Shares of the newly merged Warner Brothers Discovery (WBD -0.35%) finally began trading last week after a protracted merger saga. The share price was volatile before ultimately ending the week more or less where it began. Many Warner Brothers Discovery shareholders are AT&T (T 1.17%) investors who received shares in the spinoff and own about 71% of the new company post-merger. Some of these investors are selling their newly received shares or evaluating what to do with them. Many are income investors who own AT&T for its high dividend payout and may not be interested in shares of the new company they received as part of the spinoff, as it does not pay a dividend.
Given this dynamic, the stock will almost certainly be volatile in the near term as the shares look for a new home -- but over the long term, AT&T investors (and others) could be rewarded for giving the stock a chance to remain in their portfolios. Here are three reasons for AT&T investors to hold on to their Warner Brothers Discovery shares, and for non-holders to consider adding shares to their portfolios.
Image Source: Getty Images
Streaming powerhouse
In the streaming world, content is king. The newly combined company has an extensive library of content, with an unparalleled mix of thousands of hours of unscripted and reality-based programming from Discovery combined with some of television's most prestigious programming from HBO (think The Sopranos, The Wire, and Game of Thrones). Discovery's streaming service Discovery+ has 22 million subscribers, while HBO Max already boasts approximately 74 million. Combining these two creates a streaming powerhouse with even more scale as a combined entity.
Add in properties like the DC Universe (think of iconic superheroes like Batman, Wonder Woman, and Aquaman) and this is one of the few companies that can credibly make a case that it can compete with Disney (DIS 1.54%) on the content front. The newly combined company would have appeal as one of the only large-cap, pure-play streaming and content companies outside of Netflix (NFLX 4.17%). Other major players in streaming like Paramount Global (PARA 2.91%) and Comcast (CMCSA -0.52%) have significant exposure to other business lines, while streaming makes up just a part of the business for giants like Apple (AAPL 0.64%) and Amazon (AMZN 1.30%).
New driver at the wheel
While there are some iconic franchises here, there is also a perception that some of these brands like DC have underachieved and fallen behind franchises like Disney's Marvel. While this is a challenge, it is also an opportunity going forward. Unshackled from the monolithic AT&T and with a new captain at the helm in David Zaslav (Discovery's CEO since 2006), there is the potential for the DC Universe and other franchises to get a refresh. Zaslav helped transform Discovery into an international powerhouse and brought it into the streaming age. Along the way, he acquired HGTV and Food Network and partnered with Oprah Winfrey to create OWN in what was an unprecedented deal at the time, so this isn't his first rodeo.
Zaslav is reportedly already planning the changes and tweaks he can make to get the most value out of this content portfolio. Whether it's revitalizing the DC brand with more films exploring the stories of other characters within the universe like 2019's box office hit Joker, or looking to make CNN into more of a go-to outlet for "hard news" as opposed to opinion and editorial journalism, Zaslav and his team will work to figure out how to maximize the value of this diverse portfolio of media properties.
Capital allocation and valuation
The newly combined company expects to generate $52 billion in revenue on an annual basis by 2023, and to earn $14 billion on an EBITDA (earnings before interest, taxes, depreciation and amortization) basis. If the company can hit this goal, which seems realistic given where it is now, the stock would trade at a very reasonable valuation and would trade at a discount compared to the likes of Disney and Netflix (NFLX 4.17%).
While the company has a lot of debt (sporting a debt-to-equity ratio of five at the closing of the deal), it expects to use the significant cash it will generate to reduce this ratio to three within the next 24 months. The company is converting a lot of the money it brings in into free cash flow, so after debt is brought down to its target, management could start to reward shareholders with share repurchases or by initiating a dividend. The fact that the company generates a lot of cash flow means that it has a lot of options with how to use it and how to bolster returns for shareholders going forward.
Is Warner Brothers Discovery a Buy?
For AT&T shareholders who are deciding whether they want to keep their shares, Warner Brothers Discovery looks like it could enhance the value of their portfolios going forward.
The new company will have one of the top content and intellectual property libraries in the world and a new operator at the helm to steer it in the right direction. The company's valuation looks reasonable, and the significant cash it generates will give it options going forward. Investors who didn't receive shares as part of the spinoff can look to shares of Warner Brothers Discovery as sensible additions to their portfolios as well.
