Warner Bros. Discovery (NASDAQ) is grappling with market skepticism regarding its growth potential. Despite generating strong free cash flow and significantly reducing debt, the company’s share price has continued to decline.
Current Market Sentiment
Quantitative Factor Grades
According to Seeking Alpha, WBD’s most attractive features are valuation and profitability. However, growth has been downgraded to “D-” from “A” over the past six months, with the stock price dropping approximately 40% during this period.
Contributing Factors to Market Sentiment
Several issues are driving this negative sentiment:
- Lackluster Subscriber Growth: The Direct-To-Consumer (DTC) division has shown uninspiring subscriber growth.
- Decline in Networks Business: The Networks segment is experiencing a downturn.
- Hollywood Writers’ Strike: This has negatively impacted financial performance and market sentiment.
Financial Performance
For FY2023, WBD’s adjusted earnings were approximately $4.7 billion. This figure includes adjustments for restructuring and acquisition-related amortization expenses. The company’s free cash flow was $6.2 billion, boosted by reduced content production during the writers’ strike.
WBD is trading at an adjusted PE ratio of 2.7X and a 30% past-year’s underlying FCF yield, excluding strike impacts. These valuation multiples suggest market expectations of a severe decline, which is uncommon even for leveraged businesses facing structural challenges.
Business Segments Analysis
Networks Division
Overview
The Networks division, which includes cable TV networks like TNT, Discovery, and CNN, is the largest earnings contributor but is facing a decline due to the cord-cutting trend and shifting advertising revenues.
Future Outlook
The division will continue to generate free cash flow despite its decline, due to content spending cuts and network integrations. However, the overall decline in the pay-TV industry will impact its long-term prospects.
Studios Division
Overview
The Studios division produces films and TV content for both owned and third-party platforms. It has faced challenges due to declining linear network audiences but sees growth opportunities through DTC distribution.
Future Outlook
Despite the negative impact of the writers’ strike, the division is expected to recover in FY2025 as content production normalizes.
Direct-To-Consumer Division
Overview
DTC is the primary growth driver for WBD, encompassing HBO, HBO Max, and discovery+. It has approximately 100 million subscribers globally, including linear HBO subscribers with complimentary access to Max.
Future Outlook
DTC growth has been hindered by linear losses, but international expansion is expected to drive subscriber growth and increase ARPU. The launch of Max in Latin America and Europe, leveraging major events like the Summer Olympics, will be critical.
Strategic Initiatives
Deleveraging and Stock Buybacks
WBD is using cash flows from the Networks division to reduce debt. Once leverage targets are met, the company plans to initiate stock buybacks. This strategy could significantly enhance shareholder value, especially at current depressed price levels.
Profitability Targets
The company aims for the DTC division to achieve ~$1 billion EBITDA by FY2025. This target is seen as realistic and conservative, considering potential pricing increases in the US market.
Challenges and Risks
WBD faces significant risks, including:
- Structural Decline in Networks: The Networks division’s decline could offset gains from DTC.
- Advertising Revenue Volatility: Rapid declines in advertising revenues pose a major risk.
- High Leverage: The company’s debt levels add financial risk.
Conclusion
Investment Thesis
Warner Bros. Discovery is currently undervalued, with the market heavily discounting its growth potential. The company’s robust content portfolio and strategic DTC initiatives position it well for future growth. As WBD continues to deleverage and improve profitability, particularly in the DTC segment, there is significant potential for stock price appreciation.
Final Recommendation
Despite the inherent risks, we believe that WBD offers a compelling investment opportunity at its current valuation. We recommend a “Buy” for WBD, while closely monitoring developments in advertising revenues, cost-cutting efforts, and DTC profitability.
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