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TheStreet Open House

Is Discovery the Next Target in Big Media's Content Takeover?

NEW YORK (TheStreet) - Shares of Discovery Communications  (DISCK) jumped on Wednesday on the view that television programming, especially content that travels well internationally, may be even more valuable considering the price Rupert Murdoch's 21st Century Fox (FOXA) is reportedly willing to pay for Time Warner (TWX) and its pay-TV channels HBO, TNT and TBS.

Discovery gained 6.3% to close Wednesday $83.50 as Time Warner rejected a takeover proposal from Fox valued at about $80 billion.

Fox's interest in Time Warner underscores the rush by content providers to own more programming that can be sold to pay-TV operators and other programming services available on digital devices. The proposed combination of two of the largest U.S.-based entertainment companies comes as pay-TV operators Comcast  (CMCSA)and AT&T  (T) are seeking to get larger by acquiring Time Warner Cable (TWC) and DirecTV (DTV), respectively.

Bernstein Research media analyst Todd Juenger suggests that 2014 might be "the year of the deal", in a flash note released today. Considering the number of potential media-mergers and proposals on the table, Juenger may have been right.

Juenger writes that "the urgency to find a 'dance partner' will increase across the sector. Nobody wants to be the company that gets left out of the consolidation wave, and companies would rather control their own destinies". With that said, we have several reasons to believe media vultures may have set their eyes on Discovery Communications.

"We favor companies in the U.S. Media sector that are poised to benefit the most from increases in affiliate fees and international growth (both in TV and Theatrical) and have the best programming cost structures".

Although often over-looked, acquiring the primarily non-fiction based Discovery would be a smart tactic for any company. Despite its competition, Discovery CEO David Zaslav has managed to create a business model that has functioned quite nicely.

By focusing on what has benefited the company in the past, namely providing non-fiction content, Discovery has created a company that serves a popular and loyal niche of consumers. With this specialty market, Discovery is likely to continue to secure interested consumers, a tactic that larger media companies may not have the opportunity to create from the ground-up.

Despite its size compared to Fox and Time Warner, Discovery reaches 2.5 billion subscribers in more than 220 countries and territories, according to the company. In the U.S., Discovery has managed to almost triple its audience share over the past decade. This growth is due to the popularity of shows such as Here Comes Honey Boo Boo and My Strange Addiction.

Discovery is also expanding internationally through acquisitions and office expansion. Discovery is looking to carve out a profitable business in Europe's television market, a region Juenger describes as having "depressed advertising, low pay-TV adoptions, and undervalued TV assets."

Importantly, Discovery is getting an increasing amount of its revenue abroad. According to analysts at Barclays, the company generated "some 51% of the company's affiliate revenue and 42% of advertising revenues from outside the United States" and is likely to keep growing.

Noting Discovery's success in the U.S. and internationally, Latin America accounted for more than 14% of Discovery's total cable revenue last year; Bernstein doesn't see why Discovery can't see a repeat performance in Europe. Juenger forecasts that this change may even occur in the next 5 to 7 years with about six networks in each of Europe's major countries as opposed to its typical 3 to 6 networks currently distributed in major European countries.

A Discovery spokeswoman wouldn't comment for this story.

But how exactly will Discovery conquer Europe: possibly through sports. Although Discovery's acquisition of controlling interest in Eurosport International, SBS Nordic operations and a minority stake in Formula 1 with partner Liberty Global may have raised eyebrows, when analyzed as a whole, Discovery emerges as a media company extremely interested in sports fans, a sector guaranteed to secure viewers and generate revenue.

If Discovery really is dedicated to tapping into the pay-TV market in Europe securing real estate in sports, is clever and sure to be lucrative in the future. Barclays suggests that "Discovery seems to be building a portfolio of sports rights to move Eurosport more to a Tier I status in Europe." Eurosport is currently Europe's No. 1 pan-European TV channel reportedly reaching over 135 million homes in 54 countries in more than 15 languages.

Conversely, attempting to capture the sports sector in Europe alongside continued proliferation around the world, Discovery could be making power plays to save itself from a future filled with pseudo-monopoly like media companies. During this year's Allen & Company conference in Sun Valley, Idaho Discovery CEO David Zaslav suggests we might begin to see consolidation among television content owners. "In the next couple of years, I think it's likely there will be consolidation on the content side" and with the industry being advantageous for content owners we could see content owners coming out on top.

Granted often by-passed, Discovery has "structurally superior and sustainable cost advantages and its superior operating leverage" internationally, according to Juenger who rates Discovery as outperform with a target price of $98.

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