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Nathanson Downgrades Discovery, Scripps Networks

Analyst Michael Nathanson of MoffettNathanson Research has turned more bearish on cable networks, downgrading Discovery Communications and Scripps Networks Interactive to sell from neutral.

In a report entitled “Either You’re Live & Large or Dead,” Nathanson noted that media companies owning cable networks have seen their earnings revised downward and their stock multiples shrink relative to the broader stock market.

Pure-play cable network operators face fundamental challenges, he said, led by the drop in ratings for programming that is not live.

Nathanson notes that the media sector is now trading materially below any prior “normal” levels. But he does not expect the sector to rebound, as it did in 2008, the last time the stocks were this low.

Here’s some of Nathanson’s main trouble spots for cable networks.

“Starting at the end of 2013, TV advertising on cable networks slowed from steady mid-single digit growth down to the low-single digits. This deceleration was caused by both a fall in live GRPs and lower than expected CPM inflation as networks added more commercial inventory to offset their under-delivery,” he said.

“Starting in the summer of 2014, there was an unexpected drop in cable viewership which caused pressure on cable networks that did not have pricing leverage to offset the lower audience deliveries,” he said.

“The networks face lower-than-expected affiliate fee growth caused by a combination of factors—cord cutting, the emergency of great tier-ing, mix shift among distributors from higher-paying to lower-paying subscribers, and the impact of MVPD consolidation,” he said.

Nathanson says that biggest near-term economic risk is declines in live viewership of non-essential content as consumer behavior continues to change due to improving technologies.

Live viewing was 90% of total viewing across all major cable network groups in 2010-11, including Disney, which owns ESPN.

Sports have held their live gross ratings points better than non-sports programming. Sports programming is down 1% annually from 2010-11 to 2015-16, while non-sports is down 3% annually.

Disney is the only company to source the majority of its GPRs from live sources, with 59% in either sports or news. CBS has 47% live, Fox 43%, NBC 33% and Time Warner 18%.

Nathanson figures that networks with more essential programming will be getting rising affiliate fees and ad dollars. Well-positioned networks include Fox News, Adult Swim/Cartoon Network, ESPN and CNN.

On the other hand, networks like MTV, AMC, Discovery Channel, Bravo and FX will be at a disadvantage.

Nathanson has particular concerns about the companies he downgraded to sell.

“We remain cautious on SNI’s future outlook given increasing pressure on affiliate fees and greater competition for content pressuring programming costs,” he said.

When it comes to Discovery, “domestically we worry about competition for viewership without live marquee programming such as news or sports and its impact on advertising,” Nathanson said. “Internationally, Discovery is still in the early days of monetizing its Eurosport acquisition and newly acquired expensive sports rights, like the Olympics.”