AT&T Warner Media Spin-off/Merger with Discovery Notes

May 20, 2022 Update

Good overview of Warner Brothers Discovery

  • Warner Brothers Discovery is the second biggest media company based on revenue after Disney
  • Warner Media brings a valuable content library and a streaming service with 96m subscribers (3rd biggest)
  • Discovery brings even larger distribution networks with ~2b global viewers
  • The mix of old and new media success will be beneficial to providing a winning strategy in the streaming wars

May 10, 2022 Update

AT&T (T) completed its full spin-off of Warner Media on April 8th and both stocks started trading separately on April 11. As part of the deal, Warner Media merged with Discovery (DISCA).

AT&T shareholders received 0.24 shares of Warner Bros. Discover (WBD) for each AT&T share owned. Warner Bros. initially performed well but has slumped recently. The reason? 1) NFLX announced disappointing results, bringing down the whole streaming industry and 2) WBD reported a “messy” quarter.

I think the stock looks very attractive from a valuation standpoint. WBD is trading at 6.5x 2023 EBITDA guidance and 5.3x 2023 FCF guidance. 2023 guidance was re-iterated on the Q1 2022 call. It obviously looks cheap relative to Netflix (15x EBITDA) but also looks extremely cheap on an absolute basis. Further, with the merger, Discovery will no longer have “terminal” risk.  In other words, assuming cable goes to zero (due to cord cutting), it still has a future.

I do have a couple concerns.

1) The stock chart looks horrible (for those that care about it)
2) As of 4/28/2022, only 22% of shares have traded since the spin-off but at the time of the spin, legacy shareholders owned 71% of shares outstanding. As such, selling pressure could continue for the foreseeable future.

April 10, 2022 Update

  • With Warner Brothers Discovery (WBD) having its first day of trading tomorrow (4/11/2022) how do you value each of the pieces?
  • RemainCo (AT&T):
    • Verizon a good comp for RemainCo trades at 10x P/E
    • AT&T is currently trading at an 8.7x P/E
    • Verizon has a 4.78% dividend
    • AT&T will pay about a 4.6% dividend
  • SpinCo (Warner Brothers Discovery):
    • Compared to the competition Warner Brothers Discovery will have to be at least as strong as Disney and Netflix to really compete and survive as a top-end streamer
    • The bottom line seems strong,  with combined Quality from Warner HBO (already high ARPU) and stickiness from Discovery+ large content library plus global reach
    • Warner HBO and Discovery both also possess a low valuation compared to Netflix, Disney, and Paramount
    • WBD will have an annual $20b content spend compared to Netflix at $17b and Disney at $33b
    • Discovery brings global reach so WBD will operate in 220 countries/territories and 50 languages
    • WBD also has sports rights like NBA, European Soccer, and more
    • WBD expects to make $23.4b in free cash flow (FCF) in 2022
    • One area to watch is debt WBD will have $58b in debt to start off and around $3.4b available to pay it down after content investments
    • Comparing WarnerHBO’s and Discovery’s ARPU with competitors shows possible room for pricing growth
Streamers # of Subscribers ARPU* Forward P/E
Netflix 222m $14.78** 32
Disney+ 118m $4.41 (Global) 31****
Paramount+ 56m ~$9 (Global) 13
Warner HBOMax 74m $11.15*** N/A
Discovery+ 22m $7 (Global) 8
PlutoTV (free with ads) 64m $1.64 (Global), $2.64 (US) 13

*ARPU stands for Average Return Per User and it is measured monthly

** This return only on 75m US and Canada users

*** This return only on 46m US users

**** Disney has other businesses that adjust this as well

March 4, 2022 Update

Good overview on the setup of the WarnerMedia spinoff

  • Both AT&T and Discovery seem like potential opportunities

February 15, 2022 Update

Good write up on some uncertainty around the WarnerMedia spinoff

  • The recent exit of Jeff Zucker head of CNN caused a lot of confusion and frustration within WarnerMedia as little consistent information was given about the resignation
  • On top of this WarnerMedia is being sued by Village Roadshow Entertainment Group the co-producer of “The Matrix Resurrections” for releasing the movie on HBOmax at the same time as theaters
  • Village Roadshow has also said WarnerMedia has been restricting its ability to co-own and co-finance new content that is derived from WarnerMedia’s films

February 3, 2022 Update

  • As the AT&T WarnerMedia spin-off approaches some things to keep in mind about the merger with Discovery
  • Discovery as a whole has ~3b viewers worldwide in 220 countries the best network for content distribution by far. HBO has historically not focused on international growth, Discovery gives them the distribution rails.
  • HBO Max/WarnerMedia owns some of the highest quality TV and movie content of any streaming service
  • Together they have better content and distribution than any other service
  • Also, both WarnerMedia and Discovery own rights to sports like NBA and EuroSport: Soccer, Motorsport, Tennis, etc. (respectively)
  • Almost of all Discovery’s existing content uses niches like cooking, home improvement, nature channels to maximize each of its channels
  • Warner Bros Discovery combined is expecting $52b in 2023 revenue (over $15b is from direct to consumer/streaming)
  • They project ~60% FCF conversion
  • For reference, Netflix revenue is ~$30b
  • HBOMax has over 73m subscribers. Discovery Plus has around 25m streaming subscribers as of Q3
  • SpinCo can be compared to Netflix or the streaming portion of Disney
  • RemainCo (AT&T) can be compared to Verizon and T-Mobile

February 1, 2022 Update

  • AT&T just announced that they have opted to spin off WarnerMedia in a $43b deal to Discovery
  • The spin-off is still expected to occur in Q2 2022
  • Along with this AT&T has announced an almost 50% dividend cut
  • This cut is important because many investors hold AT&T for the sizable dividend (i.e. this may cause sell offs)
  • AT&T shareholders will own 71% of WarnerMedia Discovery
  • AT&T shareholders will receive 0.24 shares of WarnerMedia Discovery for every share of AT&T

January 27, 2022 Update

Good article on why AT&T needs more than a spin-off to reassure its investors

  • AT&T had a lot of growth in its user base this year (4.5 million new users) but analysts don’t believe that is sustainable because AT&T afford to continue to giveaway phones
  • AT&T was behind on 5G technology, however, they have started to catch up and even invested $9.1b into 5G development last year
  • This spending should continue with the company planning ~$20b in total capital expenditures for this year
  • Post spin AT&T also has said it wants to improve its debt to earnings ratio

January 20, 2022 Update

Good article on the spin/merger situation

  • In the case of a split, not a spin, shareholders could choose if they want to receive Warner Bros Discovery stock or just hold AT&T
  • If the split occurred then AT&T could “retire” about a quarter on its shares at a low price simulating a buy-back
  • In the split off AT&T would possess a competitive valuation compared to Verizon as well as better dividend
  • In the case of a spin off, there would be 1.7b shares distributed to shareholders meaning for every 4 shares of AT&T shareholders would receive 1 share of Warner Bros Discovery
  • Each share would be worth ~$7 for Warner Bros Discovery in the spin scenario

May 21, 2021 Update

On May 17, 2021, AT&T Inc.(NYSE:T) announced that it had reached a deal to combine WarnerMedia, including CNN, HBO, TNT, TBS, and and Warner Bros. studio, with Discovery Inc. (NASDAQ: DISCA), creating a new publicly traded company.

The move comes just three years after AT&T’s creation of WarnerMedia through its $85 billion acquisition of Time Warner, which was scrutinized by the DOJ on antitrust grounds. 

This combination of Discovery, Inc. and WarnerMedia will form one of the largest global streaming players. The new “pure play” content company will own one of the deepest content libraries, with over 200,000 hours of programming across all streaming platforms. 

The deal is expected to create substantial value for shareholders of both companies, better positioning them to take advantage of growing DTC (direct-to-consumer) trends in the media industry. The construction of the new company will create significant scale and investment resources with projected 2023 Revenue of approximately $52 billion, adjusted EBITDA of approximately $14 billion, and an industry leading Free Cash Flow conversion rate of approximately 60%. It is also expected to create at least $3 billion in cost synergies annually for the new company to increase its investment in new content and scale its DTC business.

Under the terms of the agreement, which is structured as an all-stock, Reverse Morris Trust transaction, AT&T would receive  ~$43 billion, in a combination of cash, debt securities, and WarnerMedia’s retention of certain debt. AT&T’s shareholders would receive stock representing 71% of the new company, and Discovery shareholders would own 29% of the new company. This transaction is anticipated to close sometime mid-2022.