Scripps Networks Interactive Lowers Its Outlook as It Agrees to Merge With Discovery

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Scripps Networks (NASDAQ: SNI) stock shot to a new high this week after it agreed to be purchased by fellow pay-TV-specialist Discovery (NASDAQ: DISCK). Yet Scripps paired that good news with preliminary second-quarter earnings results that showed continued operating challenges stemming from a shrinking pool of cable TV subscribers. Here's how the headline numbers stacked up against the prior-year period:

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Metric

Q2 2017

Q2 2016

Year-Over-Year Change

Revenue

$925 million

$893 million

2.5%

Operating income

$374 million

$373 million

N/A

What happened this quarter?

Sales growth slowed and operating income was flat, as distribution-fee growth failed to offset slowing advertising revenue.

Key highlights of the quarter include:

  • U.S. advertising revenue growth slipped for the second straight quarter, dropping to a 2.5% pace from 5% last quarter and 9% at the end of fiscal 2016.
  • Distribution fees were up 7% to mark an acceleration over the prior-quarter's 5% boost.
  • Scripps' business benefited from increased ad prices as its lifestyle brands remained in high demand from national advertisers. That improvement was mostly offset by falling ad volumes that were a consequence of declining pay-TV subscriber numbers.
  • The international business expanded at a 4% rate and saw its segment income rise to $39 million from $37 million.

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What management had to say

In light of the pending merger, Scripps executives canceled their earnings call discussion of this quarter's operating results and instead issued a joint statement with Discovery focused on the acquisition. In that release, CEO Kenneth Lowe expressed optimism that the merger represents the best path forward for the business. "This agreement with Discovery presents an unmatched opportunity for Scripps to grow its leading lifestyle brands across the world and on new and emerging channels including short-form, direct-to-consumer and streaming platforms," Lowe said.

Looking forward

Lowe and his executive team lowered Scripps' growth outlook for the year based on the surprising softness in the U.S. advertising market. They now see sales gains of roughly 4% compared to the 6% target they had aimed for three months ago. Rising expenses, meanwhile, will mean adjusted profit should be flat in 2017 rather than up 3%.

As for the $15 billion acquisition, Scripps investors are set to receive $63 per share in cash along with $27 in Discovery stock that will result in their owning 20% of the combined entity once the deal closes in early 2018. That equates to a 34% premium on their shares based on the closing price before rumors of the acquisition gained steam.

Scripps and Discovery are hoping that, by joining forces, they can reach a large enough scale in their core U.S. market to protect the profitability of their advertising and distribution agreements. Scripps is also optimistic that many of its popular brands can use Discovery's existing content network to enter attractive new geographic areas, including Latin America.

The combined entity will be a large force in the advertising and content industries, responsible for roughly 20% of the total ad-supported viewing in the U.S. and 8,000 hours of original programming each year. That's the main reason why executives believe a bold merger will improve performance over the long term even though both companies are entering this merger with soft -- and weakening -- business trends.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Discovery Communications. The Motley Fool recommends Scripps Networks Interactive. The Motley Fool has a disclosure policy.