 million, or 91 cents a share, in net income.
Domestically, CEO David Zaslav told analysts on the company’s earnings call that Discovery had a successful upfront, drawing record sales volume. 

It also said that its OWN joint venture with Oprah Winfrey turned cash flow positive in the second quarter, earlier than expectations, and has begun to pay back Discovery’s $509 million investment in the channel, which got off to a slow ratings start.

Discovery reduced its guidance for the full year's earnings. Discovery said it expects total revenue of between $5.55 billion and $5.625 billion and net income of $1.1 billion to $1.15 billion. In May, the company had said it expected revenues to be between $5.575 billion and $5.7 billion and net income to be between $1.2 billion and $1.3 billion.

CFO Andy Warren said that much of the reduction in guidance was caused by the acquisition of SBS happening later than exected and because of $130 million in amortization charges stemming from the acquisition. The company is also facing headwinds in foreign exchange and higher stock compensation expenses.

Adjusted operating income at Discovery's U.S. Networks group rose 11% to $472 million in the second quarter. Revenue rose 13% to $793 million. Advertising revenues rose 10% to $426 million.  Warren said that with Discovery getting double-digital price increases in the scatter market, it expected low double-digit ad growth in the third quarter.

In the upfront, Zaslav said that Discovery was able to get price increases in the mid to high single digital in addition to volume increases. Zaslav said that Discovery’s sales team was able to bring new, high-quality advertisers into emerging networks such as Science, Destination America and Velocity

Distribution revenues rose 17% to $348 million. Discovery said it had $37 million in additional distribution revenue from licensing agreements with streaming companies led by Netflix. Excluding digital licensing agreements, distribution revenues grew 5%.

At its international networks, Discovery's operating income rose 51% to $265 million as revenues rose 61% to $652 million.

Discovery said it repurchased 3.77 million shares of its series C common stock at an average price of $70.17 per share for a total of about $265 million. From July 1 through July 26, the company bought another 1.59 million shares for $119 million. It has purchase a total of $2.87 billion worth of shares under its $4 billion stock buyback program.

Despite missing earnings forecasts, analysts didn’t seem alarmed about the company’s prospects.

“We expect a muted response in the stock,” said analyst John Janedis of UBC in a research note. “The core business appears to be operating in-line to better.”

“Discovery missed expectations (again). As usual, most of the miss doesn't matter to our core investment,” said Todd Juenger of Sanford C. Bernstein, referring to the amortization of SBS. But Juenger expressed some concern about Discovery’s 5% growth in domestic affiliate fee growth.

“The key question is whether that will accelerate in [the second half of] 2013 (probably not), and more importantly, FY14 and beyond as more and more distribution renewals take place,” he said in a research note. We never expected heroic domestic affiliate fee growth. Our valuation and investment thesis (and Outperform rating) doesn't require it. But we do expect [more than] 6%. 5% won't do.”

Discovery shares were down about 2% in the $82 range in mid-day trading.