Discovery Inc – NASDAQ: DISCA

1. Discovery Inc – NASDAQ: DISCA 3/4/19 Ben Zhao, Kevin Kim, Katie Lee, and Jared Robinson

2. Table of Contents • Security Overview • Industry Overview • Company Overview • Investment Merits and Risks • Financial Model and Projections • Comparable Analysis • Appendix

3. Security Overview

4. Security Overview Informational Characteristics CUSIP – 25470DAE9 Coupon –4.375% Fixed, Semi-Annual Maturity –06/15/2021 Class –Company Guaranteed Amount Issued/Outstanding –650,000M/650,000M Credit Rating – Baa3, BBB- Face Value – 1,000M Notes – Call @Make whole +25bp Pricing and Yield Price –102.119 YTW – 3.398 YTM –3.398 OAS –84.7 bp Source: Bloomberg

5. Industry and Company Overview

6. Industry Overview Current State of Industry - Cord Cutting The media industry has a market capitalization of about 525.25 billion dollars. Major players include Disney, Time Warner, 21st Century Fox, Comcast NBC, Viacom, Discovery, and CBS as they generate the most advertising and affiliate fees. Due to increased popularity of streaming services such as Hulu, Netflix, and Amazon, outlook for TV advertising has remained bleak since poor ratings are a major concern. Affiliate-fee growth has slowed due to increased cord-cutting and cord-shaving by consumers, meaning fewer viewers are watching through traditional cable services. Cable service providers have tried to implement virtual pay-TV services to combat cord-cutting and retain the viewers that streaming services have been pulling away. Unfortunately, the viewer growth of these virtual-TV services, such as Sling TV and DirecTV Now, has slowed significantly. Sling TV’s 26,000 additions in 3Q were 90% lower than the previous year and DirecTV Now’s additions plunged 83%. If traditional cable providers are unable to retain viewers, major network owners will lose leverage when negotiating new deals with streaming companies, which will decrease revenue from affiliate fees. Since Discovery generates 48% of revenue from affiliate fees, the trend of increased cord-cutting will significantly hamper one of Discovery’s most reliable revenue sources. Source: Bloomberg, eMarketer

7. Industry Overview Current State of Industry – M&A Activity Many of the largest players in the media industry have recently conducted M&A activities (AT&T-Time Warner and Disney’s Fox bid) so there isn’t any expected M&A in the near future. These two deals represent two very different M&A trends that have appeared in the industry. The AT&T-Time Warner deal is more indicative of where the industry is heading in the long run since it is an example of vertical integration. It brings together global media and entertainment leaders Warner Bros., HBO, and Turner with AT&T’s leadership in technology and its video, mobile, and broadband capabilities. The CEO of AT&T, Randall Stephenson, believes that this will “offer customers a differentiated, high-quality, mobile-first entertainment experience.” Although this deal consolidates the power of popular content and distribution into one place, which is more convenient for the consumer, it also allows the company to dictate the pricing of TV bundles in the long run, which has worried the Department of Justice due to concerns over anti-trust laws. Unfortunately, the DOJ’s appeal for this merger has been rejected, which means that this deal will allow AT&T-Time Warner to have more leverage in the industry. Disney’s Fox bid is very similar to the Discovery-Scripps deal since it is a play to horizontally integrate the diverse portfolios of the two companies and cut costs in the short run. However, due to more impactful mergers like AT&T-Time Warner and companies like Amazon, Apple, and Netflix entering the media industry, these horizontally integrated mergers will have no impact on the industry in the long run. Although the media industry is very hard to penetrate, due to the large amounts of cash needed to create original content, companies like Amazon, Apple, Google, Facebook and Netflix have already invested billions into creating successful content. Since these technology companies are not traditional cable networks, they have the ability to bypass certain regulations and may be able to revolutionize the media industry by expanding vertically. Source: Bloomberg

8. Company Overview Company Overview Discovery Inc. is the world's #1 nonfiction media company, mixing entertainment and educational content, reaching over 1.8 billion cumulative subscribers in 209 countries and territories.  Discovery’s content is produced in more than 40 languages and the U.S. networks account for about 50% of the revenue. Discovery Communications network portfolio includes: Discovery Channel, TLC, Animal Planet, Science and Investigation Discovery, as well as U.S. joint venture networks: Oprah Winfrey Network, the Hub, etc.   Discovery Inc. generated 10.5 billion dollars in revenue in 2018 through two main channels: • Distribution revenue includes fees charged for the right to view Discovery’s network branded content. The largest component of distribution revenue is comprised of linear distribution services for rights to networks from cable, DTH satellite, and telecommunication providers. This segment generated 4.538 billion dollars in revenue (2018) • Advertising revenue includes advertising contracts that have a term of one year or less. • Upfront and scatter markets • Upfront: advertisers buy advertising time for the upcoming season, which will have discounted rates • Scatter: advertisers pay for advertising close to air date and have to pay a premium • Advertising revenue depends on many factors: stage of development of TV markets, popularity of TV, number of subscribers to channel, viewership demographics, popularity of content, and ability to sell commercial time over a group of channels • Advertising is typically highest in second and fourth quarters • This segment generated 5.514 billion dollars in revenue (2018) Source: Discovery 10k SEC Filing

9. Company Overview Discovery Revenue Structure US Cable Networks Market Share Source: CSI Markets, 10K

10. Investment Merits and Risks

11. Investment Merits and Risks Investment Risk and Merit Summary Investment Merits Merit 1 –Low Content Costs Compared to Competitors Merit 2 – Acquisition of Scripps Improves the Domestic Network Portfolio Offering Merit 3 – Growing International Presence Investment Risks Risk 1 – Secular Headwinds in the Cable and Satellite Industry Mitigant: Consistent Growth of Revenue in the Short-run Risk 2 – Lack of Domestic Sports Offering Puts Pressure on Reality TV Mitigant: Expansion into International Markets Risk 3 –Increased Leverage Profile Mitigant: Positive Sentiment for Future Free Cash Flow

12. Investment Merits Low Content Costs Compared to Competitors Because almost all of Discovery’s programming are non-scripted reality TV shows, the company’s content costs are lower than its competitors. For example, Discovery’s average cost per episode is around $400,000-$450,000 while a one hour drama on ABC or FOX could cost around $5-7 million. Drama or comedy shows on a larger network typically require a cast and producing crew with more stars, which increases cost of production. Also, these scripted shows take longer to produce and shoot due to the number of takes. Discovery’s non-scripted shows have been able to improve the company’s margin by 2.3% in the past two years, with smaller cost-of-revenue increases. Due to the combination of low content costs and popularity of Discovery’s trademark shows, a large portion of the company’s profits have been generated from the high affiliation fees with traditional cable companies, which makes up approximately 48% of the company’s revenue structure. By closing new affiliate deals with streaming services, such as Hulu Live and Sling TV, Discovery has pivoted with new technological advancements and consumer shifts in the cable television industry, distributing the company’s content through more channels Source: Bloomberg

13. Investment Merits Acquisition of Scripps Improves the Domestic Network Portfolio Offering On March 6th, 2018,  Discovery Communications, Inc. completed its acquisition of Scripps Networks Interactive for $11.9 billion. The Scripps Networks portfolio includes HGTV, Food Network, Travel Channel, DIY Network, Cooking Channel and Great American Country. With this newly expanded network, there is a higher potential for growth and value creation. The acquisition of Scripps strengthens not only the company’s international reach, but also attracts more female viewers with their lifestyle channels such as Food Network and HGTV. In the fourth quarter of 2017, HGTV and Food Network were both ranked in the top 10 for ad-supported cable networks for women 25-54 in sales prime. Travel Channel also delivered a 5% improvement in its adult 25-54 sales prime ratings. Because Discovery's original networks are mostly male-dominated, the merger helps Discovery diversify their target audience. Due to a wider audience, Discovery will be able to demand higher advertising fees and generate more revenue. Within two years of the acquisition, Discovery estimates cost synergies of $350 million in areas of domestic, international, corporate, and technology operations. Cost-cutting from this acquisition will allow for an increase in cash flow, debt repayment, and support for when there are declines in the TV industry. Due to the Scripps acquisition, Discovery projects a total average annual revenue growth of about 12.5% over the next five years and 3.3% year over year from 2019 to 2022. Discovery predicts to have a 41.1% EBITDA margin by 2022, an increase from 35.8% in 2018 when Discovery did not own Scripps. Source: Discovery 10k SEC Filing, Bloomberg, Scripps Network, Morningstar

14. Investment Merits Acquisition of Scripps Improves the Domestic Network Portfolio Offering Source: Nielsen

15. Investment Merits Growing International Presence Discovery has been making major headway in the international sports market.  Discovery announced on January 8, 2010, that it has acquired another 51% interest of the Play Sports Group (PSG) which will lead to an increase in revenue for the company.  Discovery previously owned 20% prior, bringing its aggregate ownership of PSG to 71%. PSG is a British-based digital media company focused on cycling, one of the most popular sports in Europe. PSG owns and operates eight cycling-based online channels accounting for 45 million video views every month, 5.7 million social followers and 3.1 million paying subscribers. Last year, Discovery announced that the company is entering a 12-year, $2 billion international multi-platform media partnership with the PGA Tour, which allows Discovery to broadcast the PGA tour to more international audiences.  The PGA Tour-Discovery rights deal, which goes into effect this year, does not include the U.S., where the tour airs on CBS and NBC (and NBC-owned Golf Channel) through 2021. Discovery’s investments in PSG and the PGA tour are examples of how the company is expanding its international reach and diversifying the company’s network offering. While other major players in the media industry, such as NBC, Fox, Disney, are investing billions on creating new content for the saturated US TV market, Discovery has used most of its 2.2 billion dollars to acquire smaller networks globally. These smaller investments in the international markets will generate a stable revenue stream for the company because the international market is less saturated with competitors. Sources: Bloomberg and 10K

16. Investment Risks Secular Headwinds in the Cable and Satellite Industry Even after the acquisition of Scripps, Discovery’s prime-time viewership was down 9% (year to date) since its top channels have been struggling to attract audiences. This has been prevalent among other cable networks in the industry due to the rising competition in the cable/satellite industry. The popularity of new streaming services, such as Hulu and Netflix, have cut into affiliation fees that cable networks usually generate as a significant portion of their revenue. Discovery’s main channel has been one of the most negatively affected, with ratings falling at mid-teens pace over the past few years. Similarly, the ratings of Scripps’ HGTV have been declining and viewership has decreased by 4% in the past year, but it still remains as one of the company’s most popular channels. The main reason for declining viewership and ratings is because non-scripted shows are usually unpopular for streaming service viewers, despite their low content costs. As a result, Discovery will lose leverage when negotiating with streaming services about whether to distribute Discovery’s networks in the main bundles. Furthermore, low ratings and viewership will hamper advertising fees. • In the Cable Networks industry (which makes up 97.70% of Discovery’s revenues), Discovery has a market cap of 20.36B of the 525.26B total market cap. Since 2013, growth in operating revenue for Cable Networks (including premium cable) has decreased steadily from a 9.53% growth rate to a 2.16% growth rate in 2017. In the same way, affiliate (distribution) revenue dropped from a peak of 49.465B in 2015 (10.36% growth rate) to 31.520B in 2017 (-20.88% growth from previous year). Since 2008, percentage of households with TV has dropped steadily from 98.6% to 96.3% in 2017. While this is still a very large percentage, the steady decline highlights the cord cutting trend. In addition, DirectTV Now’s loss of 267,000 video subscribers in 4Q points to concerns about virtual services’ ability to remain a stabilizing force for subscriber bases of smaller cable network owners such as Discovery. Sources: Bloomberg and 10K

17. Investment Risks Secular Headwinds in the Cable and Satellite Industry • Mitigant: Despite the very visible secular decline of cable networks, Discovery is still seeing positive growth across all businesses. In 2017, Discovery saw a growth of 8%, 3% and 6% for distribution, advertising and total revenues, respectively. For 4Q, ads are projected to grow at 3-5% in the domestic segment. Virtual-distributor deals with Hulu and Sling TV should bolster affiliate fees going into 2019, with the company projecting mid-single-digit gains for the full year. Cost savings should also start to be realized from the Scripps acquisition. This growth in revenues and potential increase in margins should further protect Discovery from default in the near term as Discovery has yet to feel material pressure from the greater macroeconomic landscape. Source: Bloomberg and 10k Declining Growth in Cable Network Revenue

18. Investment Risks Lack of Domestic Sports Offering Puts Pressure on Reality TV Some of the largest non-scripted service opportunities in the US include reality TV and sports broadcasting. Since most of Discovery’s content is centered around reality television, the company’s programming lacks diversity and leaves itself vulnerable to consumer shifts. Discovery’s lack of US sports deals and large number of networks means that the company is missing out on generating revenue through advertisements, which can be very lucrative given the popularity of the sports event. In 2019, sports media rights are estimated to be worth 20.6 billion dollars. As a result, Discovery’s lack of diversity in content puts more pressure on its already established reality television market to perform year over year. • Mitigant: Discovery’s recent bets on sports content in the international markets may be able to mitigate the lack of diversity in domestic content. Discovery has recently purchased pan-European Olympics rights for 1.3 billion dollars (from 2018-2024) and the rights to air a couple Bundesliga football games in Germany. In 2017, Discovery generated 3.2 billion dollars of revenue from international markets. While the opportunity for growth in international markets diversifies the company’s portfolio and generates steady revenue in the short run, it also creates the opportunity for acquisition in the long run.The media industry has been fighting back against the streaming threat by consolidating to increase content libraries, as seen through the ATT/Time Warner, Disney/21st Century Fox, Comcast/Sky transactions. While another merger may not happen soon, Discovery could be seen as an acquisition target now that it has expanded its portfolio through the Scripps acquisition and by heavily investing in international markets. Through an acquisition, Discovery would have greater negotiating power with distributors and access to streaming platforms. Source: Bloomberg

19. Investment Risks Advertisement Cost of Broadcast TV in US Source: Bloomberg, Statista International Revenue ($M)

20. Investment Risks Increased Leverage Profile Discovery currently has a debt to equity ratio of 2.12 while the industry average is .465. Discovery is highly levered compared to the industry due to the Scripps acquisition, which added an additional $2.7 billion in debt. Before the deal with Scripps, the debt to equity ratio was 1.48, which was still higher than the industry average. Net leverage was just over 4x as of Sept. 30. Discovery’s increased leverage profile from the merger poses as a risk because Discovery already has a credit rating of BBB-, which means that a downgrade puts our fund at risk of holding a bond that is not investment grade. Also, a downgrade in credit rating could force Discovery to increase the coupon rates on their future bonds, which would take away from using free cash flow for other investments. Mitigant: Discovery expects to reach $3 billion in annual free cash flow by 2019’s end because their acquisition of Scripps increases free cash flow. Discovery currently has 1.57B in free cash flow. Discovery is planning to use these extra assets to aggressively pay down debt, making the bonds we are purchasing less risky than they are currently valued. Rating companies are also usually more willing to accept temporary leverage increases when a company, like Discovery, has both the ability and promise to reduce debt. This means that Discovery expects to maintain high-grade credit ratings despite itsnet leverage of 4x. Source: Bloomberg, 10k

21. Investment Risks Increased Leverage Profile Source: Bloomberg

22. Financial Model and Projections

23. Financial Model and Projections Source: 10K Acquisition of Scripps in 2017 is the cause of lower operating income and EBITDA

24. Financial Model and Projections Source: 10k

25. Comparable Analysis

26. Comparable Analysis Source: Bloomberg

27. Comparable Analysis • Viacom is Discovery’s biggest competitor in the space. Viacom’s strategy includes expanding relationships with advertising, cable, satellite, digital, mobile, and licensing partners to target a larger audience. Viacom has been looking to expand its reach into digital media to target an increasingly online audience. The company planned to acquire Scripps Networks Interactive; however, Discovery was ultimately able to win the deal. The company has had declining revenues with revenue of $12.49 billion in fiscal 2016 compared to revenue of $13.3 billion in fiscal 2015. Viacom recently acquired Pluto TV for $340 million in an effort to accelerate Viacom’s direct-to-consumer with the addition of 12 million users. Currently, the company is focusing on turning around it’s film business, Paramount Studio, which does not represent a threat to Discovery’s network of content. • DISCA offers the most attractive OAS (96.2) as opposed to close comparable VIA (88.9). Source: Bloomberg