Is Warner Bros. Discovery about to be broken up?
Two years after the merger, numerous media outlets are reporting on an allegedly imminent split. What is really behind it.
Those of you who have been following this Substack for a while know that I have been invested in the new media giant Warner Bros. Discovery WBD 0.00%↑ since the merger of Discovery with Warner Media two years ago with little success (to say the least) so far. You can read my latest post on WBD here.
It is strange what is happening in the media world around WBD and I would like to share my thoughts with you, even if they are still somewhat disorganized.
The fact is that WBD's share price only knew one direction until a few days ago and plummeted to new lows of around $7 at the beginning of July 2024.
In the past two trading weeks, WBD shares have recovered by 20%, bucking the trend of the consolidating US indices.
The background to this:
The rumor about the Warner Bros. Discovery split-up
Currently, the headlines surrounding WBD coverage are full of the alleged news that CEO David Zaslav has admitted the failure of the merger and intends to split up WBD.
I say: This is fake news.
To my knowledge, there is no statement or action by the WBD management in this direction.
Instead, what is behind it is an analyst report by Bank of America (BofA) with the beautiful title: “Is Unbundling the Answer?”
The well-known analyst Jessica Reif Ehrlich and her team bluntly claim that Warner Bros. Discovery's current strategy is “not working”. They formulated the thesis that “exploring strategic alternatives such as asset sales, restructuring and/or mergers would create more value for shareholders than the status quo”.
In their report, the analysts describe six possible scenarios for WBD:
Sale of the entire company
Sale of some assets
Merger, preferably with a television broadcaster
Streaming merger or joint venture
Retention of the strategy
Spin-off of the Networks assets, including the majority of the debt, into a separate company so that the rest (the streaming business and the studios) represent an attractive growth company with a correspondingly high valuation on the stock market.
In my opinion, the above-mentioned headlines are only due to the fact that the media jumped on the above-mentioned 6th scenario of the well-known analyst, wrote it off and ultimately turned it into the headline “Warner is considering splitting up”.
For me, this is dubious reporting. As an inexperienced reader, you have to read very carefully between the lines and inform yourself about the background in order to get a clear picture.
Is this the turnaround in the WBD share price?
Of course I don't know either. But I do know that hardly any other company in my portfolio has had such bad press. Since the merger two years ago, the media have portrayed the company's situation as much worse than it actually is.
Time and again, developments are portrayed as if WBD were on the verge of bankruptcy.
Again and again I read about the allegedly almost unmanageable debt burden of currently around 40 billion.
There is talk of falling sales and mass layoffs
And, of course, of the billions in losses that have piled up since the merger.
What has happened at WBD over the past two years is the pattern of a successful restructuring, no more and no less: this includes closing unprofitable business areas, which leads to falling revenues and layoffs. It is also quite normal in the course of a restructuring that excessive intangible assets are written off, which has led to high reported (but not cash-effective) net losses in the past two years since the merger.
The final negotiation phase for the award of the NBA rights is currently underway. The TNT Network, which belongs to Warner, has held the corresponding rights to basketball sports broadcasts for 40 years. Negotiations for a contract extension have failed so far because Zaslav did not want to pay the asking price. Zaslav is also being harshly criticized for this. Either because losing the NBA rights would allegedly cost a good portion of the profits generated by the cable channels. Or because WBD would pay too much for the broadcasting rights, meaning that profitability would be lost anyway. Once again, the situation is being presented as if WBD can only lose.
In my opinion, this negative reporting about the company represents a huge opportunity for WBD shareholders. Shares are pricing in a lot of bad news that is by no means a foregone conclusion.
The successes of the restructuring are visible
The positive economic developments at WBD are largely ignored by the mass media, so I would like to summarize them again here:
WBD's free cash flow has increased from $2 billion to $7.5 billion over the past 12 months.
And what about the high level of debt that is supposedly strangling the company?
The high cash flow makes it possible to quickly reduce the debt, which is still too high. In the past two years since the merger, net debt has been reduced by around $18 billion to its current level of around $40 billion. The company is currently buying back its own bonds on a large scale at a discount long years before they mature (read here).
Is this how a company that is on the verge of bankruptcy behaves?
It is foreseeable that WBD's balance sheet quality will continue to improve in the coming quarters, even if the positive deleveraging trend could slow down somewhat. This is because cash flow in 2023 was positively distorted by the long Hollywood strike, as the budget could not be spent on productions as planned.
It is clear that WBD's Networks segment (i.e. cable TV channels) is in a structural and unstoppable decline (approx. 8% decline p.a.). However, the streaming platforms and studios will achieve profit growth in the coming years and should therefore largely compensate for the decline in the Networks segment. The strong FCF generation will continue overall and enable the company to further reduce its leverage. At least that is the core of my investment thesis.
By the end of 2025, WBD's net debt should be reduced to around $30 billion. By then at the latest, the cleanup of the company can be considered complete and, following the completion of restructuring and special write-downs, the bottom line can be expected to be positive again.
The valuation of WBD stock
At a share price of $8.50, WBD's market capitalization is just $21 billion, which is 3 times its cash flow!
Taking net debt into account, WBD's enterprise value of $61 billion is 8 times free cash flow. By comparison, Disney and Netflix are valued at 26 times and 41 times cash flow respectively.
It should be noted that the high cash flow is expected to be available from 2026 (after completion of the debt reduction) to invest more heavily in growth or to buy back WBD shares on a large scale if the blatant undervaluation persists.
If WBD were to spend only $2bn a year on share buybacks from 2026 onwards, it would be possible to buy back around 30% of its own shares in 3 years at today's share price - with a correspondingly positive effect on earnings per share. However, I don't think it will come to that. The WBD share price is likely to rise significantly before then.
Conclusion
There are several good reasons to buy WBD shares.
However, speculation about a demerger, which was probably the trigger for the recent share price recovery, is not one of them for me.
David Zaslav and his CFO Gunar Wiedenfels have made themselves unpopular in the media industry. Both are tough reorganizers and have stepped on quite a few toes, especially in Hollywood.
The decisive factor for me as a WBD shareholder is that the management duo I trust can act from a position of financial strength. They have worked hard to achieve this strength over the past two years through their restructuring course. WBD is not negotiating with its back to the wall, as is the case with Paramount.
Therefore, I cannot see why WBD shares should be available for 3 times cash flow in the longer term. I continue to see a clear undervaluation.
It remains exciting. I am already looking forward to August 7, when the WBD management will present the half-year results and will certainly also comment on the wild speculation surrounding a possible split-up.
If you would like to follow the Warner Bros. Discovery share together with me in the future, you can
*Disclaimer:
The author and/or associated persons or companies own shares in Warner Bros. Discovery. This article is an expression of opinion and does not constitute any investment or financial advice.