Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

The perception may be that Discovery Communications Inc. and Scripps Networks Interactive Inc. are merging from a position of weakness, when in fact rarely does a deal this large possess such clear strategic and financial merit. That's reason enough for investors to stay tuned.

Skeptics
Some analysts are rightfully concerned that Discovery and Scripps will get left in the dust as viewers switch to skinny TV streaming packages, but merging their businesses should help
Source: Bloomberg

The TV network operators announced on Monday that Discovery will acquire Scripps for $90 a share in cash and stock, implying a total transaction value of $14.6 billion. It ranks as the fifth-largest U.S. acquisition of the year (though others may be coming that will bump it down). Scripps shareholders couldn't have asked for better terms: They'll receive 70 percent of the purchase price in cash upfront and the rest in Discovery class C common stock. It's a healthy 32 percent premium to Scripps's average closing price for the 20 trading days through July 18, before word of an imminent transaction leaked. (As expected, shares of Discovery fell, dropping more than 5 percent in early trading on Monday.)

There's been a potentially destructive trend the last couple of years of buyers patently overpaying for acquisitions, blinded by their need to boost stagnating revenue and caught up in the excitement surrounding megadeals that have engulfed industries from media and packaged food to tech and pharmaceuticals. On the contrary, Discovery -- which has the backing of billionaire deal wizard John Malone -- can justify its price for Scripps, and the synergies are less flimsy than in some of the other large mergers.

Excluding cost savings -- which the companies predict to be $350 million -- Discovery is paying 10.6 times Scripps's trailing 12-month Ebitda. That's in line with the saner multiples in the 2011-2013 period, before the merger boom began and things became overheated. The deal will also immediately increase earnings and free cash flow. 

Frothy
Discovery's offer for Scripps doesn't look unreasonable relative to some of the steep prices other acquirers have paid in recent years
Source: Bloomberg

Analysts have turned increasingly bearish on Discovery and even on Scripps, the owner of HGTV, which was the third most-watched cable network last year, surpassing even CNN. Discovery's earnings -- which were also announced Monday -- missed expectations for a second time this year as ratings have been under pressure. There's concern that as smaller, less-powerful network owners, Discovery and Scripps will have a more difficult time navigating the new world of TV streaming as subscribers turn away from traditional cable packages. But while that concern is warranted, Scripps's content is a must-have for most of these new apps, as I explained here in May.

Combat Cord-Cutting
As ratings have slipped at Discovery and Scripps, it makes sense for the programmers to merge for scale and savings opportunities as they fight for spots in new apps
Source: Nielsen and SNL Kagan via Bloomberg Intelligence
Note: Prime time ad-weighted viewership for ages 18-49

HGTV and Food Network, two of its most popular networks, target viewers who are women, a demographic that advertisers have long prized. Plus, these programming genres help balance sports-heavy bundles and are cheap for distributors to carry. The addition of Scripps could help Discovery ensure a spot in more of these new packages after being left out of Dish Network Corp.'s Sling TV basic offering. (Neither company has a presence in Alphabet Inc.'s YouTube TV, which is dominated by sports programming and broadcasters). Discovery CEO David Zaslav is among industry executives working with the distributors on coming up with entertainment-only bundles for viewers who prefer the likes of HGTV's "House Hunters" and TLC's "90 Day Fiance" to, say, live football games. Scripps gives him another bargaining chip.

Limited Space
Costly sports content is making it difficult for Discovery and Scripps to squeeze into skinny bundle even though their programming is far less expensive:
Source: Kagan, a group within S&P Global Market Intelligence

The merger isn't without risk, of course, especially because it will involve substantially increasing the company's debt. That said, Discovery is going to suspend share buybacks to keep its investment-grade rating, and it will contribute almost all its free cash flow to reducing debt. 

There's also room for Discovery and Scripps to grow together. Scripps's unscripted content could easily be adapted for foreign markets, and Discovery has the international platform to make that happen. And if the two can integrate smoothly, it's possible other larger companies -- competitors or otherwise -- might look to buy them down the road as the lines between the media and telecommunications industries blur and the leaders look to transform into conglomerates. Malone has talked about this, even hinting at possible moves by the various media-connected companies he has stakes in, such as Discovery, cable operator Charter Communications Inc. and movie-studio owner Lions Gate Entertainment Corp. 

Don't be so quick to change the channel. Discovery and Scripps make a good duo. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net