Warner Bros. Discovery Looks to Max to Spur DTC Growth 

Senior Equity Analyst

Neil Macker

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Warner Bros. Discovery, the result of combining Discovery Communications and WarnerMedia, spun out of AT&T, is one of the largest media firms in the world with tremendous scale and reach. We project that the new company, led by former Discovery CEO David Zaslav, will use its combined content library and production capabilities to drive further growth in its streaming services as it navigates the transition toward a more direct-to-consumer focused model, centered on a combined HBO Max/Discovery+ service named Max. 

Warner remains one of largest traditional media powerhouses and owns a deep content library, strong TV and film studios, linear cable networks, and a growing streaming service in HBO Max. Beyond the flagship HBO marquee, Warner owns a number of well-known media brands including CNN, TNT, TBS, Cartoon Network, Warner Bros. Studio, and Bleacher Report. The firm controls major franchises via DC Comics (Superman, Wonder Woman), Adult Swim/Cartoon Network (Rick and Morty), HBO (Game of Thrones), and WB Pictures (Harry Potter). 

Discovery produces and owns unique unscripted content with proven appeal to audiences across cultures and languages. Discovery, TLC, HGTV, Food Network, and Animal Planet are the five flagship networks with the namesake channel reaching more than 81 million subscribers in the U.S. and 226 million subscribers and viewers internationally. The firm’s streaming service, Discovery+, has gained some early traction since launching in 2021. As it is already profitable, Discovery+ will remain a separate offering after the Max launch.

While Zaslav has not run a more traditional media company like Warner Bros., the longtime Discovery CEO presided over the transition of the firm from a cable network owner to unscripted content creation powerhouse. We expect that Zaslav will use his experience to help Warner Bros. Discovery transition into a DTC powerhouse by focusing further investment in both content and the user experience, which has garnered complaints on both HBO Max and Discovery+. Like its competitors, we expect the combined streaming service will expand internationally in order to reach the 2025 target of 130 million subscribers.

Business Strategy & Outlook

We assign Warner Bros. Discovery a narrow moat rating based on intangible assets. The combination of WarnerMedia and Discovery Communications has created a massive media firm with tremendous content production and distribution capabilities along with a very deep and wide content library. The new company owns a number of well-known networks including HBO, Discovery, CNN, and TLC as well as a slew of major entertainment franchises like Superman, Rick and Morty, and Game of Thrones. While we expect Warner Bros. Discovery to merge functions and offerings over the longer term, we do believe that the two firms, at least on consumer facing basis, will operate somewhat separately in the near term. 

Discovery is a vertically integrated content company that owns domestic and international channels and produces most of the nonfiction (or unscripted) programming that airs on its channels. The company’s three traditional main networks (Discovery, TLC, and Animal Planet) reach roughly 80 million households subscribing to basic cable in the U.S. with both Discovery and TLC each having more than 260 million international subscribers and viewers. The top two networks (HGTV and Food Network) acquired in the Scripps transaction are available in more than 82 million households in the U.S. Even as the media landscape continues to shift, we believe that Discovery’s exposure to international markets and content ownership provides a base to help weather any disruptions. The firm has used its unique content to launch Discovery+. While the service has gotten off to a decent start since its launch in January 2021, growth has slowed and we remain worried that the content slate for a standalone service may limit the addressable market.

WarnerMedia, now Warner Bros., was acquired by AT&T in 2018 and was then spun out to facilitate the merger with Discovery. WB is one of the oldest media firms as the namesake studio was founded in 1918 and incorporated in 1923. The current assets include the Turner Networks (CNN, TBS, and TNT among other), HBO and HBO Studio, Warner Bros. Studio, Cartoon Network, and Bleacher Report. The major franchises under control are some of the biggest in the world such as DC Comics (Superman, Wonder Woman), Adult Swim/Cartoon Network (Rick and Morty), HBO (Game of Thrones), and WB Pictures (Harry Potter, Matrix). Under the aegis of AT&T, WarnerMedia has begun the transition to the direct-to-consumer, or DTC, market by consolidating much of its most valuable content onto the HBO Max offering. Despite the strong library, concurrent streaming releases for the firm’s 2021 movie slate, and the consolidation of the traditional HBO subscribers, HBO Max still has a smaller subscriber base than either Netflix or Disney+. 

Despite changes in consumer behavior, pay-television penetration remains above 60% of U.S. households. The Discovery and Turner networks both remain important pieces in the traditional pay-TV bundle. While cord-cutting remains an ongoing issue, premier cable networks like Discovery and CNN still generate significant cash flows from both affiliate fees and advertising, with price increases generally outpacing the pace of customer losses. The firm’s combined network roster provides distributors with not only general entertainment but also live sports at the Turner channel and news at CNN and Headline, two genres that are keeping many subscribers in the pay-TV universe. Additionally, Discovery’s Food Network and HGTV have historically high live viewing rates comparable to other networks, providing additional value to advertisers and helping to retain subscribers. While we expect the pay-TV subscribers to continue to decline annually, the underlying networks remain profitable, and the cash generated will continue to be reallocated to support the direct-to-consumer efforts at Warner Bros. Discovery.

Even without a pay-TV subscription, most cord-cutters still desire to consume large quantities of video content. Both Discovery and Warner Bros. bring strong studios to the merger with minimal overlap among genres. Warner Bros. Studio is one of the five major film studios and finished as the second-highest in total box office grosses every year from 2016-19. On the television side, the combination of Warner Bros. and HBO made WarnerMedia one of, if not the, strongest creators in scripted programming with success in mass-market (Big Bang Theory, Manifest) and prestige (Succession, Game of Thrones). 

Despite many of its peers pulling back on licensing or producing content for other firms, Warner Bros. remains a supplier of programming to almost of its competitors in traditional TV and streaming. Recent examples of hit shows that were developed or co-produced by WB for outside distribution include Ted Lasso (Apple+), Manifest (NBC/Netflix), Queen Sugar (OWN), and Young Sheldon (CBS). While the new management team may reverse course on this practice, WB television content licensing for both in-house and outside consumption represented 18% of total pro forma 2021 revenue and we estimate well over 50% of that came from shows originally placed outside the firm. We expect the WB studios to continue to supply content to the best suited platform while keeping first-right of refusal for new shows and trying to retain steaming rights when possible. 

We believe that this platform-agnostic model has provided a virtuous cycle for WB Studios as the studio has been willing to find the best place for a new series and not simply shunt onto one of its own outlets. We think that this practice is more likely to help a new series become a hit while also attracting and retaining show creators who are deeply invested personally and financially in the success of their shows. The flood of money into the media landscape has somewhat weakened this cycle, but we believe it still exists. 

While Warner Bros. does produce unscripted shows, including The Bachelor and The Voice, Discovery Studio is considerably more productive in this space. The majority of the content on its domestic and international networks as well as on Discovery+ are produced in house at a relatively low cost as compared with scripted shows. Discovery has spent roughly $10.5 billion in total on content over 2019-21, which is less than either Netflix, Disney, or WarnerMedia spent in calendar 2021 alone. Even with its lower spending, Discovery owns a number of franchises including Deadliest Catch (Discovery), Chopped (Food), House Hunters (HGTV), and 90-Day Fiance (TLC). 

While we have been skeptical about the library value of the Discovery content, the recent demand for Discovery+ does show that there are fans of the programming that are looking to watch older shows. While other streaming services are creating their own unscripted content, we don’t believe that anyone else comes close to generating the number of hours or breadth of shows that Discovery does. We also think that competitors will continue to allocate time and marginal money to scripted shows, leaving Discovery in a relatively less competitive space. 

Since the production strengths of the two predecessor firms only overlap slightly, the merger of the content libraries and studios should help Warner Bros. Discovery’s DTC efforts. We expect that the new firm will begin to offer a discounted bundle of HBO Max and Discovery+ soon. Over the long term, we think that the content will be consolidated into one offering, more likely to be called HBO Max or some variant of that. We believe that the combined offering will be highly appealing to a number of consumers, especially if management holds the price below the pricing umbrella that Netflix has created in the U.S. and other developed markets. The scripted programming from WB, particularly the tentpole movies and prestige shows, would entice subscribers to join the combined offering. The deep scripted and unscripted content library and new shows should help to retain subscribers.

Narrow

Economic Moat

Warner Bros Discovery Inc

Warner Bros. Discovery, Inc. operates as a media and entertainment company. It creates and distributes a portfolio of content and brands across television, film, and streaming. Its brands and products include Discovery Channel, discovery+, CNN, CNN+, DC, Eurosport, HBO, HBO Max, HGTV, Food Network, Investigation Discovery, TLC, TNT, TBS, truTV, Travel Channel, MotorTrend, Animal Planet, Science Channel, Warner Bros. Pictures, New Line Cinema, Cartoon Network, Adult Swim, and Turner Classic Movies. The company is headquartered in New York, NY.

Earnings data Q2 2023

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Warner Bros. Discovery, Inc. operates as a media and entertainment company. It creates and distributes a portfolio of content and brands across television, film, and streaming. Its brands and products include Discovery Channel, discovery+, CNN, CNN+, DC, Eurosport, HBO, HBO Max, HGTV, Food Network, Investigation Discovery, TLC, TNT, TBS, truTV, Travel Channel, MotorTrend, Animal Planet, Science Channel, Warner Bros. Pictures, New Line Cinema, Cartoon Network, Adult Swim, and Turner Classic Movies. The company was founded April 8, 2022 and is headquartered in New York, NY.

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