In April 2022, Discovery Communications merged with Warner Media to form media powerhouse Warner Bros. Discovery Inc. (WBD, Financial). The company contains legacy Warner Media assets such as cable channels TBS, TNT, HBO and CNN as well Warner Bros.' movie and television studios. Discovery brought over great legacy assets as well, such as Discovery Channel, Food Network, HGTV and TLC. As with most media companies today, streaming services are of course a focus for the company. Primary streaming channels include HBO Max and Discovery+.
The company currently has a market capitalization of $32 billion yet carries a heavy debt load of approximately $53 billion. Estimated pro-forma revenue for 2022 is approximately $44 billion.
Direct-to-consumer update
The company’s primary streaming channels are HBO Max and Discovery+. The company reported they now had 92.1 global million subscribers, an increase of 1.7 million subscribers from the end of the first quarter. The monthly average revenue per user was $10.54 domestically and $3.69 in international markets. The subscriber count includes 4 million that are signed up for both of the key services. Warner Bros. Discovery announced that, in the summer of 2023, the two services will merge into one platform. The company projects a total subscriber base of 130 million by around 2025. Despite $2.23 billion in direct-to-consumer revenue during the quarter, the company reported an Ebitda loss of $518 million as it continues to build out content and heavily market the offerings.
Financial review
The second-quarter results for the company include the newly formed entity for the first time. On a year-over-year pro forma basis, revenue declined 3% (1% decline in foreign exchange). Adjusted Ebitda declined 31% to $1.6 billion as the company ramped up marketing and content expenses.
Operating cash flow was $1 billion for the quarter and free cash flow was $789 million. The company updated 2023 Ebitda guidance to “at least” $12 billion, which was a decrease from the original $14 billion estimate.
One of the principal reasons for the spinoff from AT&T Inc. (T, Financial) was to reduce debt, so the new Warner Bros. Discovery is highly leveraged. Gross long-term debt is $56 billion and the company’s leverage ratio on a gross basis is 5.4 times. However, due to strong expected free cash flow generation over the next several years, the company anticipates the net leverage ratio will be below 3 times within a 24-month period.
As of the end of the second quarter, the average duration of the company’s outstanding debt was 14 years, with an average interest rate of 4.2%. The company still has $6 billion in availability under its revolving credit facility.
Valuation
2022 analyst estimates are not relevant due to the April 2022 closing date of the merger. For 2023 and 2024, earnings per share estimates are $1.14 and $1.70, respectively. The ramp-up in earnings in 2024 reflects the decline in direct-to-consumer losses.
That puts the company selling at 11.5 times next year's earnings estimates. The pro-forma enterprise value/Ebitda ratio is less than 6 times currently.
The GuruFocus discounted cash flow calculator creates a value of $16.50 when using $1.14 as the earnings per share starting point and a 6% 10-year growth rate.
Guru trades
Gurus who have purchased or added to their Warner Bros. Discovery positions include the Yacktman Fund (Trades, Portfolio) and Ray Dalio (Trades, Portfolio). Gurus who have reduced their positions include Jeff Auxier (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio).
Conclusion
Warner Bros. Discovery did a good job of resetting expectations going forward in order to provide investors with a realistic vision of future operating results. The company has laid out four strategic priorities, which include world class content, widespread global distribution, a balanced asset monetization model from different revenue streams,and strong and lasting free cash flow generation.
The company appears to be undervalued based on its outlook. The current net leverage ratio of approximately 5 times is something to watch, but strong free cash flow generation should alleviate those concerns over the long term.
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