Warner Bros. Discovery Stock Drops as Post-Merger Update Doesn’t Impress Wall Street

A day after unveiling its quarterly earnings, Warner Bros. Discovery shares were falling sharply in Friday trading as investors and analysts debated the Hollywood giant’s outlook for its combined streaming, or direct-to-consumer (DTC), strategy and cost-savings plan.

Some financial observers saw the need to reduce their stock price targets, and at least one expert also downgraded his stock rating, while others stuck to their ratings and targets. Here is a look at analysts’ actions and commentary after WBD’s Aug. 4 earnings disclosure.

Analyst: Wells Fargo’s Steven Cahall
Call: Downgrade to “equal weight,” slashed target from $42 to $19.
Report title: “A Glitch in the Matrix”

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The analyst downgraded his rating on shares of Warner Bros. Discovery on Friday with movie references. “A Glitch in the Matrix,” he called his report, cutting his rating from “overweight” to “equal weight” and slashing his stock price target from $42 to $19. Management’s reduced 2023 financial guidance and more cautious streaming outlook “indicates a company going through a lot of post-merger growing pains,” he argued. “The assets are great, but the risks and capital structure create a greater range of outcomes.”

In another Matrix reference, he then used the paragraph headline “I should have taken the blue pill,” saying: “While we love the WBD collection of assets, we’re incrementally negative on the medium-term outlook. We didn’t appreciate the complexity of the task of integrating WarnerMedia, and we think Discovery similarly has gotten a little more than it bargained for. Direct-to-consumer is challenging enough for the peer group like Walt Disney, Comcast, Netflix and Paramount Global, and they’re not trying to simultaneously improve under-managed assets, integrate complex organizations and aggressively deleverage.”

Cahall argued that investors can wait to buy the stock once things clear up more. “Discovery was a roughly $45 stock prior to the deal, these assets are the best in content offerings, so when things do start to improve we think investors will be able to be late and still have plenty of upside,” he concluded.

Analyst: CFRA Research’s Kenneth Leon
Call: Reiterated “hold,” cut price target from $23 to $16.

The CFRA Research analyst stuck to his “hold” rating on the stock, but cut his price target by $7 to $16 on lowered financial forecasts for 2022 and 2023. “WBD’s share price is expected to react negatively to disappointing results. Management is facing headwinds trying to integrate a complex integration of the merger,” he highlighted. “WBD is changing its video streaming plans to be more effective in finding ways to realize higher profitability. … WBD is exiting unprofitable units and spending capital to create integrated streaming platforms for HBO Max and Discovery+ that will take time to do.” His conclusion: “We think WBD lags in a tough competitive TV market facing larger streaming providers.”

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Analyst: Goldman Sachs’ Brett Feldman
Call: Maintained “buy,” lowered price target from $22 to $21.
Report title: “Maintain Buy following DTC strategy update”

The Goldman Sachs analyst maintained his “buy” rating on Warner Bros. Discovery, but also lowered his stock price target, if only by $1 to $21. “The integration of WarnerMedia and Discovery may be a bit more difficult than anticipated, primarily because WarnerMedia’s fundamental trends are worse than management had expected and therefore require course correction,” he wrote. “WBD lowered its near- to mid-term pro forma guidance to reflect weaker trends at WarnerMedia, increased streaming competition and economic headwinds. We believe investors had expected WBD to lower its outlook, although the revised targets are likely at the low-end of investors’ expectations.” All in all, the expert said he stuck to his “positive investment thesis as we continue to believe that the merger of Discovery and WarnerMedia positions WBD to achieve material scale as a global streamer while also fortifying its linear networks business and driving significant cost synergies.”

Analyst: MoffettNathanson’s Robert Fishman
Call: Reiterated “market perform” and $18 target.
Report Title: “Reality First, Dreams Second?”

The MoffettNathanson expert maintained his “market perform” and $18 target for the company. “We expect the elevated debt load, macro headwinds and growing secular pressures from faster cord-cutting along with still some uncertainty around key strategic questions to be an overhang for shares,” he explained.

Fishman also outlined possible challenges ahead. “The lower 2023 earnings before interest, taxes, depreciation and amortization (EBITDA) guidance of $12 billion-plus versus $14 billion previously highlights WBD’s deep dependence on profits from linear cable networks that are under increasing pressure in a declining pay TV ecosystem,” he explained. “The risk is that accelerating cord-cutting and linear ad weakness could further pressure networks’ profitability, which may offset any DTC improvement after expected peak losses in 2022.”

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Analyst: Cowen’s Doug Creutz
Call: Reiterated “outperform” and $24 target.
Report title: “Prudent and Sensible Is an Approach We Can Work With”

The Cowen analyst shared one of his key takeaways in his report. “The fact that WBD management is so clearly laser-focused on managing the business for free cash flow generation over the long term will only make shares more attractive to value-oriented investors, particularly compared to other media names that still seem somewhat unsure about whether top-line growth or bottom-line performance is the more important metric,” he argued.

Cruetz said that investors had expected management to “deliver clear answers on two questions: first, what are the company’s plans to merge the HBO Max and Discovery+ services, and second, are there any changes to the company’s fiscal year 2023 $14 billion EBITDA financial guidance that was first given in May 2021.” His analysis of management commentary: “While the answers may not have been all that we had hoped for, particularly on the second question, management’s presentation was thoughtful and clearly explained.”

Creutz also noted that the company’s shares “had jumped 21 percent in the last six trading days” before Friday’s drop, concluding: “Ultimately, we believe yesterday was a clearing event and that we have likely seen a bottom in shares, barring another significant leg down for the overall market.”

Analyst: Barrington Research’s Jim Goss
Call: Reiterated “outperform” and $25 stock price target.
Report title: “Introduction of New Service Discussed but Without Specifics”

Barrington’s Jim Goss summarized the company’s strategic updates this way: “Warner Bros. Discovery spent a considerable amount of time and effort to shed some light on its plans to blend the two disparate (streaming and other) services and cultures into a new programming opportunity. However, it did not get granular in that regard, preferring to point to an investor day toward year end at which more detail will be laid out.”

He also warned: “We continue to feel there is a major challenge in blending services that range as broadly as Discovery unscripted through HBO super premium.”

Goss noted that the launch of a combined streaming service “will be sequential in terms of geography, starting (with) the U.S. first next summer and then moving onto other areas. Peak losses are expected in 2022, with the U.S. profitable in 2024 and global profitability in 2025.”

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Analyst: Barclays’ Kannan Venkateshwar
Call: Maintained “equal weight” and lowered price target from $19 to $17.
Report title: “Kitchen sink quarter; but will it be the last one?”

Barclays’ Kannan Venkateshwar highlighted Wall Street concerns ahead of the latest quarterly results. “Going into earnings, there was an expectation among investors about WBD cutting guidance, but revisions were bigger than anticipated,” he wrote. “Lack of near-term catalysts, limited visibility and execution risk may result in valuation discount persisting.”

The expert explored whether new streaming expectations were realistic. “The company re-based HBO numbers from around 100 million at the end of the first quarter to 90 million as AT&T was apparently counting HBO subs who got the service as part of a distribution bundle but never activated the account,” he explained. “Discovery also removed a base of non core streaming services (like Motor Trends, Eurosport Player etc) from the count, which were previously counted as part of (the) Discovery+ sub base. From this rebased number, the company expects to grow to 130 million subs by 2025. For context, this compares to HBO’s long-term guidance of 120-150 million subs by 2025 and our expectation of Discovery+ subs of 40.5 million by 2025 and so in some ways is coming down from around 175 million subs to 130 million subs.”

Venkateshwar then noted the possible hurdles for reaching the target. “While this appears to be achievable as the company will have to do about 11 million subs annually on average in the next 3.5 years versus the around 5 million that we expected Discovery+ alone to do annually, this goal may still prove to be a meaningful lift in the context of the broader competitive landscape.”

And the Barclays analyst noted the likely average revenue per user (ARPU) impact. “Most of this growth will come from outside the U.S. given the already high penetration in the U.S. (53 million of the 92 million subs at the end of the second quarter of 2022 were domestic), but some of the product cannot be launched in some of the biggest and less price sensitive markets like the U.K., Germany and Italy because of legacy HBO deals with Sky. This in turn means that (the) ARPU gap between domestic and international may remain wide.”

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