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Discovery Holdings, Newhouse Cut A Deal

After months of speculation, Discovery Holding Co. pulled the trigger on a deal that will consolidate ownership of Discovery Communications Inc. into a new separate publicly traded company, but will allow each of the programming giant’s two owners to keep their interests.

The deal will take place in three stages:

  • Discovery Holding, the publicly traded entity controlled by Liberty Media and including a 66.7% stake in DCI and a 100% interest in Ascent Media, will spin off Ascent to its shareholders in a separate company.
  •  DHC’s Discovery Communications stake will then be contributed to another separate company – tentatively called NewCo – and existing stockholders of DHC will receive shares of common stock in the new entity.
  • Advance/Newhouse’s 33% interest in Discovery Communications and cable network Animal Planet will be converted into preferred stock in the new company, which will be immediately convertible into a one-third equity stake in NewCo after the closing of the deal, anticipated in the second quarter.

Discovery Holding and Advance/Newhouse have been negotiating the deal for months – a September SEC filing by DHC revealed officially for the first time that the two sides were talking. While Liberty and DHC chairman John Malone has been lusting after a full consolidation of Discovery for years – it was the main reason that Discovery Holding was created in 2005 in the first place – the announced deal falls a bit short of that goal.

For example, after the deal is closed, Advance/Newhouse will still own one-third of Discovery, will retain some of its approval rights concerning specific actions taken by the new company and will receive two seats on the new company’s board of directors.

While Liberty has been pushing for a deal for years, it wasn’t until earlier this year that they started making some headway. Liberty had originally owned 50% of DCI, with Advance/Newhouse and Cox Communications owning 25% each.

In May, Cox Communications sold its 25% interest in the group of networks to DCI, a deal that increased Liberty’s and Advance/Newhouse’s stakes in the networks to 66% and 33%, respectively — for $1.3 billion in cash, the Travel Channel and a related Web site. 

That deal helped fuel speculation that a full consolidation of DCI could be close. In June, Pali Research analyst Richard Greenfield predicted a Discovery buyout of Newhouse in a research report. In September, Greenfield broke the news that Advance/Newhouse and Discovery Holdings were in talks.  

The agreement appears to remove at least some of the clouds that have surrounded DHC and will give Discovery a deal currency that it can actually use.

Because of the convoluted structure of DHC – and the fact that Advance/Newhouse’s stake in DCI was privately held – the holding company was a bit hamstrung in using that currency for any potential deals.

In a memo to Discovery employees filed with the Securities and Exchange Commission Thursday, Discovery CEO David Zaslav and founder John Hendricks said that the deal will make Discovery a “stronger, more competitive and more opportunistic in pursuing targeted acquisitions that strengthen our position as the number one nonfiction media company in the world.”

Miller Tabak media analyst David Joyce said that while the new structure may not be what Liberty was hoping for, it does unlock some value.

“Some form of this transaction was what people were looking for,” Joyce said. “As long as Advance/Newhouse was not looking at combining its interest with the overall stake, the consolidation and the theoretical access to cash flow and the voting was not there. That was keeping a lid on the valuation. Now that there is going to be one entity that holds all of Discovery Communications, that will be fully consolidated. It will be a regular stock now.”

Joyce estimated that the new company could be valued at about $32 per share.