Discovery’s share price has fallen over 65% and is now ripe for picking

With Discovery’s share price down significantly, and the streaming space heating up, the company’s merger looks like an exciting opportunity.

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Discovery (NASDAQ: DISC.A) is a media and streaming company, providing content across every genre and distribution platform, and the company also operates production studios to create its own content. With the merger of Discovery and WarnerMedia set to complete this year, I believe the recent fall in Discovery’s share price (68% since mid-March last year) is an opportune time to buy in.

There are now 1bn streaming subscribers around the world, boosted for obvious reasons since 2020. This is only the beginning, with the global video streaming market predicted to grow by 21% per year into 2028. With the improvements of WiFi in emerging countries and the rise of 5G, on-demand streaming and subscription services should continue its upward trend.

The business

Previously, Discovery had leased out content to its rivals to be aired on their platforms for a fee. However, under the company’s new business model, it is ending these contracts and pulling all its content onto one platform, Discovery+, a subscription streaming service much the same as Netflix, available on all platforms and devices. This is set to expand rapidly, with higher margins and more assured revenue. Paying subscribers have grown from 15m to 22m in its first 12 months of launch. This has only been rolled out in the US but will be rolled out globally in the near future, which should lead to booming subscription growth.

The merger

WarnerMedia is set to merge with Discovery this year, creating WarnerBros Discovery (WBD). This will create the largest content library in the world, with 200,000 hours of programmes and over 100 channels.

WarnerMedia owns HBO and Time Warner. HBO currently boasts 70m subscribers on its streaming platform; however, I believe the platform has been dreadfully underutilised by AT&T, hence the reason it’s selling WarnerMedia. Netflix is now taking on huge debt levels to produce content and continue growing subscribers. However, the merger of Discovery and WarnerMedia means a huge amount of content is already available to users, and therefore I believe under better management WBD will compete with Netflix and Disney+.

Too cheap

With strong projected free cash flow and earnings of the merged company, alongside synergies and debt levels expected to be lower than previously anticipated, I believe the market is under-pricing the streaming powerhouse this merger will create.

Discovery is trading almost as cheap as it was during the 2008 financial crisis, on a 12-month forward price-to-earnings (P/E) ratio of 8x. In comparison to this, Disney trades on a forward P/E of 28x, whereas Netflix is valued at 34x the same metric. Both companies exhibit poorer margins than DISCA, and the Discovery+ rollout has only just begun, never mind the merger.

The biggest risk to the investment case is if management cannot execute on its strategy. However, with the experienced management team led by David Zaslav, I believe this is unlikely, since Zaslav already has experience in mergers when Discovery acquired Scripps in 2018.

Should the merger complete, I believe this joint venture will become a powerhouse in the streaming space. With this business owning content such as the NBA, Game of Thrones, and Harry Potter, the brand awareness is massive. As the market wakes up to this opportunity, the share price should soar, providing a welcome boost to my portfolio!

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter McMullan owns shares in Discovery. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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