A Failed Media Experiment Ends With a Pile of Debt and Tons of Uncertainty

The new Warner Bros. Discovery (WBD) is here... Last Friday, cable network owner Discovery (formerly DISCA) and telecom giant AT&T (T) announced that they had closed their deal to merge WarnerMedia into Discovery. The new company is 71% owned by AT&T shareholders, who received 1.7 billion shares of the new company in a spin-off. The […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] A Failed Media Experiment Ends With a Pile of Debt and Tons of Uncertainty By Berna Barshay --------------------------------------------------------------- [Top accountant: Where next wave of money is headed]( U.S. Pentagon consultant says next big wave of money headed to an asset you've probably never heard of – not digital technologies, gold, cryptos, or oil. [Click here to learn more](. --------------------------------------------------------------- The new Warner Bros. Discovery (WBD) is here... Last Friday, cable network owner Discovery (formerly DISCA) and telecom giant AT&T (T) announced that they had closed their deal to merge WarnerMedia into Discovery. The new company is 71% owned by AT&T shareholders, who received 1.7 billion shares of the new company in a spin-off. The remainder of Warner Bros. Discovery is owned by former Discovery shareholders. The new stock began trading this morning under the ticker WBD. The consummation of the deal closes [the final chapter of AT&T's Hollywood dreams]( which took the form of its $85 billion deal for the former Time Warner, a deal that closed in June 2018. What started with big dreams of revenue synergies went out with a whimper, and in retrospect the deal proved a total folly. There were in fact no discernible synergies between a phone service and a creative content factory... Who knew? The AT&T-Time Warner deal made shareholders poorer... Not only have T shares greatly underperformed the S&P 500 since the deal closed, but they have also underperformed the shares of telecom peers Verizon (VZ) and T-Mobile (TMUS)... The great bull market completely passed AT&T by, as it underperformed its closest peer Verizon by roughly 35 points... And things look even worse versus the S&P 500 and competitor T-Mobile, which had exceptional performance in the wake of its accretive (and logical) purchase of rival telecom services provider Sprint. By spinning off the media assets, AT&T takes a big chunk of debt off its balance sheet – but the debt is still out there, encumbering the new company... Warner Bros. Discovery begins its trading life today with a hefty $57 billion in debt. CEO David Zaslav has promised Wall Street that he can get the new company to a more manageable leverage level of 3 times earnings before interest, taxes, depreciation, and amortization ("EBITDA") within two years. This seems like a tall order, as it requires the new entity to pay down $15 billion to $20 billion in just a couple of years. Discovery has however taken on this kind of challenge before, including when it levered up to acquire cable network rival Scripps back in 2017. Zaslav has also promised to wring $3 billion in synergies out of the newly combined company – another aggressive goal, as that number tops what media giant Disney (DIS) guided that it could pull out of the combined cost structure when it acquired Fox's (FOX) entertainment assets a few years ago. Meeting that lofty $3 billion goal will require much restructuring, mostly in the form of layoffs. The old Time Warner was no stranger to serial restructurings and there were also massive layoffs after the 2018 acquisition by AT&T. As an outsider, you have to wonder when these types of exercises start cutting into the bone. Much of the news flow this past week has centered on management shake-ups... First on the chopping block was WarnerMedia CEO (and full disclosure, my friend from business school) Jason Kilar, who announced his long-anticipated resignation on Tuesday. A parade of C-suite exits followed, including Warner Bros. Studio CEO Ann Sarnoff. Some executives departing were close allies of Kilar who joined after he took the helm, while others were Warner veterans whose tenure pre-dated his arrival. Industry rag Deadline reports that one insider estimates these C-suite cuts could save the new company about $70 million in annual compensation. But the cuts weren't just about saving money – they were about consolidating power... Zaslav, who came from Discovery, is swiftly amending reporting structures and clearing the ranks to put a small group of longtime lieutenants in charge of operations at WarnerMedia. While this combination has been called a merger, it was never a merger of equals... The WarnerMedia side brings a bigger content library, more valuable franchises, a longer history, better branding, and deeper relationships with talent. But all these departures underscore that it was never really a merger... it was an acquisition. It doesn't matter who brought more to the party here, Discovery clearly took over Warner... The minnow has swallowed the whale here. While the top of the org chart is quickly sorting itself out, more junior employees of the former WarnerMedia anxiously await their fate... But beyond the org chart, many questions remain about what the new company will look like... An eventual integration of the HBO Max app with the Discovery+ app has been confirmed... but when will it happen? And will it come in the form of a true merger of services or will it be more like a bundle, a scenario in which Discovery+ becomes an add-on that you can pay extra for with HBO Max? And what will happen to HBO Max's budget, on an individual project basis as well as in aggregate? Zaslav has helmed an empire built on unscripted programming (aka reality TV and documentary content). It's much easier to squeeze costs when making unscripted content – it's not dependent on booking (and paying for) A-list stars and writers. Zaslav has a reputation for being thrifty... but will thrifty work when you are trying to make recent HBO Max hits like Mare of Easttown or White Lotus, let alone the HBO juggernaut Game of Thrones? That HBO hit was the most expensive TV show ever made... at least until the streaming wars got going and Disney+ started spending even more on Marvel series... and then Amazon (AMZN) outspent that with the upcoming Lord of the Rings series. Zaslav indicated on Discovery's last pre-merger earnings call that he will continue to watch the content budget closely... And now we have the resources, we plan on being careful and judicious our goal is to compete with the leading streaming services, not to win the spending war. HBO Max made tremendous strides in 2021 – in terms of subscriber count, consumer mindshare, and prestige awards. Zaslav would be a fool to not tread cautiously when contemplating content budget cuts at HBO Max... but his commitment to a nascent sister service could be more fragile.... The CNN+ streaming app recently launched, but with more of a whimper than a bang, so its fate as a standalone app – as opposed to an upsell option on HBO Max – is one thing people are watching. One thing is near certain: this won't be the last media merger... The creation of Warner Bros. Discovery comes on the heels of the recent Amazon acquisition of MGM Studios, the aforementioned Disney-Fox deal, and [putting Humpty Dumpty back together by re-merging CBS and Viacom]( to create the new Paramount (PARA). All these deals were designed to strengthen streaming services. This consolidation wave is far from being over... at least, not if these services want to turn a profit. More than a dozen streaming services are duking it out for market share in the U.S. alone. Most consumers won't subscribe to more than three or four, so having too many players is driving excess churn, as subscribers turn off a service after finishing a series or two. This churn drives up costs – both in marketing to these fickle consumers and even more so in soaring content budgets, as the subscriber demand for newness becomes insatiable. Simply put, there are too many players fighting for share, and they are competing by spending more and more on content. Consolidation is the best solution to this problem, although there may also be some promise in rolling out lower-priced, ad-supported tiers that increase the addressable market of consumers willing to pay. So expect more deals... Even Zaslav himself said at a conference last year that he was still on the hunt for deals – although the new Warner Bros. Discovery needs to take a long minute to make progress on debt reduction and merger integration before it absorbs something new. --------------------------------------------------------------- Recommended Link: [The 'EVERYTHING CHIP']( A new industry is being built around an "everything chip"... that's more sophisticated than the chips in your smartphone or laptop. One little-known company is at the forefront of this technology, and the man CNBC nicknamed "The Prophet" says this company will be "America's Next Big Monopoly." Best of all, you can buy this stock for less than $10. It's no wonder the smart money, like Cathie Wood and Bill Gates, has already invested over $350 million. [Click here for the full story](. --------------------------------------------------------------- Right now, the world of media analysts and journalists divides into Zaslav fans and Kilar fans... If you're a value investor who also invests in telecom and cable and are perhaps an admirer of legendary investor John Malone of the Liberty family of companies, you probably fall in the Zaslav camp. Zaslav's career has hinged on being a stoic cash generator, watching pennies, pulling synergies out of acquisitions, and returning cash. He is old school and reliable. If you're a growth investor and regularly invest in tech, you probably prefer Kilar – the ultimate disruptor and futurist. While Kilar made many big moves in his almost two years at Warner Media, he will be most remembered for "[Project Popcorn]( the nickname given to his decision to drop all 2021 theatrical films onto HBO Max on the same day they hit theaters. He made a lot of people angry with that move, but it also greatly accelerated subscriber acquisition at HBO Max and turned the service into a true contender. It also didn't hurt that there was some incredible storytelling last year on HBO Max (the aforementioned White Lotus and Mare of Easttown come to mind, along with Hacks, The Flight Attendant, and Succession – just to name a few). After such a strong slate – and considering the franchises (Harry Potter! DC Comics!) – it seems like it was pre-ordained that HBO Max would pull ahead of the rest of the late arrival pack, leaving Paramount+ and Comcast's (CMCSA) Peacock in the dust. But remember, HBO Max entered the streaming market late, was priced at the top of the market, and was missing from key platforms when it launched... Kilar arrived just a few weeks before that shaky launch... but the team he assembled clearly made up for lost time. HBO Max was the clear winner of streaming in 2021, in terms of increasing mindshare and subs, ending the year at 74 million... Source: JustWatch HBO Max is a clear (but distant) third player in the space now, behind leaders Netflix (NFLX) and Disney, with its Disney+ and Hulu (I don't count Amazon Prime Video in this standalone race, since most people buy Prime for shipping, not streaming)... Source: JustWatch No word yet on where Kilar will go next... but given the rise of HBO Max in 2021 along with his experience as the founding CEO of Hulu, I imagine he won't be on the beach long. As for Warner Bros. Discovery, the trajectory of the stock depends on whether it will trade like a member of the new media establishment that is thriving online, i.e., like Netflix and Disney, or at a valuation more like that of the legacy media companies struggling online – here I am thinking of Fox, Comcast, Paramount, and AMC Networks (AMCX). As much as NFLX and DIS shares have been down in the dumps lately, they still trade at a giant premium to stocks in this second group. For now, I think Warner Bros. Discovery is more likely to get the legacy media valuation to go with its legacy media management, which keeps me on the sidelines with WBD shares. I love the old Time Warner assets but I don't love the debt level, and I have some worries about management here. But I will be keeping a close watch for surprises – because these are stellar assets, and the combination of a scripted powerhouse with an unscripted one is very attractive. As for AT&T, they can run but they can't hide from the legacy of botched strategy and acquisitions... I've been a bear here for two years, and my position is unchanged. This was long, so I will come back with the mailbag on Wednesday... Do you think Warner Bros. Discovery reverting to leadership from the old media world will have an impact on its future prospects or the quality of the HBO Max service itself? Would you pay for a standalone news app – not from CNN specifically – but more generally, whether from Fox, CNN, OAN, MSNBC, or wherever you get your news? Share your thoughts in an e-mail by [clicking here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Berna). Regards, Berna Barshay April 11, 2022 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2022 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. 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