In early April, AT&T (T +0.42%) spun off WarnerMedia, its entertainment portfolio consisting of well-known brands like DC Comics, HBO, and Warner Bros., to merge with Discovery, Inc. The resulting company Warner Bros. Discovery(WBD +0.13%) was born, but it's had a rough beginning as a public company, with its stock down more than 40% since inception.
Still, here are two reasons for optimism that Warner Bros. Discovery stock can rebound or even reach new highs.
Reason one: Cutting costs
To fund the spin-off and merger, Warner Bros. Discovery paid AT&T over $43 billion, which, combined with Discovery, Inc's debt of $14 billion, created a total gross debt of roughly $57 billion.
NASDAQ: WBD
Key Data Points
At the time of the completed merger, CEO David Zaslav stated that Warner Bros. Discovery's leverage ratio -- which the company defines as total debt divided by the sum of the most recent four quarters of Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) -- was at 4.6. This ratio helps determine a company's ability to pay down its debts before covering interest, taxes, depreciation, and amortization expenses. Generally, a debt-to-EBITDA ratio above 3 or 4 is considered high and may affect a company's ability to borrow additional money. For comparison, streaming competitor Netflix has a total debt to EBITDA ratio of 0.78.
The good news is that CEO David Zaslav recently reiterated confidence that Warner Bros. Discovery could achieve a leverage ratio of 2.5 to 3 within two years. The company plans to do that by aggressively cutting spending, which it has done by canceling CNN's streaming service CNN+, reportedly selling a significant portion of its stake in The CW, and scrapping its HBO Originals in parts of Europe. It's yet to be determined how these recent moves will affect the company's top and bottom lines, but one thing is clear: Management has its sights on slashing spending.
Reason two: A revenue-generating machine
Despite cutting its spending, make no mistake: Warner Bros. Discovery will generate impressive revenue. Management expects the business to produce $52 billion in revenue in 2023, with its direct-to-consumer (DTC) segment, including HBO Max and Discovery+, producing $15 billion.
For comparison, Disney produced about $54 billion in revenue with its media and distribution arm over its last four quarters -- $18 billion of which was DTC revenue.
Still, turning Warner Bros. Discovery's revenue into free cash flow -- the cash remaining after a company accounts for its operations costs and any capital expenditures -- to pay down its $57 billion debt is going to be a challenge. The good news is that management claims the merger will save $3 billion in synergies and expects the company to convert an impressive 60% of its Adjusted EBIDTA into free cash flow. If the company meets management's projected $14 billion Adjusted EBIDTA for 2023, it should be on track to leverage down its outsized debt.
Is Warner Bros. Discovery stock a buy today?
Warner Bros. Discovery's impressive intellectual property with popular franchises like DC Comics, Game of Thrones, and Harry Potter will always provide the company to produce massive entertainment hits. And better yet, Warner Bros. Discovery can distribute its content in any shape or form through television assets like TNT and TBS or streaming platforms like HBO Max and Discovery+.
With that kind of arsenal, it's going up to management to figure out how to pay down the company's excessive debt and turn a profit and the company might have the right person in the corner office with CEO David Zaslov. He oversaw Discovery Communications as a stand-alone company, which recently generated about $2.5 billion in annual free cash flow from $12 billion in revenue. Considering WarnerMedia generated $40 billion in revenue with virtually "no free cash flow," there could be a tremendous upside if Zaslov can replicate his past success with the newly formed Warner Bros. Discovery.
Look for the company to continue to cut costs in every facet of the company that doesn't generate a return on investment. If it meets its lofty revenue and free cash flow goals over the next 24 months, expect the stock to bounce back, rewarding patient investors.
