After years of horrendous stock price performance, Warner Bros. Discovery (WBD -3.23%) has finally had its day in the sun. Year to date, this media conglomerate's shares are up by more than 75%, but most of these gains arrived over the last month, as shares surged from the low teens to nearly $20 per share.
Strategic alternatives, or at least the potential for strategic alternatives, has been the key factor behind this big run-up. The question now, however, is whether this stock has gone up too far, too fast, or if there's still opportunity for investors who have yet to make it a buy.
The answer? Yes, even as Warner Bros. Discovery's valuation went from bargain-basement to richly priced, suggesting this catalyst has already baked into the stock.
Here's why.
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Split-up and takeover talk have sent Warner Bros. Discovery surging
In June, Warner Bros. Discovery, originally formed as the result of a corporate spinoff, announced spinoff plans of its own. At the time, the company's management detailed plans to become two separate publicly traded companies.
One of these companies will consist of the company's Warner Bros. film and TV studios, HBO, as well as the HBO Max streaming service. The other company will consist of its portfolio of cable television stations like CNN, TNT, and Discovery, along with the Discovery+ streaming service .
Investors reacted positively to this news, but excitement about this catalyst lost momentum during August. In September, however, a new, and arguably more significant, potential strategic alternatives catalyst came on the scene, as rumors emerged that Paramount Skydance (PSKY -5.40%) was preparing to make a takeover offer for the company.
Warner Bros. Discovery's stock popped from around $12 per share to as much as $20 per share in the day following the emergence of these takeover rumors, and in recent weeks, has held steady near that price.
Still undervalued, despite high earnings multiple
On the surface, Warner Bros. Discovery appears to have gone from undervalued to richly priced. Based on trailing-12-month (TTM) results, shares trade at a P/E ratio of around 38 . Compare that to Disney, another major media conglomerate, which trades for only 19 times TTM earnings.
However, Paramount Skydance may be willing to pay up for Warner Bros. Discovery, due to the significant cost and growth synergies that will likely arise. According to Peter Supino, a sell-side analyst at Wolfe Research, merging these two companies could mean $3 billion in potential annual cost savings.
This factor could also make this company a target of other possible strategic acquirers. A good example is Amazon, which already owns the MGM film studio and library, and could benefit from consolidating the operations of Warner with its film subsidiary. Wall Street is now speculating that there will be a bidding war for this company, possibly resulting in a sale in the low-to-mid-$20s per share.
Best of all, this may occur either ahead of the company's planned split or after the split, when the film library/streaming business completes its separation from the cable television network business.
Is it too late to buy Warner Bros. Discovery?
I wouldn't count on Warner Bros. Discovery stock to experience a rally similar to last month's rally anytime soon. That said, with Wall Street once again recognizing the underlying value of film studios and their libraries, I believe a win/win scenario for investors is taking shape.
In the months ahead, Paramount (or another strategic buyer) could make an offer for the company. If that fails to happen, shares could still rise, as investors anticipate the separation of Warner's most valuable assets from those that buyers are less interested in purchasing.
That said, keep in mind that while there may be moderately high upside potential here, there may be moderately high downside risk as well. If merger and acquisition rumors fizzle out, and if the company's film hot streak comes to an end, shares may be at risk of losing some of their latest gains.
