My thesis is that Warner Bros. Discovery (NASDAQ:WBD) faces challenges given the knowledge we acquired after the 2Q22 interval closed.
Projections Were Too Optimistic
Management is struggling to satisfy previous projections. Back on June 4th, I tweeted that I didn’t perceive how administration might present an adjusted EBITDA slide in a single a part of the May 2021 “Discovery and WarnerMedia to Combine” presentation however then say the next in one other a part of the identical presentation:
Adjusted EBITDA estimates rely upon future ranges of revenues & bills which should not fairly estimable at the moment. Accordingly, we’re not capable of present a reconciliation between adjusted EBITDA and essentially the most comparable GAAP metric with out unreasonable effort.
This is unbelievable! They have been capable of make the slide and boldly current it, however they then stated it requires “unreasonable effort” to clarify the numbers within the slide:
In the 2Q22 name, administration confirmed that the $14 billion adjusted EBITDA quantity for 2023 within the above slide is flawed:
Based on the total yr affect of our 2022 corrective actions and $2 billion to $3 billion of synergy realization in 2023, we anticipate adjusted EBITDA to be no less than $12 billion.
The 60% FCF conversion determine within the above slide can be unrealistic till after 2023. This is what administration stated about it within the 2Q22 name:
We anticipate to transform roughly 1/3 to half of our adjusted EBITDA into free money move in 2023 as we make progress in the direction of our long-term goal of roughly 60%.
This is a prodigious distinction for FCF in 2023. The slide above says $14 billion in adjusted EBITDA with a 60% FCF conversion, that means about $8.4 billion in FCF. The 2Q22 name says $12 billion in adjusted EBITDA with a 1/third to 1/2 FCF conversion, that means FCF of about $4 billion to $6 billion.
Like every little thing else within the slide, the income quantity is flawed too. The slide exhibits $52 billion in total income, with $15 billion or extra coming from DTC. The 2Q22 presentation exhibits that year-over-year income development for DTC was solely 4% from $2,352 million in 2Q21 to $2,410 million in 2Q22. Annualizing the 2Q22 figures offers us $9,640 million, and it isn’t practical for this to leap to $15 billion or extra for 2023:
Unlike rivals comparable to Netflix (NFLX), WBD has important debt, such that their enterprise worth (“EV”) is way greater than their market cap. Looking on the 2Q22 10-Q, now we have $51,388 million long-term debt plus $1,097 million short-term debt plus $328 million redeemable noncontrolling pursuits plus $1,236 million noncontrolling pursuits. This is partially offset by $2,575 million money, such that the enterprise worth for WBD is round$51.5 billion greater than the market cap.
Debt is way lighter at Netflix such that their enterprise worth is barely about$8.4 billion greater than their market cap as a consequence of $14.2 billion in long-term debt that’s partially offset by $5.8 billion in money
In the 2Q22 name, CEO David Zaslav defined that WBD has 4 to six “cash registers” or income sources:
We successfully have 4, 5 – 6 money registers. If there’s a money register the place a client can are available and both watch or pay for a chunk of content material, now we have each platform within the ecosystem. And in a world the place issues are altering, and there’s a lot of uncertainty and there’s a lot of disruption, that’s much more steady and lots higher than having one money register.
Having a number of money registers in a altering world may be each a blessing and a curse relying on components like sturdiness. The DTC streaming money register continues to develop in significance, and The Innovator’s Dilemma by Clayton Christensen explains that having a number of money registers may be problematic as a result of the non-streaming money registers can stop administration from specializing in the DTC streaming money register. One trace of this focus dilemma was the remark administration made within the 2Q22 name relating to the discharge of direct-to-streaming movies:
As movies transfer from one window to the following, their total worth is elevated, elevated, elevated. We noticed this clearly demonstrated with the Batman and Elvis. We have a unique view on the knowledge of releasing direct-to-streaming movies, and now we have taken some aggressive steps to course appropriate the earlier technique.
In the 2Q22 name, administration made extra feedback about windowing that might damage their DTC streaming product:
For many years, our business has embraced altering expertise and client demand by evolving a really profitable windowing strategy to exploiting content material. However, lately, a technique has emerged that implies the video enterprise shall be higher off collapsing all home windows into streaming, overpaying for and overinvesting in content material and providing all of it on the similar time for a low worth. We do not consider on this technique.
The legacy networks register is by far the most important contributor to EBITDA, and one hazard is that administration will focus an excessive amount of on this money cow and never give the DTC streaming enterprise the eye it wants:
Having only one money register, Netflix is galvanized to get streaming proper. WBD can get it proper as nicely, however they might face struggles with respect to focus.
Per the 2Q22 10-Q, the streaming enterprise had a quarterly professional forma working lack of $(1,534) million. I don’t suppose the $472 million restructuring fees symbolize future economics, so I consider the working loss as being nearer to $(1,062) million in sensible phrases. The 10-Q additionally exhibits the identical figures we noticed within the 2Q22 presentation slide above – quarterly DTC adjusted EBITDA of $(560) million on quarterly DTC income of $2,410 million:
Here are the brand new streaming parameters from the 2Q22 presentation:
In the 2Q22 name, CEO Zaslav targeted on the U.S. DTC break even expectation for 2024 and the $1 billion international DTC EBITDA for 2025:
But the quantity — the quantity on the nook of JB’s desk and mine is the breakeven and the $1 billion. If we try this – I do not actually care what the [subscriber] quantity is. We’re not within the enterprise of attempting to choose up each sub. We wish to ensure we receives a commission. We receives a commission pretty. We have very high-quality content material in lots of markets, we must be paid extra as a result of we’re offering dramatically higher content material and extra strong content material and better high quality content material. If the [sub] quantity is 122 and we’re making over $1 billion, that’s the quantity for us. We’re going to develop subs considerably, however we wish to run – we wish to drive profitability and free money move.
Today’s quarterly DTC income determine of $2.4 billion is a far cry from Netflix’s 2Q22 quarterly income of $8 billion. Part of it’s because Netflix has higher month-to-month common income per person (“ARPU”). The Netflix 2Q22 letter exhibits ARPU of $15.95 for the U.S. and Canada, $11.17 for Europe, the Middle East and Africa, $8.67 for Latin America and $8.83 for Asia Pacific. Meanwhile, Discovery International CEO Jean-Briac Perrette defined within the 2Q22 name that the WBD ARPU figures are decrease:
Turning to ARPU. As we simply reported, our present ARPU is sort of $8 globally, comprised of practically $11 domestically and nearly $4 internationally.
It shall be tough for WBD administration to maintain up with the breadth of content material we see at Netflix with out the good thing about the amount of streaming income we see from Netflix. In the 2Q22 WBD name, EVP of Global Investor Strategy Andrew Slabin defined this want of getting a breadth of content material as a way to hold churn below management:
And finally, the breadth of the providing issues to get the churn down so that there is one thing for everybody within the family, everybody within the household. And we have seen it throughout all our knowledge factors the place the extra individuals you have got in a family, utilizing the service, the stickier it’s, the decrease your churn is the extra viable our companies. And so on the finish of the day, placing all of the content material collectively was actually the one choice we noticed to creating this a viable enterprise.
Looking on the 2Q22 presentation, adjusted quarterly EBITDA is $1,764 million, which involves $7,056 million annualized. This excludes curiosity on debt so I feel by way of enterprise worth as a substitute of simply market cap when taking a look at this metric. Given the expansion expectations, I wouldn’t be shocked if some buyers suppose the enterprise worth must be 10 to 12 instances this annualized determine, or $70.6 billion to $84.7 billion.
If we change over to FCF, then curiosity on debt is included, so we are able to hone in on market cap. Eventually administration hopes to transform 1/third to 1/2 of adjusted EBITDA to FCF in order that hopeful FCF determine is $588 million to $882 million quarterly and $2,352 million to $3,528 million annualized. I feel some buyers would wish to see WBD’s market cap at about 10 instances this annualized vary, or $23.5 billion to $35.3 billion.
Per the 2Q22 10-Q, there have been 2,427,592,861 shares as of July twenty first, and we multiply this by the August tenth share worth of $13.10 to get the market cap of $31.8 billion. As we defined above, the enterprise worth is considerably greater than the market cap, coming in at $83.3 billion for a distinction of $51.5 billion.
The market cap and enterprise worth are within the vary many would anticipate. Given the uncertainty from the best way administration has modified numbers just lately, I’m pretty impartial and I don’t have a robust feeling in help of or towards Mr. Market at the moment. Technically I’m lengthy as a result of I purchased a single share, however I’m impartial from a sensible perspective as I proceed to be taught extra about this enterprise and take into consideration if and once I ought to construct an actual place.