Warner Bros. Discovery

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Warner Bros. Discovery is a global media and entertainment company that produces and distributes content across various platforms, including theatrical releases, television networks, streaming services, and video games.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Warner Bros. Discovery, or WBD, operates in the intensely competitive media and entertainment landscape where strong moats are hard to establish. The company possesses a narrow moat, scoring a 2 out of 5, primarily built on its portfolio of valuable franchises and a diversified distribution network. However, these advantages are facing significant headwinds that are eroding the moat over time.

Business Overview

WBD operates through three key segments:

  1. Studios: This segment is responsible for producing and distributing feature films and television content through its renowned studios, including Warner Bros. Pictures, New Line Cinema, and Warner Bros. Television.
  • This segment is often seen as the core of WBD with a wide variety of Intellectual Properties and the capability to create content for other segments.
    1. Networks: This segment encompasses a portfolio of cable television channels (such as CNN, TBS, TNT, and Discovery Channel). It earns revenue from affiliate fees, advertising, and content sales.
  • The network segment has been affected by cord-cutting and the rise of cord-nevers. It is one of the most established, profitable and well known part of the business, it also has some the highest profitability.
    1. Direct-to-Consumer: This segment comprises WBD’s streaming platforms, such as Max and Discovery+. This business generates revenue through subscription fees.
  • This is the biggest focus going into the future.

Revenue Distribution:

  • For the first three months of 2023, the Studio segment generated $2.84B, Networks segment generated $5.59B, and DTC generated $2.54B.
  • Revenue breakdown for 2022 shows Networks still accounts for more than 50% of the revenue, followed by Studios and finally DTC.
  • Note: In the latest filing, the revenue is broken down by Studios, Networks, and DTC.

Industry Trends:

  • The media and entertainment industry is experiencing a rapid shift towards streaming services, which are increasingly dominating content consumption.
  • Cord-cutting continues to negatively affect the traditional cable television business, and WBD is not immune to this trend.
  • Content creation costs are rising, making it more difficult for companies to compete, and forcing them to rely heavily on established franchises.
  • The competition in the DTC space is very high, with companies pouring money into the creation of new content. This is an area with high burn rate and profitability concerns.
  • Content licensing is becoming an increasingly competitive field, with more platforms vying for distribution rights.

Competitive Landscape:

  • WBD faces intense competition from other large media conglomerates, such as The Walt Disney Company, Netflix, Amazon, and Paramount. These companies have significant resources, diverse offerings and established streaming presence, increasing the cost for WBD to catch up.
  • The company is also facing competition from newer streaming platforms, such as Apple TV+ and Peacock, as well as large technology companies that can allocate a significant amount of their large financial resources into these fields.
  • The ability to retain subscriber churn and acquire new subscribers in the streaming world will determine future successes.

What Makes WBD Different:

  • WBD possesses a vast library of intellectual property (IP) with iconic franchises like Harry Potter, DC Comics, Looney Tunes, and Game of Thrones, providing them with a unique content advantage.
  • The company also has a diversified distribution system across linear TV channels, streaming, and theatrical releases, which can give them more flexibility, in theory.

Financials

The latest earnings call highlighted some key aspects of WBD’s current financials. Most of the focus was on the “transformation” of the business and making the company profitable. The financial statements for the latest quarter (3 months ended March 31, 2023), released on May 4th 2023, reveal some key information.

Revenue:

  • Consolidated revenues for the first quarter of 2023 were $10.7 billion, a 5% decline compared to the pro forma combined revenues in the prior year quarter.
  • The Networks segment experienced a decline, while the Studios segment and DTC increased.
  • The overall revenue decline was largely due to the decrease in linear network sales, a trend that has been going on for several quarters. The company is working on improving the profitability, even if it means that revenues do not grow.
  • The company has reported a revenue of $11.078B for Q2 2023, a 4% increase compared to Q2 2022. This was mostly attributed to DTC, which is now starting to generate more revenue than it did in previous quarters.

Profitability and Margins:

  • Operating profit before the impact of interest, taxes, depreciation, and amortization was $2.08B and Free Cash Flow (FCF) was $1.03B for the latest quarter.
  • These results were helped by cost-cutting measures that are starting to take hold.
  • DTC had a loss of -$217 million, primarily attributed to restructuring charges, which means it was profitable before these charges.
  • Management has stated several times in the earnings calls, that they are focused on reaching a “sustainable level of profitability” and that “future results will show growth.”
  • The company is aggressively cutting costs across many sectors, which might boost profitability going forward.

Debt:

  • WBD carries a large debt burden of $45.7 billion.
  • This high debt load creates financial risk, making them particularly vulnerable to macroeconomic downturns.

Cash Flow:

  • As mentioned before, WBD generated $1.03 billion in free cash flow. This number was boosted by cost-cutting strategies.
  • The management has stated they have prioritized debt repayment with their free cash flow.

Other important factors:

  • The management has also reported that advertising revenues are improving year-over-year, but they are still lower than pre-pandemic levels.
  • Streaming subscribers increased and the company is taking steps to improve the profitability of these streams.
  • Management has reported that they are focusing on revenue growth from their most valuable segments, like movies and licensing, while they are cutting costs in less profitable ones.

Moat Rating: 2 / 5

Justification:

  • Strengths:
    • WBD’s large portfolio of IP provides a strong content base, offering exclusive content that can attract subscribers and viewers.
    • The diversified distribution system, including linear, streaming, and theatrical, gives WBD flexibility to reach various audiences.
  • Weaknesses:
    • The high-competitive space in DTC can quickly erode the advantages WBD gains, while also forcing them to spend a large portion of their revenue on creation.
    • Cord-cutting and shift towards streaming is slowly killing the company’s profitability.
    • Their high debt burden makes them vulnerable to higher interest rates and can impede future investments.

Risks to the Moat and Business Resilience

  1. Technological disruption: The media and entertainment landscape is rapidly changing, and WBD risks being outpaced by innovative newcomers.
  • The speed at which streaming and internet entertainment is evolving makes traditional movie businesses much more riskier and volatile.
    1. Intense competition: The company faces stiff competition from well-established and deep pocket companies such as Netflix and Disney.
    2. Cord-cutting: The continued decline in linear television viewing may erode WBD’s revenue from its networks division.
    3. High debt: The high level of debt may limit WBD’s ability to invest in its business and navigate economic challenges.
  • It also limits the company’s ability to improve their business when other companies are spending much more in similar spaces.
    1. Economic downturn: The threat of recession could curb ad spending and lower consumer disposable income, affecting both the networks and DTC segments.
    2. Content performance: The success of a business like WBD hinges on the reception to their latest content. If the quality of their shows and movies is not up to par, it might lead to lower subscribers.

Business Resilience:

  • Although WBD possesses well-known brands, its resilience is threatened by high debt, fast changing consumer preferences, and rising costs of creating new content.

Understandability: 3 / 5

Justification:

  • WBD’s business model is easy to grasp-produce content and distribute it through various means. However, the complexities arise when it comes to managing costs, creating consistent new content, and competing in the highly competitive streaming world.
  • Understanding the long-term implications of the changing consumption behaviors requires detailed analysis, which makes it a bit more difficult.
  • The business is also very sensitive to macro trends like advertising spend, inflation, and consumer spending, which increases the risk as well.

Balance Sheet Health: 2 / 5

Justification:

  • The company’s high debt level significantly lowers its balance sheet health. Although management has stated that they are prioritizing paying down debt, the task is daunting given the company’s current revenue profile.
  • They have a relatively good cash flow, which is the only reason they are not rated lower than a 2 in balance sheet health.
  • The high debt load, and a somewhat underwhelming financial performance warrants a low rating on balance sheet health.

In conclusion, WBD faces a challenging future where its narrow moat is constantly being tested. They have strong brands and franchises but the rising costs in streaming and decline in linear TV sales, might hamper their long term success. The company also has a very concerning debt, and a bad or average showing on any financial performance will put them at great risk.