Warner Bros. Discovery (WBD 0.59%), formed by the merger of WarnerMedia and Discovery, has had the unenviable task of merging the former media arm of telecom giant AT&T with iconic but mismanaged brands like HBO, with a profitable cable and streaming company known best for reality TV.
CEO David Zaslav, who led Discovery before the merger, has said that the company was a financial mess following the merger. Spending at WarnerMedia was out of control, and Zaslav has taken steps, including layoffs, to rein things in.
Freeing HBO
Under AT&T, WarnerMedia rested its streaming strategy on HBO's shoulders. The HBO Max streaming service featured not only HBO content, but also everything else in WarnerMedia's catalog. One problem with this strategy is that the HBO brand is known for edgy series and movies. Slapping HBO's name of a broader streaming service risked hurting the brand and pushing potential customers away.
Zaslav is aiming to fix this problem with a rebranding. HBO Max will now simply be called Max. The service will still feature the same slate of content, including HBO series and movies, but the hope is that the new name will send the message to consumers that the service has something for everyone. Max will include content from Discovery as well, although the Discovery+ streaming service will remain separate.
Focusing on cash flow
The streaming business right now is a losing proposition for Warner Bros. Discovery, at least in terms of profitability. The direct-to-consumer business posted an adjusted EBITDA loss of $217 million in the fourth quarter. That loss is despite the segment having 96.1 million subscribers globally.
The DTC business is at a roughly $10 billion annual revenue run rate. The company is aiming to boost the subscriber count to 130 million by 2025, which will boost revenue significantly. Add in the impact of cost cutting, and it's not hard to imagine the DTC business eventually accounting for a significant chunk of the company's cash flow each year.
Cash flow is particularly important for Warner Bros. Discovery because the company is saddled with debt. Total debt stood at $49 billion at the end of 2022, and interest payments ate up $558 million in the fourth quarter alone.
Despite the losses in the DTC business, Warner Bros. Discovery is plenty profitable on a cash-flow basis. Free cash flow totaled $3.3 billion in 2022. The problem is that this cash-flow generation is largely coming from the company's networks segment. All the cable TV channels that the company owns, which include TBS, CNN, HGTV, TLC, and a handful of others, are unlikely to be growth businesses in the age of streaming.
What has to happen for the stock to rally
Warner Bros. Discovery must convince investors that it can grow cash flow in the DTC business fast enough to at least offset any declines in the networks business. Right now, the market isn't buying it. The company has a market capitalization of $31 billion, putting the price-to-free-cash-flow ratio just over 9.
That's a pessimistic valuation for a media company with a broad portfolio of high-quality assets. Of course, the company needs to do a much better job of leveraging some of those assets. Warner Bros. Discovery owns DC Comics, for example, but attempts to create a cinematic universe that rivals Walt Disney's Marvel have largely fallen flat. The company is now rebooting the whole franchise, and it could become a big moneymaker down the road.
Warner Bros. Discovery has the potential to be a cash flow machine, but it's not there yet. The market isn't confident in the effort, but if the company can pull it off, the stock should be worth far more a few years from now than it's worth today. The pieces are all there. All that's left is for the company to execute.
