April 11 marks the first anniversary of Warner Bros. Discovery (WBD -1.07%) as a stand-alone public company. Yet, its stock has struggled to gain support among investors, falling roughly 40% since its debut, as the company has struggled to pay down its excessive debt.
Here is why Warner Bros. Discovery's stock is struggling and two reasons it might be a good time to buy.
What happened to Warner Bros. Discovery's stock?
Warner Bros. Discovery formed last April when AT&T spun off Warner Bros. Media to merge with Discovery, Inc. The market almost immediately soured on the new entertainment conglomerate as its debt became a primary concern.
The new stand-alone company paid AT&T $43 billion for Warner Bros. Media and assumed Discovery, Inc.'s $13.5 billion debt, creating a total gross debt of roughly $56.5 billion.
While Warner Bros. Discovery has been paying down its gross debt, which stood at $49.5 billion in its most recent quarterly earnings report, it has struggled with another metric: net leverage ratio. The company defines net leverage ratio as total debt divided by the sum of the most recent four quarters of adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization). At the time of the merger, Warner Bros. Discovery had a net leverage ratio of 5, and it remained at 5 by the end of 2022.
When Warner Bros. Discovery first launched, CFO Gunnar Wiedenfels said the company could achieve a net leverage ratio of 2.5 to 3 by the end of 2024. To his credit, Wiedenfels stood by that timeline on the company's last earnings call.
The company will be incentivized to pay its debt, considering it paid nearly $2 billion in interest last year. It will have a similar expense in 2023 with an average interest rate of 4.3% on its $49.5 billion gross debt.
Reason No. 1 for optimism: Intellectual property
Warner Bros. Discovery has some of the most impressive intellectual property in the entertainment industry. With popular franchises like DC Comics, Game of Thrones, and Harry Potter, the company consistently produces massive hits for both film and television.
For 2023, the company's studio division is already responsible for the second-highest-grossing movie of the year with Creed III. It also has a slate of highly anticipated blockbusters, including Aquaman and the Lost Kingdom, Aquaman and the Lost Kingdom, and The Flash.
Furthermore, Warner Bros. Discovery can distribute its content as it sees fit through cable television assets like TNT and TBS or direct-to-consumer (DTC) streaming platforms like HBO Max and Discovery+.
Image source: Getty Images.
On the DTC side, Warner Bros. Discovery had 96.1 million global subscribers at the end of Q4 2022. Althouhg the company's subscriber count pales in comparison to Netflix's 230 million subscribers, Warner Bros. Discovery grew its total subscriber count by roughly 11% from 2021 to 2022, compared to 4% for Netflix. Additionally, the company relaunched HBO Max on Amazon Channels in December 2022, making it easier for Amazon Prime Video users to find and subscribe to its flagship streaming service.
Reason No. 2 for optimism: The company generates cash
Despite the severe debt concerns, Warner Bros. Discovery generates a lot of cash. One key metric that the company excels in is free cash flow (FCF) -- the cash from operations minus capital expenditures. During 2022, Warner Bros. Discovery produced a free cash flow of nearly $3.3 billion, $2.5 billion of which was generated in Q4.
For comparison, streaming competitor Netflix produced $1.6 billion in free cash flow for 2022 and guided for $3 billion in 2023. While Warner Bros. Discovery doesn't have the clean balance sheet that Netflix has, it has already reached a higher free cash flow than Netflix ever has on an annual basis in just one year of operation.
Free cash flow is a great metric to determine a company's ability to pay down its debt. While management expects a negative free cash flow in Q1 2023 due to the lumpiness of the entertainment industry, it guided for $3.3 billion to $5.5 billion in free cash flow for the entire year.
Is Warner Bros. Discovery stock a buy today?
Warner Bros. Discovery won't be able to turn around its outsized debt problem overnight. However, management plans to correct course, including cutting current costs by $4 billion through 2024.
With a treasure trove of intellectual property, the company can continue to tap and produce blockbuster content that will resonate with fans for years to come. In the coming year, look to see if Warner Bros. Discovery can meet its lofty free-cash-flow guidance. If so, the company should be able to eventually reach its debt goals and reward patient investors with a crowd-pleasing comeback story.
