Shares of Warner Bros. Discovery (WBD 6.01%) declined over 10% as investors digested the commentary from its first-quarter earnings call. The call covered the period between Jan. 1 and March 31, so the results precede the merger with WarnerMedia (formerly a unit of AT&T (T -1.00%)) which was officially completed on April 8.
On a day when stocks fell across the board, the market was rattled by the company's lowered 2022 profit guidance as well as management's commentary that the year will be a "messy." But this is also where opportunity lies. Here's why investors have cause for optimism.
Taking a scalpel to underperforming assets
Chief Financial Officer Gunnar Wiedenfels didn't pull any punches on the earnings call, stating that first-quarter operating profit and cash flow for WarnerMedia were "clearly below my expectations" and singling out "special projects" as a reason for this drag on cash flow. The acknowledgement that it will be a "messy" 2022 as management sorts out how to deal with sub-optimal performance by WarnerMedia properties led shares to sell off.
However, over the long term, this is an area where Wiedenfels and Chief Executive Officer David Zaslav can create value by putting each segment under a microscope and evaluating the best path forward. Wiedenfels bluntly remarked that some of the investment initiatives underway at WarnerMedia didn't have sufficient return profiles, stating that he and his team would act "quickly" to rectify this, offering last week's decision to shut down CNN+ as "Exhibit A."
Wiedenfels points out that WarnerMedia made about $40 million in revenue over the past 15 months, but that it came with "virtually no free cash flow," and that "looking under the hood" there are a lot of investments that "don't meet the ROI [return on investment] hurdles that I would like to see for major investments."
Clearly, Zaslav and Wiedenfels are willing to change things quickly, which is good news for investors. As they figure out which initiatives to jettison and which properties to tweak to generate better cash flows, costs should decrease and earnings should increase over time. In advance of the merger, Discovery had spoken of $3 billion in synergies that could be realized from the deal. Now, Wiedenfels says that the $3 billion target could end up being conservative.
Growing subscribers and adding services is all well and good, but not beneficial to investors if they don't generate a return over time, so it is refreshing to see the management team evaluate each business through this framework. To this point, Zaslav stated:
We have no religion about any one platform or window versus another, and we intend to approach each and every decision through a lens of enhancing asset value against a set of financial returns. Our goal is to maximize long-term shareholder value and asset value, not just subs. We will not overspend to drive subscriber growth.
Just because Zaslav said that the company won't grow subscribers just for the sake of growth, that doesn't mean that growth is going to stagnate. Discovery's streaming service, Discovery+, added two million subscribers in the quarter, bringing its subscriber base to 24 million , at a time when competitors like Netflix (NFLX 0.39%) lost overall subscribers . HBO Max, which is under the Warner Bros. Discovery umbrella, already revealed a gain of three million subscribers for the most recent quarter, which brings its total subscriber base to 76.8 million. Adding the two subscriber bases together brings the total subscriber base to over 100 million.
Looking ahead, the growing subscriber base, extensive content library, and new focus on generating a higher return on investment on initiatives make Warner Bros. Discovery a long-term buy.