Warner Bros. Discovery (NASDAQ: WBD) has continued to weaken since its IPO, with its market capitalization falling below $30 billion. Meanwhile, the company is locked in an expensive streaming war that has undermined its position.although As such, the company has the financial strength to command strong future returns, making it a worthwhile investment.
Warner Bros. Discovery Channel Financial Results
The company has been working to substantially improve its financial profile, especially free cash flow (“FCF”).
The company’s revenue fell slightly, from $10.8 billion to $10.4 billion. You might be concerned about that top-line number, but its overall business has improved substantially. The company’s adjusted EBITDA grew more than 20% year-over-year to an annualized amount of more than $8 billion. Meanwhile, the company’s free cash flow has more than doubled.
Company annualization FCF is currently close to $7 billion, which is incredibly strong for a company with a market cap of just under $30 billion. That’s even after accounting for the company’s debt load.
Warner Bros. Discovery Studios and Networks
The company’s business did have several segments that underperformed, impacting its business.
Revenue at the company’s studio and network segment fell 24%. This is due to a combination of TV production (strike driven) and some slower releases. Of course, the company’s cost of revenue was also down 30%, and operating expenses were down 23%, so it did line up with the revenue decline.
The company’s networking segment also underperformed, with revenue down 5%, largely due to timing. In this regard, the company also managed to reduce operating expenses by the same amount. The company draws some tough comparisons, but its ability to handle declining operating expenses shows its strength.
Warner Bros. exploring DTC
The company’s direct-to-consumer (DTC) business is a new business and one that we need the company to succeed.
The company’s revenue rose 14% year over year, from $2.4 billion to $2.7 billion. The company faced the same difficulties as other streaming services, with its total DTC subscribers down by 1.8 million quarter-over-quarter. However, global average revenue per user (ARPU) increased by 2%, matching the quarter-over-quarter user change. The company’s business here remains strong.
The company’s content revenue grew, and advertising revenue also benefited from user growth. Operating expenses also fell due to the shutdown of CNN+, leading to a substantial improvement in overall EBITDA. EBITDA is currently at breakeven and we expect it to continue to improve.
Warner Bros. explores corporate debt improvement
The company remains committed to its key priorities of deleveraging and improving its debt structure.
The company’s total debt is $47.8 billion, but it has the benefit of having 97% of its debt fixed and an average cost of debt of 4.6%. It at least enables the company to pay its debts as they come due. However, with 23% of debt due in less than 3 years, the company does have some debt to pay off early.
However, based on its reported free cash flow, the company managed to pay down $1.6 billion in debt in the most recent quarter and launched another $2.7 billion in tender offers. The firm expects its leverage ratio to be below 4.0x by year-end and around 2.7x by 2024 as the company comfortably reaches investment grade.
Unfortunately, with the spin-off, AT&T (T) left the company with a large amount of debt, but luckily it’s fixed rate. The company is trying to improve its positioning here, but it will take a few years to clean it up.
Warner Bros. Discovery Guide
In the long run, we expect the company to be rewarded handsomely.
The company expects EBITDA to be at the lower end of its range, likely due to the current Hollywood strike. However, US DTC is expected to be profitable, which is the company’s goal. Annualized free cash flow is expected to be approximately $4.8 billion, or an EBITDA conversion rate of 40%, and the company will continue to work to increase this to 60%.
The company is still targeting $500 million+ in synergies, but expects the cost to achieve that will be closer to $1.5 billion. However, this should still be highly profitable as the company’s leverage ratio approaches its target. Continued deleveraging should deliver strong returns to shareholders over the next few years.
The biggest risk to our thesis is that this is a difficult industry with changing fundamental business models. A basket of streaming services may cost the same as a cable subscription, but there are other options and customers don’t need them all. It can make it harder to easily earn the same income and performance.
Warner Bros. Discovery, Inc. is saddled with huge debt following its spin-off from AT&T. The company is still trying to clarify the issue, but it suffers from the same negative industry influence as its competitors. Still, it has an incredible portfolio of assets, and the company is working on important financial issues.
The company’s current FCF conversion rate is 40%. The company is working to increase that to 60% while paying down debt. Unfortunately for investors, they need to be patient and wait 2-3 years for the company to pay off its debt load. Still, the company’s ability to drive long-term shareholder returns makes it a worthwhile investment.