Warner Bros. Discovery: Is This New Entertainment Stock a Good Investment?

Entertainment giant Warner Bros. Discovery (WBD 5.79%) was born April 8 from a merger between cable TV titan Discovery Inc. and WarnerMedia, the former entertainment division of AT&T. This newly formed firm released first-quarter earnings last month, but since the company didn’t exist in Q1, earnings its report covered only Discovery’s performance.

At this point, to know if the new Warner Bros. Discovery is a good investment, investors must separately examine the historical performance of WarnerMedia and Discovery and combine that data with the new company’s plans moving forward to form a more complete picture.

I did that legwork, and though it’s still early in the life of this global entertainment company, some key insights emerged. Here’s a look at the factors that can help assess whether Warner Bros. Discovery is a compelling long-term investment.

Image source: Getty Images.

What WarnerMedia and Discovery bring to the new company

The former WarnerMedia is the larger of Warner Bros. Discovery’s two half. Last year, WarnerMedia delivered $35.6 billion in revenue, compared to Discovery’s $12.2 billion.

WarnerMedia brings a deep film history as its motion picture studio prepares to celebrate its 100th anniversary next April. It also touts globally recognized, iconic brands, such as the Harry Potter and Batman films. TV networks are a part of the mix too, including HBO, a subscription service with a reputation for quality programming, such as its Game of Thrones series. Discovery adds a slew of well-known TV brands that include Oprah Winfrey’s OWN channel, HGTV, and the Food Network.

HBO is home to WarnerMedia’s streaming service, HBO Max, which has steadily grown in subscriber count since debuting in 2020. HBO’s total subscribers reached 76.8 million in Q1 compared to 55.6 million at HBO Max’s launch. Thanks to its streaming service, HBO added over 13 million subscribers in 2021, the highest of any year in HBO’s half-century history.

Discovery’s own direct-to-consumer (DTC) efforts in the form of its streaming service, discovery+, have also seen steady growth since the streaming product’s launch in 2021. DTC rose from 15 million at the end of Q1 last year to 24 million this year.

While streaming competitor Netflix reported subscriber losses in its Q1 earnings report, HBO Max and discovery+ continued to grow. Both gained a combined 5 million subscribers in Q1.

A diversified plan for the future

Warner Bros. Discovery plans to combine its two streaming services to strengthen its consumer offering. This strategy also smartly avoids requiring customers to manage multiple streaming solutions.

While streaming services are important, the management team’s approach to Warner Bros. Discovery’s business is one of the more compelling aspects of the new company. CEO David Zaslav stated Warner Bros. Discovery will not engage in the entertainment industry’s “direct-to-consumer spending war.”

Rather than be dependent on streaming subscriptions, Warner Bros. Discovery will produce revenue through diverse sources including advertising, theatrical ticket sales, and content distribution deals. The company will take a measured approach to its growth, focusing on profitability and healthy free cash flow generation.

This approach is one reason why Warner Bros. Discovery shuttered the newly launched CNN+ streaming service, implemented by WarnerMedia before its merger with Discovery. The Warner Bros. Discovery management team recognized CNN+’s return on investment didn’t warrant continuing the service.

The company can afford to make such choices. Both Discovery and WarnerMedia are experiencing rising revenue. Thanks to growth in advertising and discovery+ subscriptions, Discovery saw Q1 income increased 13% year over year to $3.2 billion, which continued the double-digit revenue growth Discovery experienced in 2021.

Meanwhile, WarnerMedia saw 2.5% year-over-year Q1 revenue growth to $8.7 billion on the strength of expanding streaming subscriptions, theatrical ticket sales, and other revenue sources such as video game licensing. Q1’s increase followed double-digit growth in 2021 which saw $35.6 billion in revenue, exceeding 2020’s $30.4 billion.

Short-term pain, long-term gain

Warner Bros. Discovery’s goals are helped by Discovery’s pinchant for generating strong free cash flow. The company ended 2021 with $2.4 billion in free cash flow, up 4% from 2020. In the first quarter of 2022, free cash flow was up 33% to $238 million compared to $179 million last year.

On the other hand, WarnerMedia isn’t up to snuff, according to Warner Bros. Discovery CFO Gunnar Wiedenfels. In his review of WarnerMedia’s financials, he stated, “Q1 operating profit and cash flow for WarnerMedia were clearly below my expectations.” He also indicated that “2022 will undoubtedly be a messy year,” given the integration work to be done between WarnerMedia and Discovery.

But once past this year’s integration efforts, Warner Bros. Discovery expects to capture $3 billion in cost savings, such as efficiencies in marketing spending by the newly combined company.

For investors who can endure this year’s ups and downs as the company goes through its integration efforts, Warner Bros. Discovery has the potential to be an excellent entertainment stock.

When looking beyond 2022, the company’s disciplined approach to financials, its diverse revenue streams, and its impressive mix of content and brands are key factors that make Warner Bros. Discovery a worthwhile, long-term investment.

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