Discovery’s potential $14.6 billion deal for Scripps Networks will be up against some serious headwinds and risks, according to MoffettNathanson analyst Michael Nathanson.
One risk in particular is the sustainability of Scripps’ advertising growth, as 2017 has seen the programmer’s most popular networks flatten out in terms of ratings growth. Scripps for the past few years has outperformed the industry on ratings and ad revenue growth, but now that its ratings for top channels like HGTV and Food Network have fallen, its ad revenue growth has trended back toward the low single digits.
“Following weaker than expected 3Q ratings trends, we are lowering our Scripps Networks U.S. advertising estimate from +4% to flat, resulting in U.S. revenue growth of +2% (vs. +5% prior),” Nathanson wrote.
Looking ahead, Nathanson is estimating 3% domestic ad growth in 2018 for Scripps but warned that sliding that estimate down only 200 basis points would result in net income estimates falling 1%.
The second big risk for the merged companies is the decline of the big cable bundle and limited virtual MVPD options for Discovery. The continued decline of traditional pay-TV subscribers combined with Discovery only being featured on 2 of 5 major vMVPDs presented an issue for Discovery.
“Even worse, Discovery’s long tail of networks yield 62% inclusion in PlayStation Vue and only 38% on DirecTV Now. Discovery’s 20% inclusion across the board is the second lowest in the industry,” Nathanson wrote.
However, Nathanson notes that Discovery has said its top five channels drive most of its domestic economics so he expects Discovery will consider getting rid of some of its smaller channels, particularly after the Scripps deal.
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Since Discovery in July announced its intentions to buy Scripps, analysts have been both upbeat about the improved outlook for the companies after teaming up while still practicing caution as it relates to overall pay-TV trends.
“While we believe the two companies are likely better positioned together, rather than apart, the longer-term issues facing the industry still remain,” said Jefferies analyst John Janedis in a research note from July. He specifically noted declining viewership on TV and on cable networks, the combined companies’ networks making it harder to push a skinny bundle, and Discovery's content traveling globally more easily than Scripps'.