Warner Bros. Discovery stock has recently taken a dive and is now standing at a meager $17 billion market cap or about $7 a share. Despite this, the company continues to generate significant amounts of free cash flow, recording $6.2 billion in 2023, which represents 86% growth year over year. As a result, they are currently trading at less than 3x trailing free cash flow, while the broader industry has a multiple closer to 23. Could this be a rare buying opportunity in a very expensive market or a falling knife destined for bankruptcy? This write-up will aim to address that question with a brief look.
Warner Bros. Discovery (WBD) is a global media and entertainment company arising from the recent merger between Discovery and Warner Media, commands attention as a global media and entertainment behemoth. They report in 3 segments: Networks, Studios, and DTC. These segments include their legacy cable TV business, newer streaming services, and content-producing movie studios.
WBD's financial landscape reveals a $41 billion debt burden stemming from the merger and subsequent spin-off from AT&T. However, amidst this, the company benefits from historically low interest rates and far-out maturities, with 91% of its debt fixed rate and a weighted average interest rate of 4.3%. This debt structure is quite favorable as they were able to lock in some of the lowest interest rates in history while also facing little to no interest rate risk. It may even benefit from high interest rates by being able to pay off debt below par value.
Yet, risks persist. Market volatility and shifts in consumer behavior could impede advertising revenues, impacting financial performance. Moreover, the profitability of the direct-to-consumer (DTC) segment, housing platforms like HBO Max and Discovery+, remains uncertain. However, their management, led by CEO David Zaslav and backed by industry stalwarts like Dr. John Malone, is primed to navigate these challenges with a focus on disciplined investments and expense management. These insiders own a large portion of the stock themselves, proving their personal interests are aligned with shareholders.
Despite these uncertainties, WBD's vast IP portfolio, featuring iconic brands such as HBO and DC, presents a compelling investment thesis. The potential synergies from the merger, alongside management's ambitious $4 billion synergy target, underscore the company's growth potential. On top of this, management clearly understands how to maximize shareholder value from here on out with a focus on generating the highest returns on their intellectual property regardless of monetization method.
Addressing concerns surrounding the DTC segment, WBD's long-term outlook is bolstered by already profitable streaming services, which generated $103m of EBITDA in 2023 and are expected to bring in $1bn of profitability by 2025 with over 130 million global subscribers.
Moreover, the company's proactive debt reduction strategy, evidenced by repayments totaling $5.4 billion in 2023, offers a pathway to financial stability. Most importantly, the company expects significant free cash flow generation in the future, well beyond what is required to pay off its debt as it matures.
Its valuation suggests significant returns could lie ahead. With merger synergies and growth in the DTC segment, I would not be surprised to see a share price well over $20 or even $30 in 5 years. However, this company does not come without risk, as its business model is heavily dependent upon advertising and consumer behavior, which can easily change due to macroeconomic conditions. In the unlikely event they cannot produce enough free cash flow, they could be forced to refinance their debt at unfavorable rates. In such an event, the current share price does offer a lot of downside protection, but depending on the severity could mitigate a lot of the upside.
Overall, I think this is about an average quality business trading at a very cheap price. As far as ratings go, I would give it a 6/10 on business quality and a 9/10 on cheapness, with my overall interest level in doing deeper research being a 9/10. It has some characteristics of a strong portfolio position, not as a buy-and-hold forever stock, but more like a stock that would best be sold when it reaches fair value. However, considering recent price action, it is definitely tough to hold with all the volatility, negative sentiment, and potential risks. Whether or not you pursue further research on this name depends on your financial situation, risk tolerance, and level of experience in the industry.
By the way, I am currently in the process of producing my next research report, which will be released to subscribers only. The company it covers is my personal largest position and makes up 20% of my portfolio, excluding the unrealized gains. Based on my research I think the stock could double or triple in the next 3-5 years. So stay on the lookout for that! Thereafter, I am open to hearing any recommendations on what to research and give my opinion. The only requirement is you must be a Substack subscriber.