Warner Bros. Discovery (WBD -2.17%) is making headlines in 2023 for, among other things, the overhaul of its flagship streaming platform, cuts at Turner Classic Movie, dropping CNN ratings, and involvement in the ongoing writers strike. However, despite all the controversy, the stock has surged by approximately 30% year to date.
Still, like any good narrative, there's more than meets the eye with this company. So, let's examine Warner Bros. Discovery's brief history as a public company and evaluate whether its stock should be considered a buy, sell, or hold.
A Frankensteinian media company emerges
In April 2022, AT&T spun off Warner Media, owner of well-known brands like DC Comics, HBO, and Warner Bros. Warner Media immediately merged with Discovery, known for lifestyle brands like Discovery Channel and HGTV. The resulting company was Warner Bros. Discovery, which began trading for $24 per share, meaning the stock is down roughly 49% since its public debut.
To achieve this merger, Warner Bros. Discovery effectively paid AT&T more than $43 billion and absorbed Discovery's debt. As a result, the newly established media powerhouse commenced operations with a substantial total gross debt of $56.5 billion.
Warner Bros. Discovery's debt looms large
An outsize debt can create a significant problem for any company, especially one that can't pay it down. To management's credit, by slashing spending and consolidating operations, the company has brought its gross debt down from $56.5 billion to its most recently reported $49.5 billion, or 12% in just one year.
Despite the progress, the company's debt is becoming more expensive as interest rates rise, and it continually needs to take out additional loans to pay its short-term debt obligations. It recently took out a new $1.5 billion loan at a fixed rate of 6.4% to help pay off two short-term loans.
As a result of its financial maneuvering, Warner Bros. Discovery's average duration outstanding debt has increased from 14 years to 14.2 years, with the average cost of debt rising from 4.2% to 4.6% since the company was formed.
This debt will continue to weigh on the company's balance sheet, with management hoping to decrease the company's net leverage ratio (which the company defines as net debt divided by the sum of the most recent four quarters' adjusted EBITDA) from its most recently reported ratio of 5x to below 4x by the end of 2023. Yet management hasn't succeeded in easing investors' concerns, as the company's net leverage ratio has essentially remained stagnant at 5x since the first quarter after the merger occurred.
Warner Bros. Discovery generates a lot of revenue
Despite its flawed balance sheet, the company generates incredible revenue for an entertainment and media company. Over the past 12 months, the company posted $41.3 billion in revenue compared to competitors Netflix's and Paramount's $32 billion and $30 billion, respectively.
Image source: Getty Images.
With a portfolio of intellectual property from DC Comics and franchises like Game of Thrones and Harry Potter, the company should be able to produce content that resonates with viewers continually. And with its distribution arm, WBD can easily release its films and television shows on its direct-to-consumer platform Max or its linear cable networks like TNT and TBS.
Can Warner Bros. Discovery be profitable?
Strong revenue and an enviable portfolio of assets are a good start for determining the likelihood of a company's long-term success, but it also needs to be profitable. WBD is not currently profitable when looking at net income; however, that's mainly because management recognizes the need to pay down its debt. Instead, free cash flow (cash remaining from operations minus capital expenditures) is a metric that can offer insight into the company's future profitability.
Warner Bros. Discovery produced free cash flow of roughly $2.2 billion for the trailing 12 months despite taking a $1.2 billion hit in cash restructuring and merger-related costs. For comparison, Netflix generated free cash flow of $2.9 billion. That means without what should be one-time expenses for Warner Bros., the company would've produced more free cash flow than Netflix over the past 12 reported months.
WBD Free Cash Flow data by YCharts
Is Warner Bros. Discovery stock a buy, sell, or hold?
If you squint past its incredibly high debt, investors should see the potential of this entertainment and media giant. However, Warner Bros. Discovery's debt is genuine and will become more expensive as interest rates likely increase or, at the very least, stay elevated for some time. Therefore, this is a stock to hold due to its long-term prospects, and investors should only consider buying it when management has a handle on its debt.
