Insiders Swoop In on Warner Brothers Discovery

Multiple insiders, including the CEO and chief financial officer, have recently been buying shares of Warner Bros. Discovery (WBD, Financial) stock. Substantial open market purchases by key insiders are strong indications that the stock could be undervalued. Is that the case here? Let's take a look.

Merger of media giants

Warner Bros. Discovery (WBD, Financial) was recently formed by spinning out Warner Media from AT&T (T) and simultaneously merging it with Discovery Inc. to form one of the largest media and entertainment companies in the world.

Warner Media is one of largest traditional (i.e. linear) media companies and owns a deep content library, strong TV and film studios, cable networks and a streaming service in HBO Max. Beyond the flagship HBO brand, Warner Media owns a number of media brands, including CNN, TNT, TBS, Cartoon Network, Warner Bros. Studio and Bleacher Report. The company also owns a number of major franchises such as DC Comics (Superman, Wonder Woman), Adult Swim/Cartoon Network (Rick and Morty), HBO (Game of Thrones) and WB Pictures (Harry Potter, The Matrix).

Discovery produces and owns unscripted informational content with appeal to audiences across cultures and languages. Discovery, TLC, HGTV, Food Network and Animal Planet are the flagship network brands for the company, with the channels reaching more than 81 million subscribers in the U.S. and 226 million subscribers and viewers internationally. The company's streaming service, Discovery+, was launched in 2021.

The combined company's streaming offering (HBO Max and Discovery+) is well set up to compete against the top-tier peers like Netflix (NFLX, Financial) and Disney (DIS, Financial) Plus, as well as second-tier players like the streaming offerings from Amazon (AMZN, Financial) and Apple (AAPL, Financial) TV, in the evolving world of on-demand streaming. Video media consumption is more and more shifting to on-demand streaming vs. linear video. However, cable (pay) TV penetration, though declining, remains at about 60% in the U.S. I would expect Warner Bros. Discovery to soon offer a bundled subscription of HBO Max and Discovery+ in order to consolidate subscribers.

I think the streaming entertainment industry will continue to consolidate with the smaller players being absorbed in into larger players. The industry is on its way to becoming an oligopoly. Producing big series like Game of Thrones or The Mandolrian costs a lot of money, and the studios want to spread the cost over as many subscribers a possible. Scale is going to be key in the new world of mass streaming. As Napoleon once said about war, "God favors the big battalions." I think the same applies to big streamers.

Valuation

Morningstar's fair value estimate is $40 for Warner Bros. Discovery and implies an enterprise-value-to-Ebitda ratio of 13.5 The Analyst is projecting top-line growth of the combined company to be around 6% over the next five years. At the current price of ~$18 per share, the stock is being offered at less than half of fair value based on these estimates.

The GF Value chart, a unique intrinsic value estimate from GuruFocus which uses the stock's historical price multiples, past returns and estimates of future business performance, rates the stock as significantly undervalued as well.

Conclusion

AT&T's shareholder base is heavily retail investor oriented. Many of them value dividends over capital gains. AT&T shareholders held 70% of Warner Bros. Discovery at the time of the spinoff-merger in April. I suspect many of these investors don't want to hold Warner Bros. Discovery shares, as they do not pay any dividend. This may have created selling pressure on the stock.

This happens frequently in a spinoff situations and can thus create a value opportunity. I think this situation is happening now, and it will probably take the rest of this year for the shareholder base to sort it self out.In the longer-term, I believe Warner Bros. Discovery represents excellent value due to its great cash generation potential. Multiples should expand as currently the stock is priced very much below the other big streaming companies.