Discovery Stock May Look Tempting, but the Math Just Doesn’t Work

Discovery (NASDAQ:DISCB) generates a great deal less revenue from its streaming channels than from its cable channels. Its streaming channels are not even profitable yet, which is a problem for Discovery stock.

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In the past, I’ve described the difficult issues that Disney (NYSE:DIS) is facing as a result of the cord-cutting phenomenon, and Discovery has a very similar problem.

While investors have bid up DIS stock a great deal, Discovery’s shares are unlikely to get the same treatment.

In the U.S., Discovery has 12 channels that are available to Comcast (NASDAQ:CMCSA) viewers. According to The Motley Fool columnist James Brumley, channels like those of Discovery usually generate per-viewer revenue of  “$1 per month, if not much, much less” from cable companies.

Let’s dig in and see what the implications are for the long term.

A Closer Look at Discovery Stock

Let’s conservatively say that Discovery gets an average of 70 cents per month per viewer from cable and satellite providers. That means that Discovery is making $8.40 per viewer per month from the cable and satellite companies, i.e. the 12 channels multiplied by 70 cents).

The company, however, is only charging $4.99 per month for the ad-supported version of Discovery+ and $6.99 for the version without ads.

But the math gets worse for Discovery. In fact, it gets much worse.

While Discovery obtains revenue from each and every cable and satellite customer who gets its channels, not every one of those customers who subscribe to its channels through their pay-TV packages will order Discovery+ after they cut the cord.

In fact, likely preferring to take their chances with Netflix (NASDAQ:NFLX), Disney+ or one of the major broadcast network’s offerings, most of these cord-cutters won’t pay for Discovery+.

Let’s estimate that 25% of cord-cutters do order Discovery+, though I think that’s actually very optimistic. Let’s further assume that the company’s average revenue per user for Discovery+ comes in at $5.50. Finally, let’s maintain our 70 cents per user per pay-TV channel per month estimate.

Under that scenario, for every 10 million cord-cutters who used to subscribe to ten of Discovery’s channels on cable or satellite, the company will go from obtaining  $70 million per month to generating $13.75 million per month.

So even if Discovery+ is very successful, the cord-cutting phenomenon, which is likely to only accelerate going forward, is quite negative for the company and DISCA stock.

Providing further backing for that hypothesis, “Discovery will lose between $200 million and $300 million more on its direct-to-consumer offerings in 2021 than it did in 2020,” The Wall Street Journal reported in December, citing an unnamed source.

Discovery Is in a Much Worse Position Than Disney

Disney has a tremendous brand that’s well-known and well-respected all over the world. Further, many tens of millions of children globally love the company’s shows and movies.

Therefore, by selling hundreds of millions of subscriptions to Disney+ in dozens of countries, Disney could eventually make up a sizeable portion of the revenue and profits it will lose to cord-cutting.

Of course, Discovery’s brand doesn’t have nearly that kind of power. Therefore, it will have much more trouble making up for its cord-cutting losses than Disney.

Additionally, whereas cable and satellite providers have no choice but to carry Disney’s channel, they can get away with excluding Discovery’s.

So as Discovery looks to enhance the appeal of Discovery+ by putting top-notch content on it, the pay-TV companies will have an excuse to stop carrying Discovery’s channels, thereby eliminating the need to give a portion of their diminishing revenue to the content provider.

Indeed, in February Dish (NASDAQ:DISH) CEO Charlie Ergen indicated that he may stop carrying Discovery’s channels.

The Bottom Line on Discovery Stock

Even if Discovery+ is extremely successful, Discovery’s financial results are likely to get badly hammered by cord-cutting sooner or later.

Meanwhile, Discovery is caught in a very tough Catch-22; if it moves much of its best content to Discovery+, the cable and satellite providers will stop carrying its channels, eliminating its largest and most profitable revenue streams. But if the company doesn’t show its best content on Discovery+, it will have trouble meaningfully boosting the channel’s subscriber base.

All in all, Discovery stock is very badly positioned.

On the date of publication, Larry Ramer did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Larry Ramer has conducted research and written articles on U.S. stocks for 14 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015.  Among his highly successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at @larryramer.

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