Warner Bros. Discovery: News and DC Universe as a solution (NASDAQ:WBD)

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(Note: This article originally appeared in the June 5, 2022 newsletter and has been updated as needed.)

Warner Bros. Discovery, Inc. (NASDAQ: WBD) the stock has recently lagged the market. This, of course, brought out a lot of comments from trend followers that the current trend will continue. It may be because you never know the future. Moreover, during the last conference call, management commented on a noisy 2022 fiscal year. This should have come as no surprise when it comes to a merger of this size. Traders hoping for an instant rise in stocks were disappointed. Long-term investors should realize that the initial drop in the stock price is a buying opportunity.

Warner Brothers common stock price history and key valuation metrics

Warner Brothers common stock price history and key valuation metrics (Seeking Alpha website, August 1, 2022)

The long-term story is still intact. It’s just that the market got carried away with stories of big cash flow tomorrow, then realized tomorrow was pushed back.

It is not uncommon for the market to worry about cash flow and earnings as the time for the upsides approaches. The idea that management would have an instant fix that delivers day one benefits is speculative at best. The stock price shown above is much more common.

” to give up.” It takes time for a new balance to be established between buyers and sellers.

Management highlighted many superior strengths acquired during the merger. But they also pointed out that the acquired division had little to no free cash flow. This, unfortunately, shows how poor previous management of the division had been. Well-managed companies in this industry generate a good amount of cash flow.

Management also noted on the conference call that Discovery was generating this free cash flow. Management now intends to adjust this free cash flow to the amount it should be for the combined company. Usually this means getting rid of a large number of initiatives that management believes are not meeting a performance threshold.

The market worried about a lack of accurate disclosure. But the management really didn’t see the assets other than any review before the purchase. Management said they need to look into things much better before giving advice. It’s a rare realistic approach that the market will initially hate. But this approach also begins to build the reliability so important to driving stock prices up the road to the “trust factor.”

One of the keys to superior management must be a frank discussion of right and wrong. The conference call provided exactly that, along with a warning that a household involving a merger of this size would take up a good chunk of fiscal 2022. Managements that lay out the issues in advance to public shareholders are much more likely to solve these problems even if they make a few mistakes along the way.

Discovering financial advice from what is now Warner Brothers Discovery

Discovering financial advice from what is now Warner Brothers Discovery (The old Discovery presentation of the merger that became Warner Brothers Discovery.)

Management clearly had concerns about acquisition cash flow. The difference in the relative cash flow margins presented above is striking. The old Discovery clearly had excellent cash margins. This gives investors an idea of ​​the long-term margins that management will strive to achieve with the merged company. This informal target should also provide years of earnings growth as the combined company moves towards this type of cash flow.

As management indicated during the conference call, the leverage will be higher than expected. But this leverage will not approach the worst-case scenario presented above. The combination of debt repayments from free cash flow and EBITDA growth should achieve the target leverage objective.

Pre-merger discovery Description of post-merger assets.

Pre-merger discovery Description of post-merger assets. (Introducing the Discovery merger before what is now Warner Brothers Discovery.)

Deleting projects that have no hope in management’s eyes will be the easy part, even if management sometimes makes a mistake. The longer term project will be the establishment of financial ratios that were apparent in Discovery prior to the recent merger.

There are a lot of possibilities here and one can certainly wonder which one will dominate. For me, the DC Universe probably has the most profit opportunity given what Disney (DIS) has done with their comic book movies. This company now owns the Batman and Superman franchise as well as many other previously unexplored characters. These two alone likely have much higher earning potential than was the case under AT&T(T). Management pretty much said that on the conference call and I have to agree.

Second, CNN’s news business must be managed on a cash flow basis. The news industry has changed in ways I never dreamed of since I was young. Now, news outlets tend to seek out an audience, with some going out of their way to tailor the layout to the preference of those audiences in order to “guarantee” a profit.

This direction seems to be trying hard to bring reliable information to what it hopes will be a much larger audience that wants real information with a little less opinion. The way it was said at the press conference prevented management from offending all sorts of vested interests. Achieving this in a future of sufficient cash flow (and earnings) is going to be an interesting undertaking. There could be many shards to be served by the medium that would be profitable to mine.

After that, there are lots of significant possibilities that may end up overtaking these two. Mr. Market was clearly concerned about the lack of detail because he doesn’t like uncertainty. As a result, a recent memo to employees attracted a lot of attention.

One of the things promised to investors and the market was a breakdown of the company’s finances by reporting areas that make sense for the new venture. This company, like Disney, is going to benefit a lot from the streaming service in ways that won’t show up as streaming profits. Also, this company does not directly compete with Disney in many areas except for some overlaps like the DC Universe.

The two companies compete for people’s free time. But the entertainment promised by each is vastly different. It’s a clear advantage for both as the streaming competition heats up. The winners of the competition will be those who find a profitable streaming niche where the competition is less than the “general market”.

Amazon (AMZN) and Apple (AAPL) don’t have the related divisions profiting as much as Disney and Warner Brothers Discovery. Therefore, Amazon and Apple are potential victims of this long-term competition.

The most efficient operations are likely to be the long-term winners. Disney and Warner Brothers Discovery both have a lot more potential upside in other divisions to offset reported losses in the streaming division. This means that neither has to report a streaming profit to improve the overall profitability of the business. It also means that Warner Brothers Discovery can expect strong earnings growth regardless of the outcome of the streaming wars, as streaming will likely prove a long-term benefit to the company each year the company participate in integration.

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