Seth Klarman (Trades, Portfolio) is a legendary value investor that I like to follow. He is the founder and portfolio manager of The Baupost group, an investment firm with $6.74 billion in its 13F equity portfolio for the second quarter.
Despite Baupost's equity portfolio having 54 stocks, the firm only purchased three new stocks in the second quarter, one of which was Warner Bros. Discovery (WBD, Financial). Klarman bought a substantial 18 million shares of Warner Bros. Discovery in the second quarter of 2022, during which the stock traded for an average price of $18.65. This is 31% more expensive than where the stock trades at the time of writing.
What does the company do?
Warner Bros. Discovery is an American media conglomerate which was formed after the spinoff of WarnerMedia by AT&T (T, Financial) and its subsequent merger with Discovery Inc.
The company provides some of the largest streaming services in the world. These include HBO Max (76.8 million subscribers) and Discovery+ (24 million subscribers), which the company plans to merge together by 2023.
In addition, the company owns CNN, the Food network, TNT and Turner classic movies. As with any video streaming or TV network, content is king, and the company hopes that by merging, it can further leverage the popularity of its content network. Warner Bros. Discovery has a partnership with Paramount Global, which should also expand its content database.
Let’s also not forget that Warner Bros owns widely popular and iconic franchises such as Harry potter, The Matrix, Batman, Mortal Kombat and many more. The ownership of such popular franchises should act as a competitive advantage or moat moving forward.
Merging financials
As the company has only been merged together for a short period of time its financials are a mess, but here is what we know. Second quarter revenue was $9.8 billion, down 1% year over year. The net loss was a staggering $3.4 billion, which includes $2 billion in intangible amortization and $1 billion in restructuring costs. Then of course, there was an extra $983 million in transaction and integration related expenses as the company merged.
The good news is the company is expected to realize up to $3 billion in acquisition synergies by 2024. This will be driven by the consolidation of HBO Max and Discovery+, in addition to staffing reductions.
Source: Warner Bros. Discovery investor materials
Total reported adjusted Ebitda was $1.664 billion, with a pro forma combined decline of 31% highlighted. The good news is cash provided by operating activities increased by over $1 billion and free cash flow popped by $789 million.
The company ended the second quarter with $3.9 billion in cash and gross debt of an eye-watering $53 billion. Management has plans to reduce its debt over time, and AT&T is paying WarnerBros. Discovery $1.2 billion over the next couple of months as part of the separation agreement. Altogether, the company aims to reduce its debt to $50 billion over the next few months.
Management is optimistic about future growth and is forecasting 130 million global subscribers by 2025, in addition to over $1 billion in Ebitda for the direct to consumer segment. The Average Revenue Per User (ARPU) is also forecasted to grow with long-term margins of over 20%.
Valuation
Valuing the company is difficult as the merger is relatively new and complicated. However, we can see the stock has a forward price-earnings ratio of 12, which is cheaper than Disney's (DIS) forward price-earnings ratio of 20 and Netflix's (NFLX) 22. For comparison, the chart below shows these companies' trailing 12-month price-earnings ratios.
The GF Value calculator indicates a fair value of $30 per share for the stock but also indicates a possible “value trap." This may be due to the sharp decline in stock price and profitability combined.
