Deep Dive: Warner Bros. Discovery (WBD)
Deep Dive: Warner Bros. Discovery (WBD)
Cashing in on the present and betting on the future
Warner Bros. Discovery (WBD) is an interesting situation. Some investors think it is straightforward while others find it a complicated mess. The business does have all the ingredients for an absorbing story - it has streaming wars, tons of debt, key industry figures like David Zaslav and John Malone, and now, a writers strike thrown into the mix!
At the surface, the thesis is very simple:
WBD has $49 bn in debt but Zaslav is adept at finding synergies and cutting costs. While linear TV is in trouble, WBD can increase its EBITDA over the next two years due to Zaslav’s skill.
With it, it can eliminate $10-11 bn in debt and get to a more manageable 3.5-4x gross leverage ratio in 2024 from its current very high ratio of 5x.
A lot of hard pill swallowing has been done and we see that WBD took $3.8 bn in pre-tax restructuring charges in FY 2022.
Eliminated debt and streaming success de-risks the company and bumps the multiple due to which its stock can go from current $12-15 levels to more like $25-30. In fact, that may be at the lower end of the estimates as we know that Zaslav’s incentives do not kick in before the stock gets to $34 per share (he is already very rich..FYI).
This is a very lucrative return over the next 2-3 years but the following assumptions have to hold:
Zaslav has to be good at deriving synergies and cost cutting without stifling the creative talent at Warner.
Linear TV declines have to be managed.
WBD cannot lose the NBA in 2024-25
Advertising, which is cyclical, has to hold.
Max, WBD’s streaming service, has to win subscribers and show increasing profitability. Management has a $1 bn EBITDA target.
Streaming profitability has to make up for linear declines after 2024
Value investors often talk about the difficulty of investing in growing businesses as they necessitate assumptions about the future growth of the business, but then turn around and buy companies such as WBD which require making difficult assumptions on the four points mentioned above!
The difference between a growth stock and a situation like WBD comes down to valuation. WBD is trading at 7x 2023E EBITDA and 12.5x EPS which is very reasonable and if they can indeed meet expectations on deleveraging then this is a 30%+ IRR opportunity.
In this report, we delve into the underlying business factors driving these assumptions. Is the stock truly undervalued? Let’s dive in.