Warner Bros. Discovery: Long-Term Buy Based On IP & Streaming

HBO Max WarnerMedia Investor Day Presentation

Presley Ann/Getty Images Entertainment

Warner Bros. Discovery (NASDAQ:WBD) is finally here. It makes one think there should have been an opening scroll of text a la Star Wars to announce its arrival on the first day of trading. Of course, that probably should read Streaming Wars, but that’s okay, we all get the point. And make no mistake – the Warner assets have been through a war of sorts, after merging years ago with Time, and then America Online, and finally, with AT&T (T), the latter a bit of an embarrassing attempt by a telephonic company to play Entourage. Unfortunately, the Ari Golds of Hollywood were too tough to handle for the debt-laden 5G player, and after selling a bunch of assets to make room for the Time Warner business, T felt it had enough and found itself yearning for a simpler time of cellphone contracts and communication-tower upgrades. I had hopes that T could have used WarnerMedia as a growth engine, and I still believe the company could have done so; unfortunately, a lack of synergistic imagination meant that Bugs Bunny and DC and HBO didn’t stand a chance in those corporate hands.

First thing to note: I believe the company is a buy for long-term investors in the media sector. There will be ups and downs and stretches of base-formation, as always, but you can count on many severe downturns when subscriber numbers aren’t going the company’s way during short-term moments. Over the long haul, I see the assets as being a powerful value-driver. Plus, I also see the CEO, David Zaslav, as being keenly motivated to take this start of a new era in Warner’s history and running with it. There are risks, as he transitions over from unscripted to scripted, an observation shared by others, but at some critical point, I’m looking for the company to strike a synergistic balance between streaming and theatrical that will propel the shares to higher total returns.

In this article, I will take a big-picture look at potential strategies that might be employed by Zaslav as he looks into this next act of his media career.

WarnerMedia Is No Looney-Tune Asset

There’s no question that David Zaslav knows the power of unscripted IP. Reality shows have been with us since the debut of The Real World on Paramount Global’s (PARA) MTV unit back in 1992. Discovery has its fair share of reality series, such as Deadliest Catch, and all manner of channels dedicated to unscripted/documentary-type offerings such as OWN, HGTV, and Travel Channel (there’s a great cheat sheet published over at Variety).

What excites me most is how the Discovery-type content can act as a hedge against the tentpole business plan of the Warner side. And, of course, the Warner/DC side is what will essentially help to drive the theatrical/streaming revenues. That’s what really takes investors who held positions in Discovery to a new level of growth.

Discovery has 22 million subscribers as of last count. HBO/H-Max has just under 74 million. One would have to presume there is a good chance the combined company will merge those two subscriber bases in a bid to counteract not only Netflix (NFLX), which has its own exposure to reality programming, but Disney (DIS), which specifically made sure to increase the value proposition of its D+ service with the Fox-IP/studio purchase, which netted the National Geographic channel and its associated shows.

There are a few things I am looking at as I try to envision how the company forms a strategy for the future.

Talent obviously is of prime importance. I am very curious as to how the overall-deal slate evolves over at H-Max. The cheat sheet lists some impressive names in the industry, such as George R.R. Martin, but I expect more deals to be struck sooner rather than later with high-profile producers. I also wonder if Zaslav will try to carve out narrow deals for certain platforms with talent that is currently tied up in other agreements that nevertheless allow for it – in other words, perhaps separate overall deals for theatrical or streaming or broadcast, et cetera. J.J. Abrams, as an example, demanded non-exclusivity in certain instances with his H-Max deal. I imagine deal structures will change over time such that we will see novel permutations with them (e.g., first-look deals are supplemented with second-look deals); this would seem logical given that competition for talent lockups is sure to increase along with consolidation activity. The key here is to get some news flow for a couple big gets, as they say in Hollywood; in this way, the company will announce to the industry that it is serious about succeeding (and hopefully signal to Wall Street institutions to get long the stock).

Next, I am assuming a careful, thorough analysis of the company’s library, a data-driven one that will attempt to surface the best bets for remakes, reboots, prequels, sequels – whatever new (or derivative) cinematic universes are there waiting to be formed, you can bet Zaslav will want to catalyze them into existence. Former Disney chief Robert Iger casts a long shadow in the corner offices of all the major media conglomerates, so rest assured that Warner Bros. Discovery is going to attempt to create its own history in the tentpole business (and that goes for big screens and as well as the smaller ones).

I expect, too, that some sort of reorganization along the lines of current Disney CEO Robert Chapek’s mandate that the internal producers of the Mouse’s content won’t have outsized influence over where content is placed (i.e., whether it goes to theaters, H-Max, or TBS) will take place at WBD. That would make sense for a media company that has so many platforms and programs.

On the topic of theatrical: Expect that to be a focus. As it should be.

Theatrical-film IP represents one of the best ways in which to promote an over-the-top service, or even legacy linear assets. It also sets up opportunities for day/date experiments (when needed, whether because of new SARS variants or because of slowing growth in streaming); more likely, of course, would be near day/date scheduling, since it is becoming more clear that this is usually the better distribution paradigm (it could be forty-five days after theatrical debut, or thirty-five, or nineteen…whatever works best for each specific project – true tentpole productions obviously would go longer, especially those in it for multibillion-dollar worldwide grosses).

All of this will be driven by Warner IP, and that IP will find its way to H-Max streaming and linear (TBS, TNT, etc.). With the combination of the Discovery content, it’s going to make for an attractive entertainment ecosystem in the eyes of Wall Street analysts.

I will also note here an advantage that will power that ecosystem in comparison to the tech giants and their streaming competitors, Apple (AAPL) and Amazon (AMZN) in particular: there will be more of a direct line to management of content with WBD than there would be with tech or telephonic outfits. With AT&T or Amazon, the CEOs of those companies basically delegated just about all content decisions to Hollywood…to me, that doesn’t necessarily lead to maximum concern for shareholder value so much as it does maximum concern on the part of the hired hand to greenlight projects that may or may not add shareholder value, perhaps based on networked friendships forged in the past. Zaslav will probably be more hands-on, and he won’t have the obligatory distractions of a major technology corporation. I get the feeling, too, he will want to produce mainstream, commercial content as the main product line (i.e.: stuff that actually makes money).

Zaslav And Content Spend

Briefly, I want to mention the issue of content spending. Zaslav back in February discussed his approach to investment in filmed entertainment, as highlighted in this trade piece. The basic gist is this: Zaslav wants to be very, very careful in terms of investing just for the sake of investing. This is understandable, considering the company has well over $50 billion of debt on its balance sheet, as mentioned here.

If there wasn’t that much debt, you can bet the CEO would be more open to competing on content spend. For now, I like that he’s looking at spending as something that can’t get out of control.

Question is, will that net WBD the projects and the talent relationships that it needs?

Management has stated that it plans to radically reduce the debt in a few years. I haven’t read any specific deleveraging plans, but it probably would be prudent for the new company to look at its asset base and see if there is anything it can sell off. There have been reports that The CW, a joint venture between Warner and Paramount Global, wants to sell out, with one possibility being that the media companies keep a smaller percentage. Whatever form the transaction takes, it would be best for WBD to keep a multiyear content deal going so it can essentially continue to use the network as an incubator of sorts for new IP. Another option, of course, would be to sell out entirely (at least as far as Zaslav is concerned) and then use linear broadcasters to develop product; that might not be a bad idea, since the main focus will be the streaming unit, and joint ventures like this sometimes don’t go the distance as media environments change.

Obviously, a transaction centering on The CW isn’t going to solve the debt problem, and it’s difficult to say what other assets should be sold, since many of them add value to the synergy-potential of the ecosystem. But if Zaslav wanted to go all-in on streaming and reduce linear, then perhaps selling stakes in the Turner properties could be another opportunity.

Either way, something to supplement the eventual projected cash flow (by some) of over $8 billion will help out the debt situation. Which brings me to the next topic.

Acquisitions…?

We know that, at some point, WBD is going to head out on a shopping trip. Consolidation continues on in Hollywood, even though some of the bigger assets have already been spoken for.

Which brings me to a favorite topic: Lions Gate Entertainment (LGF.A) (LGF.B). I am long this company.

Would David Zaslav be interested in this company?

It would seem the answer would be yes (if Lions Gate is still available at the time).

One interesting fact is that John Malone, the catalyst for the Lions Gate/Starz merger, is the media exec that placed Zaslav in the captain’s seat over at Discovery. As Discovery’s largest shareholder, he blessed the Warner purchase; it would seem logical to assume that Lions Gate CEO Jon Feltheimer is hoping to pitch at some future date (probably near-future if he can make it happen) the value of his company, considering he clearly wants to sell out.

What exactly would WBD want from LGF? Consider that the latter is basically composed of two parts: a studio/library, a streaming service. The Starz asset might not be wholly important to WBD…with H-Max and Discovery content, creating another hub within that ecosystem could possibly represent overkill.

Feltheimer might want to think very seriously about jettisoning Starz as soon as possible, whether to a SPAC or some other conglomerate, and then concentrating on building up a hit movie slate, because that would be the most attractive thing for WBD: more IP, and more content from Lions Gate’s large library. It’s not that having Starz would be a bad thing necessarily…Starz could be a very useful asset for the correct owner, whether it be an Amazon or a Comcast (CMCSA) or even AMC Networks (AMCX). But with the focus solely on the combination of content from H-Max and the reality side, and with debt as high as it is, separating Starz from the rest of Lions Gate might offer an attractive price for both WBD shareholders and the shareholders of the smaller studio.

WBD is going to affect consolidation in the industry, and some have mentioned that perhaps some other entity might target the new stock. Disney is always in the market, it seems, for becoming larger through acquisition, so that would be another possibility.

Would Apple want WBD? It’s not out of the question, although the idea of it happening anytime soon is questionable. CEO Tim Cook has allowed the strategy of his streaming unit to be dependent upon exclusive original content as opposed to licensed libraries from legacy linear players. He’s slowly building out a curated collection of new programming that’s helping to up the value of production houses.

WBD will buy something, you can bet on that. The timing will depend on cash flow and asset mix evolution. Stay tuned for future earnings reports…(and I want to note that the work and comments of SA user LONGBULLPLUS on my media articles always help me when I think about the topic of media consolidation in general and with LGF specifically).

A Note On DC

DC will be going to battle with Marvel. And from what I’ve read about Zaslav’s thoughts on the matter, I think the company has the correct attitude for it.

Weaponizing IP against competitors can be complicated, but DC is a major trademark with iconic characters that some critics point out haven’t been utilized in the right manner. Zaslav has a chance to fix that, and it looks like, according to this article, that he may try to clone Disney’s Kevin Feige. That’s exactly what he should be thinking: how do I replicate the Marvel strategy?

That can help to drive the core strategy of DC, making the Warner superhero tentpoles more symmetrical in their storytelling and thus more satisfying to the audience, both the hardcore and casual components. But I also would like to see, as this piece mentions, more exploration of Joker-type films – lower-budget affairs that exude a different kind of quality and appeal (all costs will have to be looked at given the debt).

In all cases, I hope that the company foregoes risk-mitigation techniques on production. Back in 2019 I wrote about how the Joker spoils had to be split with a financing partner. Zaslav should definitely invest in risk in the movie business so that profit can be maximized on each project and potential franchise. It’s a shame, for instance, that the company has to share the risk on the Godzilla franchise with Legendary. The other side of the argument articulated to me on more than one occasion is that spreading the risk just makes good business sense in the movie industry. Here’s what I say to that: Yes, at one time that was more true than now. Today, movies and television series seem to be higher in quality than they were in the past (thus, less risky), especially considering technological advances at all stages of production. The example I often bring up is the co-financing that went on with some projects at Disney’s Touchstone label – having investors come in to help with, for instance, What About Bob? was a logical move in the 1990s (that might be a bad example, because that actually was a pretty good comedy, but the point is made); studios today just don’t need investors for Judd Apatow films (although I’m sure it still happens). Essentially, one can call a streaming platform a financing partner given its ability to vertically amortize the cost of production.

DC is yet another reason to go long WBD, and if you believe some of the reporting from a few years ago, Disney almost merged Marvel with Warner’s comic-book concern; if Iger wanted DC in the Disney fold (and this might have been a better acquisition than Fox IP), then you can bet a media company that owns DC and a growing streaming service is a stock worth watching.

Conclusion

There will be future earnings reports to give us hard data on exactly how the Warner Bros. Discovery story is unfolding, but it seems clear to me, and to many others, that this stock is a long-term buy based on IP and streaming (there are bear arguments as well, as one would expect in any trade, but I believe the good of the story outweighs the risks by a fair amount).

There’s been some discussion about the streaming wars entering a different phase, one where growth may slow and subscriber-count volatility increases. Perhaps that is so.

David Zaslav, however, is ready to go Hollywood in a big way. He’s got the reins of some powerful movie brands, he’s moved into a former mogul’s estate, and he’s set his sights on giving Reed Hastings something to think about. I’m not saying there isn’t any risk of execution – hey, nothing in this industry is too big to fail. But can WBD take on Netflix and Disney and get a high multiple in a few years? Stranger things have happened…

Be the first to comment

Leave a Reply

Your email address will not be published.


*