Friday Mailing: Warner Bros. Discovery Is "A Real Company" Facing A Flip-of-a-Coin Future
Two quick follow-ups to past mailings:
To Monday's Bored Ape Yacht Club, Hello Sunshine, World of Women & New Frontiers for IP, Nilay Patel of The Verge interviewed Tonya Evans, a law professor at Penn State Dickinson Law, about crypto assets and how they interact with the law (transcript and audio can both be found here)
To Three More Acquisitions from Blackstone's Candle Media (Kevin Mayer & Tom Staggs) from early January, Hello Sunshine made its first acquisition since having been acquired itself by Candle Media last year. It acquired The Home Edit, founded by stars of the Emmy-nominated Netflix series "Get Organized with the Home Edit". The move aims to help accelerate the household organizing outfit’s move into a lifestyle brand.
Warner Bros. Discovery Is "A Real Company" Facing A Flip-of-a-Coin Future
David Zaslav -Discovery Chairman and soon-to-be CEO of WarnerBros. Discovery - has been one of the more entertaining people to watch navigate the disruption from streaming. There has been an enviable boldness and shamelessness to his salesmanship of and advocacy for his business.
discovery+ has been sold to investors with analogies to an SUV, and Zaslav promised investors at last year's Goldman Sachs Communicopia Conference that the content spend of Warner Bros. Discovery would "shock and awe":
We don’t want to be confusing and we also want to put ourselves in a position for a shock and awe global strategy, when you look at the menu – the diversity, the power of the content that we have in one place when this company comes together.
The shamelessness was noticeably dialed back in Zaslav's introductory sales pitch for Warner Bros. Discovery in yesterday's call:
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.
Zaslav and his team were asked often about cost management, cost savings and the impact of greater cost spend on EBITDA and free cash flow. Amusingly, despite promises of being "careful and judicious", Zaslav returned to his SUV analogy (which seems to have been downgraded to a car) and his "shock and awe" logic in his answer to the final question of the call:
Would we do - [would] HBO be doing a lot better if it had three more really successful scripted series at this moment. It's not clear that they would be. Why? It's sort of the example of if you took Food Network and you said that we do 600 hours on Food Network and we nourish an audience and they're happy and they like it and they feel like that's their place, and we make $400 million as an example.
If we decided to do another 400 hours of content, then maybe the audience would be a little bit happier. But now we'd make no money. And so, when you put Euphoria on and then that audience could then watch 90 Day Fiancé and they could watch Fixer Upper, that there's a real balance of content here that we can go to. And there's a lot of nourishment in our library together with a lot of shock and awe in the Warner library. And the shock and awe together with the nourishment and the great personalities, we think is a really compelling menu. And it's a great recipe that we think we can lean into.
We're going to spend more on content, but you're not going to see us come in and go, all right, we're spending $5 billion more, because the first thing we're going to see is we have so much rich content and so much nourishment, as well as so much content that's compatible or reaches different audiences that they don't reach, that the excitement is going to be when we come together. Let's take this car out for a ride. Let's see how this does. We're going to continue to spend, but don't expect us to come out and go a couple of billion dollars more and off we go.
No, we're going to be measured. We're going to be smart and we're going to be careful, but we're going to invest in the streaming platform. But that's not our only game. Our game is to create a business that generates sustainable growth, that's global in nature, that generates a lot of free cash flow. And we're quite confident in the numbers that we've given you. If something changes in the next year and a half that we think there's a substantial amount of opportunity for long term growth and long term economics, we'll come back to you with it, but we're quite comfortable doing it.
I think there are a few things in this quote that are worth teasing out.
Marginal Return on Spend
I wrote in The Curse of the Mogul Strikes Back in 2022 that audiences may not be in "shock and awe" if content cannot break through:
...content spend is escalating, while the risk of "nothing [cutting] through" to mass audiences is escalating. There will be $115B in content spend in 2022 with fewer guarantees of success, if not increasingly opaque definitions of success emerging.
Notably, Zaslav is conceding this is risk is now a market reality.
There is also an implicit concession that the 20% drop in Paramount Global's (née ViacomCBS) stock price after its earnings call has had aftershocks. I think Paramount management's projection of $1B in operating income losses through 2024 had the unintended effect of reinforcing deeper questions about whether streaming is a good business, at all.
The emphasis on EBITDA and Free Cash Flow in both the analyst questions and Zaslav's response played out as a bit of a dance over how he foresees "shock and awe" playing out in the marketplace. Zaslav is not walking the analogy back, per se, but it now raises more questions than he and Discovery management seem comfortable with.
Warner Bros. Discovery & "Less is More"
In Wednesday's Fox's "Less is More" & Paramount Global (née ViacomCBS) in 2022, I wrote about "how the 'less is more' simplicity of Fox's corporate structure and focus contrasts with the complexity of Paramount's."
I concluded:
If 2022 marks a crossroads for [Paramount Chairwoman Shari] Redstone that mirrors the one she faced in 2017, there are plenty of simpler business models that Wall Street is more inclined to reward with a higher P-E ratio than the one Redstone has pursued by betting so heavily on streaming.
Discovery currently has a PE ratio of 15, almost 3.5x that of Paramount and 90% of Fox Corporation.
So, investors like Discovery's model as much as they Fox Corporation's, and more than Paramount's.
That said, the lurking issue in this call is whether Warner Bros. Discovery will be a better business as a larger entity. Part of this reflects the question of whether Warner Bros. Discovery's value proposition will be something that customers will want. It also reflects whether Warner Bros. Discovery is making a Shari Redstone-type of zigging where Fox's "less is more" strategy zagged.
This line from Zaslav's answer, above, left me suspect:
"...when you put Euphoria on and then that audience could then watch 90 Day Fiancé and they could watch Fixer Upper, that there's a real balance of content here that we can go to.
We have yet to hear from the data-driven WarnerMedia and HBO Max leadership release data that this is what streaming consumers actually do on the app. So, it invites the logical question of whether Zaslav may be spinning the combination too hard here.
Churn
Current HBO Max EVP and GM Andy Forssell has been rumored to be leaving with current WarnerMedia CEO when the merger closes. HBO Max ended 2021 with quite the growth story.
HBO Max has a better growth story than Discovery's: 20% growth to 73.8MM subscribers, versus Discovery doubling its base of streaming subscribers globally to 22MM. The more interesting question is churn, which Zaslav described as "still not certainly even on par with some of the best in market yet".
JB Perrette - Discovery’s president and CEO of streaming and international and the presumptive heir to the HBO Max business - recently discussed Discovery's struggles with churn in streaming at a streaming conference hosted by Wall Street research firm MoffettNathanson:
“How do you make sports something other than a pay-per-view business? It becomes very challenging from a churn perspective, which is why we decided to collapse our EuroSport business into our Discovery+ product."
The takeaway is that if churn is a problem for Discovery now, it is only going to get worse when existing HBO Max management leave.
In other words, these two streaming businesses simply may not belong together, nor under this management team.
A Flip-of-a-Coin Future
It's obvious why investors have confidence in Zaslav and his management team: the story continues to be managing towards positive free cash flow, and they deliver on their promises.
HBO Max as a business that requires more spend and within a larger entity that offers $14 billion EBITDA and $8 billion free cash flow guidance for 2023. The risk of losses on content spend may be mitigated in the new model.
Then again, the implication from the above is maybe not. HBO Max will be under a different management team and a less ambitious set of streaming objectives focused on competing with, and not defeating, the competition. The interesting question of when, and not even if, growing production costs start eating into the projections of EBITDA and free cash flow.
I recently heard a compelling case (off-the-record) from a media CEO that by Q4 this year we will start seeing more public media companies see their bottom lines get hit by expanding production costs.
One has to wonder how quickly these costs will hit Warner Bros. Discovery. David Zaslav's answer, above, suggests there is a real risk it will be sooner than later:
Let's take this car out for a ride. Let's see how this does. We're going to continue to spend, but don't expect us to come out and go a couple of billion dollars more and off we go.
If it seems hard to predict the future of Warner Bros. Discovery, that's because there are so many moving pieces that a coin flip may provide a better answer.