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Alger: “Discovery (DISCK) Will Need to More Significantly Increase Content Spending to Better Compete”

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Alger, an investment management firm, published its “Alger Mid Cap Focus Fund” second quarter 2021 investor letter – a copy of which can be downloaded here. During the quarter, the largest portfolio sector weightings for the fund were Information Technology and Industrials. The largest sector overweight was Industrials. Class Z shares of the Alger Mid Cap Focus Fund underperformed the Russell Midcap Growth Index during the second quarter of 2021. You can take a look at the fund’s top 5 holdings to have an idea about their top bets for 2021.

In the Q2 2021 investor letter of Alger, the fund mentioned Discovery, Inc. (NASDAQ: DISCK), and discussed its stance on the firm. Discovery, Inc. is a New York, New York-based mass media company, that currently has a $14.2 billion market capitalization. DISCK delivered a 5.15% return since the beginning of the year, while its 12-month returns are up by 32.85%. The stock closed at $27.54 per share on August 06, 2021.

Here is what Alger has to say about Discovery, Inc. in its Q2 2021 investor letter:

"Discovery is a diversified global media company serving content across 220 countries and 50 languages. Its intellectual property spans sports, home, food, nature and reality, with brands like Discovery Channel, TLC, Food Network, Animal Planet, HGTV and others. Discovery has long been considered a secular decliner due to the dwindling U.S. cable subscriber base where the company makes the majority of its profits; however, it has been able to offset that volume pressure with pricing that led to low single-digital growth.

At the end of 2020, Discovery launched its direct-to-consumer streaming platform, Discovery+, which we believed would reinvigorate growth to the mid-teens range this year and then mid-single digits to high-single digits in the coming years, which would be attractive acceleration compared to the company's legacy growth. While the margin profile of the streaming business is structurally lower, we believe the reinvigorated growth outlook and ability to expand to new international markets would be value accretive, so we invested in Discovery based on our belief that the streaming business was not being accurately reflected in the stock price.

We believed that a reacceleration in streaming subscribers at Discovery+ resulting from launching services with partners such as Amazon.com and more importantly with Vodafone in Europe (where Discovery owns the streaming rights for the summer Olympics) would be a positive catalyst, but instead, Discovery announced that it would take on significant debt to effectively acquire the content portfolio of Time Warner Media. While we believe that the Time Warner Media business can help Discovery over the long term, the stock performance was weak as the deal is not expected to close for the next 12 months, and subscriber numbers are now diluted by the overall portfolio (Time Warner's HBO Max already has more than 30 million subscribers compared to just 12 million for Discovery). This acquisition also brings in more structural cost fears, as Discovery historically was able to produce inexpensive content with very strong margins, but the Time Warner Media portfolio includes much higher content costs, and as a scale player, we think Discovery will need to more significantly increase content spending to better compete. Overall, we were hoping for an inflection in growth and a valuation re-rating this summer, but the merger removes that near-term catalyst, which we believe has significantly pressured the stock."

Based on our calculations, Discovery, Inc. (NASDAQ: DISCK) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. DISCK was in 40 hedge fund portfolios at the end of the first quarter of 2021, compared to 31 funds in the fourth quarter of 2020. Discovery, Inc. (NASDAQ: DISCK) delivered a -13.64% return in the past 3 months.

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.

At Insider Monkey, we scour multiple sources to uncover the next great investment idea. For example, pet market is growing at a 7% annual rate and is expected to reach $110 billion in 2021. So, we are checking out the 5 best stocks for animal lovers. We go through lists like the 10 best battery stocks to pick the next Tesla that will deliver a 10x return. Even though we recommend positions in only a tiny fraction of the companies we analyze, we check out as many stocks as we can. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. You can subscribe to our free daily newsletter on our homepage.

Disclosure: None. This article is originally published at Insider Monkey.