Following last year's merger between Discovery and AT&T's WarnerMedia business, the new Warner Bros. Discovery (WBD -1.38%) has a wealth of intellectual property to monetize. The merger brought The Lord of the Rings, Game of Thrones, Harry Potter, Batman, Superman, Wonder Woman, CNN, TNT, Discovery Channel, and Looney Tunes together under one roof.

Warner Bros. Discovery clearly has a valuable library of content to monetize and then deliver returns to shareholders. These opportunities have value investors wondering whether the stock's haircut last year makes it a bargain worth buying right now.

While I'm hesitant to call the stock a buy due to the company's dependence on TV advertising and its heavy debt burden, the success of Warner Bros. Games' latest release makes it worth a closer look. Here's why gaming is an overlooked growth opportunity that could make the stock a good investment under the right scenario.

Gaming is a goldmine for Warner Bros.

Warner Bros. is known for its century-long heritage of making blockbuster films. This advantage could pay off over the long run as the company invests in original content for the upcoming relaunch of HBO Max, which will combine content from Discovery under one streaming service.

But Warner Bros. is also the only studio heavily investing in making big-budget video games. A typical best-selling video game can cost tens of millions of dollars to produce, and that doesn't include a few hundred million dollars spent on marketing leading up to its release. This is why video games are a big business, with estimates putting the gaming industry's value around $200 billion, which is more than the estimates for movies and music.  

Warner Bros. Games' Hogwarts Legacy was released in February and has sold over $850 million at retail since launch. The Harry Potter-based game has gotten good reviews overall and could be one of the best-selling games of 2023.

Tapping established fans from the company's top movie franchises to sell video games could grow into a sizable revenue stream for Warner Bros. It may not build a large enough source of revenue from movie-based games to become as large as, say, Call of Duty maker Activision Blizzard, which generates around $7.5 billion annually in revenue. But growth from Warner Bros. Games could add substantial value for shareholders.

What is Warner Bros. Games worth?

In addition to Harry Potter, Warner Bros. has several franchises that would appeal to a wide gaming audience. Batman, Superman, Game of Thrones, and The Lord of the Rings all have the makings of smash-hit video games that could reach $1 billion in lifetime sales each.

There is high demand for quality games based on action-adventure franchises. For example, Sony revealed last year that Marvel's Spider-Man from Insomniac Games had sold 33 million copies, suggesting the game has reached over $1 billion in sales since its release in 2018. Hogwarts sales, so far, are another indicator of the demand these types of games can pull.

Before the merger, the company's games and other revenue was nearly $1.6 billion in 2020, down from $2 billion in 2019. That stems mostly from releasing average-selling titles from DC Entertainment, Harry Potter, and Mortal Kombat franchises.

Still, that would value Warner Bros. Games at around $5 billion to $8 billion, using an average valuation of 4 times revenue for a gaming company. On an enterprise value-to-revenue basis, video game stocks currently are valued almost twice the multiple of Warner Bros. stock, suggesting the company could create more value for shareholders by investing more in the gaming business.

ATVI EV to Revenues Chart

Data by YCharts. EV = enterprise value.

If Warner Bros. Games continues investing in blockbuster releases like Hogwarts, it could conceivably double the value of its gaming business. If it generates $3 billion a year from games in the next 10 years, Warner Bros. Games could grow to be worth one-third of the company's current market cap of $35 billion. But that's on the conservative side. It could be worth a lot more, depending on how profitable the division becomes.

Warner's weakness overshadows its strength

Hogwarts Legacy is a deep game that can take around 30 hours to play through. The level of depth in the game design shows that Warner Bros. Games might be investing more in gaming to deliver more growth. During the fourth-quarter earnings call, CEO David Zaslav said the company was "thrilled" by what the gaming business is producing right now, adding that gaming "represents a core part of our overall strategy."

In fact, releasing blockbuster games based on established fan bases of Batman, Superman, and other franchises could be a more profitable and lower-risk business than Warner's TV networks. In the fourth quarter, TV networks revenue fell 6% year over year, driven by weak advertising. Network revenue makes up half of the company's total adjusted revenue.

Advertising is a cyclical business that goes with the direction of the economy, while Hogwarts Legacy is minting money at the cash register. The writing is on the wall -- the more attractive growth opportunity for Warner Bros. Discovery is in entertainment, not cable TV.

Warner Bros. Discovery's dependence on advertising and its $49 billion of debt overshadows its growth opportunities. I would wait until the advertising market is stronger and the company's debt is lower before buying the stock.