Warner Bros. Discovery Now a Straight Bet on Streaming

WBD has lost 60% of its value since then. Including dividends, investors in AT&T are actually up modestly in a down market.

The size of the decline in WBD seems nearly impossible. Warner Bros. Discovery has lost about $36 billion in market capitalization since April. The deal only cost the company $43 billion, including the assumption of debt.

At these levels, there is a bull case to make for WBD. Valuation is reasonable as is, and when considering synergies and the eventual end of losses in the streaming business, the stock looks downright cheap.

But there’s one big Achilles heel here that means the decline so far this year is logical. The plunge in WBD isn’t being driven solely by AT&T investors dumping the WBD shares they received in the WarnerMedia deal (though that selling no doubt hasn’t helped). It isn’t being driven solely by a cyclical downturn in advertising revenue (though that, too, has not helped).

Rather, Warner Bros. Discovery remains reliant on its cable networks business. That’s an exceptionally dangerous spot to be in, and it means WBD stock, even down 60%, remains a huge and somewhat risky bet on streaming growth.

On its face, WBD does not look particularly cheap. The company closed the third quarter with net debt of $47.9 billion. Its market capitalization, fully diluted, sits at $24.4 billion, giving the business an enterprise value of $72.3 billion.

After Q3, adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) guidance for the year sits at $9 billion to $9.5 billion. An EV/EBITDA multiple just below 8x is attractive on its face — but for the media space, not exceptionally so.

But those 2022 figures don’t fully capture the underlying performance here. The direct-to-consumer business, led by HBO Max and Discovery Plus (which are being merged ) is losing money as it invests in customer acquisition. In Q3 alone, the DTC business posted an EBITDA loss of $634 million — more than double the previous year on a pro forma basis (ie, if the businesses had been merged at the time).

Get The App

Join the millions of people who stay on top of global financial markets with Investing.com.

Download Now

Those losses will abate in 2023 and beyond, and from there the business will move to profitability and then, hopefully, growth. Meanwhile, on a consolidated basis Warner Bros. Discovery sees significant cost savings: a total of $3.5 billion, with just $750 million being realized in 2022.

And so WBD, as the company put it after Q3, is “working toward” EBITDA of $12 billion next year — which would imply a 6x EV/EBITDA multiple. There’s still incremental cost savings in 2024, along with further improvements in DTC.

Look out a couple of years, and this is a business that conceivably could generate free cash flow of $4 billion to $5 billion annually — at least. Apply a low double-digit multiple to that figure, and WBD stock has a chance to double from here. Indeed, at least for now Wall Street still is standing by the stock. The average price target of $21 suggests the stock could double in 12 months, though those price targets may come down after the disappointing Q3 report .

But here’s the catch. The profits WBD is generating at the moment largely are coming from its linear networks, including Discovery, TNT and TBS. And that business is in big, big trouble.

Cord-cutting continues to pressure affiliate fees paid by cable and satellite companies. Advertising revenue is taking a hit amid macroeconomic pressure, and likely will never reach prior peaks.

Simply put, cable networks are a declining business, and investors are reacting accordingly. ESPN has been a problem for shares of Disney (NYSE:DIS) for years now. AMC Networks (NASDAQ:AMCX) is trading at a seemingly impossible forward P/E multiple of 2.5x.

At the moment, it’s the networks segment that is driving essentially all of WBD’s earnings. Profits from its studio business, which has its own challenges amid declining movie theater attendance, are basically offset by streaming losses.

And so the argument that WBD is ‘cheap’ has an easy retort: It should be cheap. Investors are not assigning any material multiple to earnings from cable networks, given that those earnings clearly are in long-term decline.

The good news for WBD is that cable network profits are in decline — but in theory those profits should be migrating toward streaming operators. The long-term bull case for Warner Bros. Discovery is that, over time, the cable networks business and the streaming business essentially trade places. Streaming becomes the profit center; cable networks see profits decline gently (hopefully) until the point arrives at which the entire industry is some version of streaming.

To some extent, that case absolutely can play out. WBD ended Q3 with 94 million subscribers. It’s behind only Disney, Netflix (NASDAQ:NFLX) and Amazon.com (NASDAQ:AMZN), though the latter service is part of the broader Prime package. HBO remains a prestige brand and a content powerhouse; it would seem like WBD’s streaming service can replicate the success of HBO (and other networks) in the linear space.

But it will take a lot of work, and a lot of time. There’s a lot of risk as well. AT&T management was slow to get the streaming business off the ground. Netflix, in particular, has a huge head start. Disney has roughly 70 million more subscribers.

It’s also possible that, on the whole, streaming simply isn’t as profitable as linear networks were. The model of getting revenue from cable operators and from advertisers was quite attractive. The constant price competition and easy churn of the streaming world may not be nearly as lucrative.

Investors willing to bet on HBO Max, in particular, should be looking at WBD here. But this is not a slam dunk; WBD stock has plunged for good reason.

Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.