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Since my previous article on Warner Bros. Discovery (NASDAQ:WBD), the stock has been under pressure. Not much can be done about it, as the current bearish take on equities by the price-setters on Wall Street continues on.
As of this writing, the 52-week range on the shares was between $13.59 and $31.88. Also as of right now, the stock had a $14-handle. Which goes to show how weak the company’s debut has been.
The current forward P/E is roughly 12. For all the WarnerMedia IP. The theatrical distribution system. The platforms, both streaming and linear. And all the future possibilities of entertainment monetization at CEO David Zaslav’s disposal.
Yeah, I’m still long and would look to add here.
In this brief piece, I wanted to continue some thoughts about the company, in particular the studio’s movie strategy, as well as the CEO’s seeming approach to business. Preview: He seems to want to take seriously the idea that one should be careful to not be looked at as other people’s money in Hollywood.
Zaslav Wants To Emulate Disney
Zaslav recently sent out a memorandum to employees that looked to set a tone for the film strategy. At its basic core are three segments: projects from Warner Bros. and New Line labels, Warner Bros. Feature Animation, and movies that feature DC superheroes.
Do you get a sense of deja vu?
You perhaps should, because it sounds an awful lot like former Disney (DIS) CEO Robert Iger’s approach.
And that’s a good thing.
As I stated, Zaslav is taking his new role as media mogul seriously; he wants to make money, and because of that, he knows his films will need to make a splash in the marketplace. He, therefore, is creating divisions that can focus on their own separate IP franchises, and the hope is for future tentpole success to fuel subscriber growth with HBO/Discovery streaming.
DC will obviously go after the Marvel audience, and I suspect he will want that division to look toward a model of emulation of Disney’s approach, specifically, and as I mentioned in the previous WBD article, a replication of what Kevin Feige is doing: how the latter develops his films and separates them into phases that are linked between silver screen and streaming screen offerings. DC has seen its cinematic universe experience varying levels of success; Zaslav will want more Disney-like consistency post the Warner/Discovery merger.
One very distinct advantage I see that WBD has that Disney doesn’t is represented by the recent announcement of a sequel to the Joker film. That 2019 project is still making waves today. At the time, it exploded in the marketplace, opening above $90 million at the beginning of October. It eventually grossed over $330 million domestic and over $1 billion on a worldwide basis. The budget is said to be a little under $60 million. This was a very different kind of movie, almost an independent-minded take on a Batman-franchise villain that didn’t necessarily rely on over-the-top plotting and intense visual effects; Disney arguably doesn’t have an equivalent mechanism to produce this sort of film, since Disney is determined to remain faithful to its own data sets and not add risk by straying too far from the formula. This is understandable.
But Warner took the risk, performed the experiment, retrieved a new data set – it then put together a new equation and decided to expand the 2019 Joker IP into a potential franchise. The Joker 2 screenplay is now in development.
If Zaslav can balance traditional DC product with Joker-type takes on characters, perhaps using the latter to create its own parallel cinematic universe, then different audiences can be served at different times of the year, and revenues can increase. Most likely we won’t see the kind of returns Joker generated, not all the time, anyway – but if the studio can maintain quality control and at least put in a good-faith creative effort, then risks will be mitigated. Plus, this scheme offers the ability to lower the overall average budgetary costs of a DC movie slate – I can envision films of this nature being less than $60 million to produce.
The Warner animation segment obviously wants to go after the family market and be as strong a competitor as possible to Disney. That will be a tall order, but Zaslav seems to be an exec who wants to be out there fighting in the marketplace. It’s smart to go after the animation crowd, and there’s a lot of opportunity for growth here – i.e., while Warner has access to many famous characters (Looney Tunes, Lego, etc.), we have to be honest and say that when one thinks animation projects, one would think Disney and Comcast’s (CMCSA) DreamWorks Animation/Universal cartoons first before Warner (at least, that’s how I see it). The specific opportunity is to try and find a way into new IP that casts the kind of quality-spell over the zeitgeist in similar fashion to Pixar’s portfolio. It can be done, but it takes persistence and risk-on thinking.
The Warner/New Line live-action division will hopefully focus on commercial product slates that range from tentpole features to lower-budget IP franchise-starters. Very interestingly, this division represents a chance to be a key differentiator to the Disney model. In fact, Disney’s closest analog would be the Twenty-First Century asset, but the company so far doesn’t seem to be focusing on that acquisition as being a hedge against family-oriented productions (which it should).
With Warner/New Line, WBD can figure out new live-action franchises while continuing on with existing ones. The best example here is The Conjuring universe. There are several films in that branded franchise, and it certainly could lead to series on streaming (episodic versions of this IP presumably would be a strong subscription-driver in my mind). Horror is an extremely vital genre, especially in terms of generating shareholder value – those who have read my articles in the past know that I believe the Blumhouse horror model is something to be emulated and expanded upon. Unless this aspect of Hollywood completely goes over Zaslav’s head, his next memorandum to his troops should be to incubate more Conjuring-type franchises…movies that can start out in the $5 million – $10 million range and then rise gently up to a limit of $25 million – $30 million. Blumhouse creates concept-driven projects that are anchored by a star thespian or two and are easily marketed to the younger demo quadrants. Conjuring films have hit this demo area, and it’s definitely a space that Disney hasn’t explored (and for other studios that have explored the space, Warner definitely has an edge over them considering the impact this trademark has had on the marketplace).
Warner live-action can also pump out comedy franchises as well as dramatic one-off projects. But I see the biggest value-driver being with the horror genre. Yes, Harry Potter and the like will be important as well, but I’ll be keeping my eye on this genre of filmmaking.
This CEO Wants To Control Costs
Here’s an interesting Hollywood tale involving J.J. Abrams.
You’ll recall that Apple (AAPL) attempted to sign him up for an overall agreement before WarnerMedia won his business. This trade piece mentions that Apple actually wanted to pay more than Warner. In exchange for non-exclusivity (Apple apparently wanted exclusivity), Abrams valued the ability to sell product anywhere over an increased payout. Not a bad deal for Warner considering, to the best of my understanding, Warner Bros. would still have been a distributor on most product that found itself on non-Warner platforms (mostly, non-HBO Max platforms). Nevertheless, Warner may end up paying over a quarter of a billion bucks to Abrams over the life of his deal (including extra backend compensation).
The word on the streets of Hollywood, however, is that Zaslav is carefully evaluating what it means to be spending money on expensive overall-deal structures. Even more interesting, at least in this case and according to the linked trade article, is that Abrams understands that the merger may have retroactively changed the assumptions on the agreement his production company made with Warner a couple years ago. Most likely, not every star talent will be so understanding (which means Zaslav is going to have to be tough in negotiations).
And you have to wonder how understanding Abrams is now considering his project Demimonde has been shuttered. Abrams wanted $200 million for the project’s construction, and someone at HBO said no (Zaslav, maybe?). Whoever pulled the plug, the culture is perhaps set: unless there is a good reason for content to be made (reason being that it stands a reasonable chance of connecting with audiences in an economically-friendly manner), it maybe should not be made. That’s a shareholder-maximizing mindset.
The biggest factor with talent/overall deals is whether or not the talent in question is highly motivated to go for commercial product; it can’t be simply for reasons of personal taste, or the desire to do passion projects. Nothing wrong with any of that, and even those ideas can work in the marketplace, but they should be appropriately budgeted at the very least, and come only after requirements for a low-risk/high-reward slate are satisfied. Considering Abrams, if I was Zaslav, I would be asking him to create another Cloverfield-type franchise – something that doesn’t cost a lot but would resonate with the current generation of moviegoers.
While most of the focus will be on the normal cost synergies from a merger – he wants to save $3 billion – that would include staff reductions and the like, movie and episodic budgets will be key going forward, because the CEO doesn’t appear willing to get into a spending war with other streamers. Wall Street is going to forgive that for now, but when Netflix (NFLX) gets its mojo back (and, for that matter, when the market as a whole stabilizes and returns to a more bullish stance, whenever that may happen…) and competition for talent heats up, there may be a more studied look at content on HBO/Discovery and how it compares, quantity-wise as well as quality, to the rest of the pack; in other words, the streaming wars are called that for a reason, and investors will want to make sure Zaslav is hitting the right numbers. I do agree, though, that volume doesn’t always make sense, and that each project, whether for multiplex or digital, has to be reasonable in terms of above-the-line costs.
My hope is that Zaslav will get creative. Take animated films, for instance. I always wonder why cheaper, unknown talent isn’t utilized for these pictures.
The theory goes that a star voice essentially acts as a marketing tool; while it may not be absolutely necessary to cast someone like Dwayne Johnson to be the voice of a character in a film like Moana, he brings celebrity power to the proceedings in a big way…his social-media presence alone is worth a load of backend, many might say.
However, Zaslav could experiment with above-the-line costs-control by comparing the returns on cartoons with inexpensive talent. It’s a first step toward looking at the topic as a whole (i.e., along with live-action contracts).
The CEO will continue to learn about the scripted side of the business and how it can be brought into balance with the Discovery business he knows best. They’re two different worlds, but the economic lessons in one can be applied to the other.
Conclusion
As I’ve said, I’m still long WBD. To me, the story behind the stock – the IP, the platforms, theatrical, et cetera – take precedence for me until several quarterly-earnings announcements are in the books.
Still, from a valuation perspective, WBD is attractively rated by SA, with a B score. On forward adjusted earnings and forward cash-flow projections, in particular, the studio is looking good. On price action, the SA ratings are, as one would expect, bad.
But consider all that IP, all that potential for David Zaslav to wield in a cost-efficient manner to generate shareholder value – when you put that up against the backdrop of a pullback in the stock, and bad market sentiment that a few years from now will be in the rearview mirror (hopefully, of course!), WBD simply looks too good to me to pass up.
So, yes, we have to wait for future data from the company in 10-Q filings – but Warner Bros. Discovery is definitely recommended to any potential media investor for further investigation after its drop in price.
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