When AT&T (T -0.50%) announced an agreement to merge its WarnerMedia entertainment division with cable network titan Discovery (DISC.A) (DISCK) on May 17, AT&T's stock sank. It continued to slide lower over the next six months and hovers near a 52-week low at the time of this writing.

The merger will see AT&T reduce its dividend, but that makes sense given the loss of the WarnerMedia division's revenue. In exchange, shareholders will receive stock in the new company, to be called Warner Bros. Discovery. In my view, this is a boon for shareholders.

Warner Bros. Discovery is positioned to experience years of growth, while the WarnerMedia spinoff allows AT&T investors to better evaluate the organization on its strong telco business. A look at WarnerMedia and Discovery illustrates the potential strength of the combined company.

Two people sit on a  sofa watching television.

Image source: Getty Images.

WarnerMedia's resurgence

When the pandemic struck last year, WarnerMedia was hit hard by theater closures, the cancellation of sporting events, and a spending pullback from advertisers. This division suffered a year-over-year revenue drop of 13.7% in 2020.

But in 2021, it experienced a strong recovery. It earned $25.8 billion in revenue through three quarters, a 17.7% increase from 2020's $21.9 billion.

WarnerMedia's streaming service, HBO Max, helped that revenue growth. The service launched in May 2020; since then, WarnerMedia's direct-to-consumer business has increased revenue and the number of HBO subscribers every quarter.

Quarter Global HBO Subscribers Direct-to-Consumer Revenue
Q3 2021 69.4 million $2.24 billion
Q2 2021 67.5 million $2.14 billion
Q1 2021 63.9 million $1.93 billion
Q4 2020 60.6 million $1.90 billion
Q3 2020 56.9 million $1.78 billion
Q2 2020 55.6 million $1.63 billion
Q1 2020 53.8 million $1.50 billion

Data source: AT&T.

Forecasts predict that HBO Max will exceed 100 million subscribers in the next two years. The majority of subscribers are from the U.S., giving the service an international growth opportunity.

HBO Max isn't the only reason for WarnerMedia's success. Its theatrical revenue is recovering nicely from 2020's decline. In Q3, it reached $1.3 billion, the highest total since the fourth quarter of 2019. With hits such as Dune and popular intellectual properties including Batman, WarnerMedia's theatrical revenue is well-positioned to continue growing.

Its advertising business is also rejuvenated. While Q3 ad revenue was down 12.4% year over year due to the timing of sporting events and lower political ad spending, 2021 ad revenue through three quarters was up 15.1% to $4.9 billion.

Discovery's strengths

Discovery adds its own strengths to the merger. Its CEO, David Zaslav, will take the reins of the new company. He has been Discovery's CEO since before it went public in 2008.

Under Zaslav, the company launched its own streaming product at the start of this year. Since then, Discovery grew the service to 20 million subscribers through the end of Q3, up 3 million from Q2.

The streaming service helped the company grow Q3 revenue 23% year over year to $3.2 billion. After three quarters, Discovery's $9 billion in 2021 revenue positions the company to exceed 2020's full-year total revenue of $10.7 billion by the end of this year.

Discovery's success wasn't due only to new streaming subscribers. The company's advertising income roared back from pandemic-induced declines in 2020, particularly in international markets, where it experienced 28% year-over-year growth in Q3.

The Q3 results followed Q2's whopping 88% year-over-year increase in international revenue. Overall, 2021 advertising revenue was up 13% year over year to $4.5 billion through three quarters.

Discovery also manages its finances well. Total assets of $34.3 billion eclipsed total liabilities of $20.9 billion last quarter. The company had $3.1 billion in Q3 cash and equivalents and generated free cash flows of $1.6 billion so far this year. Cost savings will result from the WarnerMedia merger, helping to continue Discovery's track record of financial health.

A win for shareholders

Discovery complements WarnerMedia very well. Discovery's portfolio of nonfiction television networks, such as Animal Planet and the Food Network, adds to WarnerMedia's popular fiction offerings, which includes Friends and the Harry Potter franchise.

Investors can receive AT&T's high-yield dividend, currently at an eye-popping 8.62%, until the merger by buying the telecom stock now. When the merger completes in mid-2022, AT&T shareholders will receive Warner Bros. Discovery shares equivalent to 71% of the new company. From there, investors can continue earning a dividend from AT&T while benefiting from Warner Bros. Discovery's growth opportunity.

With a potent new company in Warner Bros. Discovery, and an established telecom giant in AT&T, which is still in the early stages of its 5G network rollout, investors can look forward to compelling opportunities from both companies in the years ahead.