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Discovery Lacking Cash For Scripps Looks To Dilution And Synergy

The Swift FCF Yield | by DIYSI
August 01, 2017

Discovery will offer stock and hope for cost savings to afford deal with Scripps

Discovery Communications, Inc. (NASDAQ: DISCA) stock price is undergoing the normal setbacks according to merger arbitrage. Having disproportionately low cash and equivalents for the acquisition of Scripps Networks, Inc.(NASDAQ: SNI); the purchase requires Discovery to offer stock and dilute present shareholders' position. In contrast, the price offered to Scripps is a premium and those shareholders have been quickly rewarded as the PPS jumped from $70 to nearly $90 PPS.

Discovery Communications, Inc. won the biding process versus Viacom, Inc. (NASDAQ: VIAB) even though Viacom had the larger cash pile. Viacom's free cash flow (FCF) was greater and their cash and short term investments were more than twice those of Discovery with $671 million. To complete a purchase of Scripps, Discovery will offer up immediate detriment in hopes of the long-term synergy paying off.

"In announcing the cash-and-stock deal earlier on Monday, the companies highlighted the deal would allow for $350 million in cost savings as they combine popular brands..." - Hollywood Reporter

Discovery recently posted Q2 2017 earnings on Monday, the 31st of July. The SEC form has yet to be filed. It is possible the market will continue to lower the PPS of this stock as it revalues all the expenses that the company has taken on. The long-term outlook is that the company could save with employee restructuring and increase revenue as the newly acquired content and brands complement each other.

Basic stock investing metrics point out that Discovery Communications, Inc. had a recent price to earnings (P/E) ratio of 12.93. Viacom, Inc. had a recent P/E of 11.58. As for cash flow, Viacom appeared to be in the better position during the competing bids.

Free Cash Flow (FCF) Yield

At the end of July 2017, Discovery Communications, Inc. had $188m in cash from operating activities. Their capital expense was $31m leaving them a free cash flow of $157m. Viacom, Inc.'s cash flow on the other hand was $405m and their capital expense was $95m.

Discovery's FCF Yield is approximately 1.71% (Market Capital), which is near the low end of yield value. The yield in relation to Enterprise Value is 0.63%. This is typically not a good value investment based on the FCF Yield metric alone. Both Viacom and Scripps showed to have more appealing yield.

Discover Communications FCF Yield Chart

Free Cash Flow is obtained by taking the value of the company's operating cash flow and subtracting from it the value of capital expenses. The yield is then formulated by dividing the result by either the market capital or enterprise value.

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Disclosure: I/we have no positions in DISCA, VIAB, or SNI, and no plans to initiate any positions within the next 72 hours.

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Image source: Derivative of "Cash" by Ted Van Pelt (CC BY-SA 4.0)