If you bought shares of the S&P 500 ETF SPY as 2022 dawned, you are down around 10%. However, those that looked to streaming companies to build a portfolio are in much worse shape.
Year-to-date, Warner Bros. Discovery (NASDAQ:WBD) has slipped over 20%, Comcast (CMCSA) is down about 18%, shares of Disney (DIS) and Amazon (AMZN) have both fallen around 25%, and Netflix (NFLX) takes the proverbial cake, with a stock price that plummeted over 65%.
With a loss of 6% in 2022, Paramount Global (PARA) stands out as the winner, so to speak, among this bunch.
Here is a stat that might surprise many readers: every stock listed above has underperformed the S&P 500 over the last three years by a wide margin. In fact, Amazon is the sole company with a share price gain over that time frame, and it lags the S&P by more than 15%.
Will this trend continue?
Following the merger early last month, WBD ranks as the number-three player in the U.S. video streaming business behind Netflix and Disney. If content is king, an argument can be made that WBD takes the crown.
Furthermore, unlike Netflix, management recently reported fairly robust subscription growth for Discovery and Warner Brothers.
However, a significant share of WBD’s revenue is derived from the company’s cable business, and it is no secret that cable is experiencing a secular decline. Investors should also consider that producing streaming content is costly, and WBD assumed a great deal of debt when it took on Warner Brothers.
What Discovery’s Q1 Results Revealed
Q1 marked the final earnings report for Discovery as a standalone company.
Bolstered by strong international results, WBD increased total revenue by 13% to $3.16 billion. Revenue from U.S. Networks jumped 7% to $1.93 billion while International Networks registered 25% growth to $1.23 billion. Were it not for the effects of foreign exchange, International would have recorded a 30% increase.
Net income for the quarter hit $456 million, with EPS of $0.69 cents. That compares to $140 million in net income and EPS of $0.21 in the comparable quarter.
The company posted FCF of $238 million, and operating expenses decreased 8% to $907 million.
Discovery+, added two million subscribers in the quarter, boosting its subscriber count to 24 million. Discovery had reported 20 million subs as of Sept. 30 of 2021.
The company posted a 5% growth in U.S. advertising and an 11% increase in distribution revenue due to Discovery+.
Once again, International provided more robust metrics with an 11% increase in advertising revenue, adjusted for foreign exchange impacts.
The company reported nearly $450 million in next generation revenue, a 55% increase over the prior-year quarter.
Of course, the numbers behind the earnings report pertain to the former Discovery, Inc; however, management provided some important metrics related to WarnerMedia, as well as some relevant commentary.
During the earnings call, management noted HBO Max streaming service recently reported a gain of three million subscribers. This increased its subscriber numbers to 76.8 million. Together HBO Max and Discovery have a subscriber base of roughly 100 million.
Management discussed a number of concerns to be addressed now that the merger is complete. One is a relatively high rate of churn.
…we also think that one of the big opportunities here is going to be churn reduction. There is meaningful churn on HBO Max, much higher than the churn that we have seen.
Gunnar Wiedenfels, CFO
Poorer than expected performance of late from WarnerMedia was also highlighted.
Q1 operating profit and cash flow for WarnerMedia were clearly below my expectations. And given that Q1 performance and previously unplanned projects in sight, I currently estimate the WarnerMedia part of our profit baseline for 2022 will be around $500 million lower than what I had anticipated.
Gunnar Wiedenfels, CFO
But if I take a step back here and just look at, call it, the past 15 months for WarnerMedia sort of as a carve out-group, we’re looking at more than $40 billion of revenue and really virtually no free cash flow. And right or wrong, management has made a decision to invest a lot of the incoming funds into a number of investment initiatives. And as I’m looking under the hood here again, CNN+ is just one example, and I don’t want to go through sort of a list of specific examples, but there’s a lot of chunky investments that are lacking what I would view as a solid analytical, financial foundation and meeting the ROI hurdles that I would like to see for major investments.
David Zaslav, CEO
Management also emphasized that the company will take a circumspect approach to content spend.
We will not overspend to drive subscriber growth.
Our focus is to invest in content and platforms that extend the life and return of our global IP, and position us to drive greater returns out of each dollar of content spend than our peers and to ultimately drive free cash flow.
…we will continue to be very thoughtful about our spend. We will not launch any new markets for the time being. We will not sort of chase aggressively behind subscriber growth…
David Zaslav, CEO
In the last quarter before the merger, AT&T reported 2.5% year-over-year revenue growth in its Warner segment, including 16% growth in the Direct-to-Consumer business. WarnerMedia’s operating income declined 35% year-over-year.
The Bull Case For WBD
The strongest case for WBD is the massive supply of content associated with WarnerMedia. Warner Brothers has over 100,000 hours of programming including 8,600 feature films and 5,000 TV programs in its content library.
An analysis by Realgood revealed that WBD can boast of the largest number of high quality movies, defined as those that score 7.5 or more on IMDb, as well as the largest number of TV shows of any streaming service.
This array of content serves to attract and retain subscribers. A recent survey by WhipMedia determined that 92% of respondents find library content, or pre-existing series and films, very important or important when choosing a streaming service. That same study revealed that when questioned regarding their level of satisfaction among SVOD services, HBOMax received the highest score.
Now consider that the portfolio of Discovery+ will be added to that of HBOMax, and you have the makings of a content king.
Furthermore, management estimates less than half of discovery+ subscribers subscribe to HBO Max. The thinking is that this could lead to a surge in subs when the two services are combined. Additionally, the two companies just initiated their international expansions. Consequently, there could be significant overseas subscribers added.
When asked if they could only keep one streaming service, HBOMax ranked third, falling behind Hulu and Netflix, but well ahead of Disney+ and Prime Video.
Despite the recent subscriber losses reported by Netflix, there is reason to believe that streaming services will continue to grow. Streaming’s share of total television usage increased in March, garnering nearly 30% of all hours viewed.
The Bear Case For WBD
A great deal has been made of how the combination of Discovery+ and HBOMax will create a winning streaming service; however, Discovery ranks low in terms of customer satisfaction and is near the bottom of the ratings regarding which streamer would be retained if viewers were limited to one service.
Moreover, the merger resulted in WBD assuming a great deal of debt. At the end of 2021, the pro forma debt for WBD was over $56 billion. That brings the company’s net debt to around 4.5x EBITDA. To balance that debt, at the end of 2021, WBD had a bit over $4.1 billion in cash.
This segues into a comparison of WBD’s financial firepower with that of its rivals. NFLX has a projected net debt-to-adjusted EBITDA ratio of 1.3 for 2022. NFLX also held $6 billion in cash.
Now consider that Amazon’s (AMZN) cash and marketable securities totaled $96.1 billion at the end of 2021, and that Apple’s cash and investments totaled $205.6 billion at the end of 1Q22.
Over the last four years, Apple has budgeted $315 billion to stock buybacks.
WBD projects $20 billion in content spend in 2022. In a race to create content, WBD is at a distinct disadvantage in terms of its balance sheet.
S&P rates WBD’s debt as BBB-/positive, the lowest level of investment grade.
Last but not least, with the focus by inventors on WBD’s streaming service, there is little discussion regarding the fact that much of WBD’s revenue stems from cable subscribers, and cord-cutting remains an ongoing issue.
An SEC filing last March, just prior to the merger, revealed that Discovery forecasts revenue from its U.S. linear TV business will decline by 4% per annum through 2025, while expenses are expected to accelerate. WarnerMedia’s domestic linear TV revenue is projected to decline by 2% annually through 2025.
What Is WBD Stock’s Outlook?
WBD currently trades for $18.88 a share. The consensus 12-month price target of the five analysts rating the stock is $37.25. One of the analysts rates WBD as a sell.
The forward P/E for the company is 8.68x, and the 5-year PEG is 0.43x.
Is WBD Stock A Buy, Sell, or Hold?
There is no doubt that WBD will possess a formidable content portfolio. Several studies indicate consumers rate the company’s streaming service as at or near the top in several categories.
Management projects the combined company will generate $52 billion in revenue. Of that, $15 billion will be generated by direct-to-consumer services. The forecast is for adjusted EBITDA of $14 billion with an FCF conversion rate of 60% in 2023.
The company previously expected $3 billion in annual run-rate synergies from the merger, but during the last earnings call, CFO Wiedenfels stated the $3 billion target might be conservative.
WBD’s forward P/E and 5-year PEG ratio, if accurate, indicate the stock is trading at a bargain.
However, I admit I have reservations regarding the company’s debt load and financial prowess. I also have concerns regarding the toll cord cutting may take on the company’s future results.
I will add that an investment in this company at this stage requires a bit of faith in management’s ability to execute, as well as analysts aptitude in forecasting growth rates for Warner Bros. Discovery.
Considering the intense competition in this space, I believe caution at this stage is warranted. Consequently, I rate WBD as a HOLD.