The April merger of AT&T's WarnerMedia division and Discovery to produce Warner Bros. Discovery (WBD -3.51%) has investors talking about whether this entertainment and streaming giant is a stock to buy.
It's a new company, and its financials are initially going to be messy as two cultures are joined together, but even more so because of the potential for a recession to hit. With rampant inflation, elevated gas prices, and rising interest rates, consumers are likely to start aggressively culling their streaming subscriptions as well as how they spend any discretionary dollars.
Warner Bros. Discovery opened for trading on April 11 at $24.08 per share but has since lost 67% of its value, recently closing below $14.50 per share. While there certainly seems to be long-term potential for a company with a portfolio of well-known, brand-name media and entertainment assets, that's what the rationale was when Warner Media was acquired by AT&T, but instead it became an albatross for the wireless carrier.
Let's take a look at whether Warner Bros. Discovery can overcome the structural hurdles in front of it and become a stock worth owning.
A brave new world in streaming
The streaming video side of the business gets the most attention, particularly now that Netflix (NFLX 1.19%) just reported it lost 1 million subscribers. That is seen as a win by many since the streamer had expected to lose a minimum of 2 million subscribers and is forecasting it will gain all of them back this quarter.
Although Warner Bros. Discovery competes against Netflix with HBO, HBOMax, Discovery+, and several other streaming services, it's also a partner through the receipt of licensing fees for programming, such as from its broadcast network CW.
A joint venture of Warner Bros. Discovery and Paramount Global, CW was never much of a winning platform, though it was ultimately profitable as a result of the licensing fees. However, with the need of content for their own streaming services HBOMax and Paramount+, the deal with Netflix was allowed to expire (existing shows will still air for a few years).
That makes CW a potential expense again, which is why it is about to be sold to Nexstar Media Group, though both Warner Bros. Discovery and Paramount will retain an ownership interest in it. Yet all the content that Warner Bros. Discovery owns -- from the Discovery Channel, HGTV, and Food Network to the Oprah Winfrey Network, The Travel Channel, and many more -- bodes well for its streaming services.
There's even talk about getting HBOMax back on Amazon.com's (AMZN 1.43%) Prime movie-streaming service. In fact, HBOMax ranks as the second must-have streaming service behind Netflix, which happens to rank dead last in perceived value even as it maintains its considerable first-place lead.
Opportunities and concerns abound
Of course, Warner Bros. has its theatrical division too, and it had a successful release of The Batman back in March, a somewhat less well-received release of the next installment in its Fantastic Beasts franchise, and is currently enjoying some modest success with its recent Elvis movie.
Movies are but one lever Warner Bros. Discovery has to pull among several (gaming, premium TV, and pay TV are others) to generate cash from synergies with its properties after the merger, but there are concerns too.
A recession could stunt the advertising market upon which the entertainment giant relies heavily upon for revenue, not to mention needing to service the substantial $43 billion worth of debt it assumed upon completion of the merger.
What it means is there's a lot of fog ahead for Warner Bros. Discovery that obscures its potential and will likely depress its stock price until there is better clarity. Yet as soon as things clear up, the opportunity to capitalize on its stock's discount will be lost.
Waiting it out
Warner Bros. Discovery trades at seven times trailing earnings, nine times next year's earnings estimate, and at less than 14 times the free cash flow it produces. That makes it significantly cheaper than Netflix or Disney, and puts it on par with Paramount, though Warner Bros. Discovery has much better long-term earnings growth potential than its rival.
Warner Bros. Discovery is a stock to consider for investors who have the patience to wait for the clouds to part.