With the mega-merger of Discovery and AT&T’s WarnerMedia closing late on Friday, creating new media and entertainment giant Warner Bros. Discovery, Wall Street is turning its attention to the outlook for the new conglomerate’s stock that began trading on Monday under the ticker symbol “WBD.”
In early Monday trading, the shares of the conglomerate, led by CEO David Zaslav, were down 1.8 percent, at $23.99.
But before the new trading week kicked off, the new Hollywood titan and former Discovery stock was met with some Wall Street love, earning upgrades from at least two analysts.
Atlantic Equities’ Hamilton Faber upgraded his rating on Warner Bros. Discovery shares from “neutral” to “overweight” on Monday with a $40 stock price target. “With a portfolio of some of the world’s strongest content brands, we believe WBD is positioned to be equally as successful as Disney in direct-to-consumer, yet the new company is trading at a very material discount,” Faber wrote in a report.
Given that a portion of AT&T shareholders who all received WBD shares in the merger will want to sell off the entertainment company’s stock, “there will likely be some near-term selling pressure on the shares, but this will probably be short-lived,” he also noted. But overall, he is bullish on the new stock. “We believe investors will be drawn to the opportunity of investing directly in the Warner assets, the first time in four years this has been possible,” Faber wrote. “These are among the best in the industry and are close to, if not on par with Disney.”
The analyst took the Disney comparison further, arguing: “The combined direct-to-consumer (DTC) presence will be similar to Disney. On closing, WBD will have 96 million combined Discovery+ and HBO Max DTC subscribers. We suspect management will consolidate the two services and have assumed 60 percent of Discovery+ subs will be subsumed into HBO Max, giving the company a pro forma total of around 83 million subs, ahead of Disney+ excluding India at 74 million. Both HBO Max and Discovery+ have shown strong traction, adding a combined 25 million subs in 2021. We see both WBD and Disney+ ex-India reaching 150 million subs in 2024 and also see both companies spending a similar $10-$11 billion on DTC content that year.”
Evercore ISI analyst Vijay Jayant also upgraded the former Discovery stock on Monday from “in line” to “outperform” with a $40 stock price target in a report entitled “Deep Dive Into The First Direct-to-Consumer Free Cash Flow Machine.” That was a reference to Discovery management’s comments in recent years, touting the company’s free cash flow momentum.
The merger created “the second-largest media company after Disney with 2021 revenues of $46 billion, a content budget of over $20 billion annually supporting a library with over 200,000 hours of programming, and most importantly the assets to successfully compete in the global direct-to-consumer (DTC) video streaming opportunity,” Jayant explained. “We think the shares are undervalued,” the analyst concluded, while also acknowledging that the “spin-merge transaction structure is likely to create a massive supply of stock,” meaning that “we recommend long-term fundamental investors to take advantage of this technical aberration as our year-end 2023 price target of $40 per share provides over 60 percent upside from current levels.”
Jayant also highlighted that the merged firm will be the “third-largest streaming player,” arguing that “the combination of HBO Max and Discovery+ into a single service will be highly synergistic.” He added: “HBO Max will bring the expensive, flashy originals needed to acquire customers, while Discovery+’s unscripted content provides the large library of content needed to retain those customers. We expect the company to grow its streaming revenues at a 21 percent compound annual growth rate (CAGR) from ’21 until ‘26, in line with our expectations for Disney. Revenue growth will moderate in ‘22 before reaccelerating in ‘23 with the launch of a consolidated DTC product in the first quarter of ‘23 followed by a ramp-up of international launches.”
He also sees 2022 as “the peak year for streaming losses.” Jayant’s conclusion: “On management’s guidance for ‘23, which we think is ambitious but achievable, WBD is the cheapest media company on levered free cash flow yield (14 percent) and the second-cheapest on enterprise value/earnings before interest, taxes, depreciation and amortization (7.9 times).”
Meanwhile, Deutsche Bank analyst Bryan Kraft on Monday made the “buy”-rated stock his “new top pick in media,” explaining: “We view the new Warner Bros. Discovery as one of the best positioned companies in the global streaming video entertainment industry given its content and IP portfolio, combined with its widely recognized HBO Max brand and existing base of 92 million streaming subscribers. From a content perspective, we view WBD as number 1 in scripted general entertainment content given the Warner Brothers + HBO libraries and current production slates; and number 1 in unscripted given legacy Discovery’s content across its lifestyle brand portfolio. We also view CNN as a valuable and differentiating asset for WBD’s global streaming business; with sport rights in key markets also bolstering the company’s position, namely in the U.S. and Latin America.”
Kraft is forecasting the firm will reach 194 million global streaming subscribers by the end of 2026, noting: “Given that Netflix is already at 222 million subscribers, we believe there could be upside to our WBD forecast.” The analyst boosted his stock price target by $8 to $48.
MoffettNathanson analyst Michael Nathanson launched his coverage of the stock post-merger with a “neutral” rating and $27 price target though, summarizing in a Monday report entitled “Contender or Pretender?”: “We expect the elevated debt load and uncertainty around key strategic questions to be an overhang for shares. In addition, we are worried about the added pressure on WBD from AT&T’s shareholder base inclined to sell the 71 percent stake due to a different investment profile.”
The Wall Street expert also highlighted that “the world has changed in the year since the surprising Discovery-WarnerMedia deal was first announced on May 17, 2021.” After all, “given the current rising interest rate environment, investors have shifted away from using simplistic revenue multiples on total addressable market (TAM) narratives to more anchored fundamentals like sustainable profits or cash flow for valuation purposes,” Nathanson explained. “Now, there appears to be a greater focus on the costs to achieve long-term revenue growth and heightened interest about steady state profitability and industry cost structures. The current valuation of Warner Bros. Discovery appears to be a casualty of this sentiment change.”
The analyst added: “Also impacting sentiment is the fact that direct-to-consumer (DTC) subscriber growth across the industry has slowed for most companies, whether this is due to the pull forward nature of the pandemic or other SVOD specific reasons. This makes it more difficult for media companies earlier in their own DTC pivots to have the confidence necessary to go all-in on streaming, especially if the market isn’t rewarding them for doing so in the same way as last year.”
Nathanson also noted in his report that “while there are many still unanswered questions at WBD, the future of DTC growth will likely determine the future and shape of this new company.” He added: “At the top of the list, will the combination of HBO Max and Discovery+ be enough to lead WBD to growth?”
The analyst also addressed near-term financial challenges. “Despite potential upside with DTC, given WBD’s dependence on profits from linear cable networks in the declining pay TV ecosystem, it is hard to ignore the higher starting around five times gross debt,” Nathanson said. “In addition, heightened inflation and geopolitical risks combined with accelerated declines in general entertainment viewership have renewed fears of slowing high-margin advertising revenues. That said, perhaps an unexpected development over the past year has been the stability of pay TV declines. While it is relatively positive that we have yet to see cord-cutting accelerate much above the about 5 percent range, the industry-wide pivot to DTC puts increasing pressure on affiliate fee revenue growth.”
Meanwhile, the stock of AT&T opened down 22 percent on Monday at $18.89 after spinning off WarnerMedia and merging it with Discovery. AT&T CEO John Stankey sent a farewell memo to WarnerMedia employees on Friday, writing “I remain confident we have set the right path.”