Warner Bros. Discovery, Inc. (WBD) Earnings Call Transcript & Summary

Hello, everybody. Good morning for those in the States. Good afternoon for those over in Europe. I'm Ben Swinburne, Morgan Stanley's media analyst, and welcome to our Barcelona -- our virtual Barcelona TMT conference. We're very excited to welcome back, from Discovery Communications, Gunnar Wiedenfels, the CFO. Gunnar joined Discovery, I think, back in April of 2017, following 7 years at ProSieben. Gunnar, it's great to see you again.

Thank you. Thank you, Ben, and good afternoon, everyone. Great to be here.

So I'm sure most who follow Discovery have the context that you guys have a big event coming in the not-too-distant future that's going to be focused on direct-to-consumer. So I'm going to nonetheless try my best to needle in a lot of questions about that and see what I can extract. I guess maybe, Gunnar, why don't we start -- we're doing this virtually, obviously, because of COVID. COVID has had a substantial impact on the media business, particularly around consumption trends. And maybe we could start there. And I'd love for you to just talk about how has engagement with your networks and your B2C assets been impacted by COVID? And how do you think the business has performed during this very challenging year?

Right. Sure, Ben. As much as I would like to be in Barcelona today, we can't, unfortunately. But kidding aside, the truth is that we have held up way, way better than I think -- than -- certainly than I thought when this whole thing started, when we started running our models, early March. And also, I think, way better than some of the things could have gone. So again, being here today, being able to talk about these numbers, the third quarter that we put forth, a lot of things have gone very well, and I'm super grateful the entire Discovery team has really leaned in hard, top to bottom. Most importantly, our people in [ culture and ] security teams have done a great job keeping people safe. That's the #1 priority, and it's paid off because we have been able to really deliver a very, very strong performance. Starting with the content that you're pointing out. People have engaged with our brands in much more intense ways, and that has been materializing in very strong rating gains. Television usage, of course, was up globally as part of the first wave of lockdowns. But we've been benefiting above and beyond what everyone else was experiencing. Number one, because of the unique nature of our content, very relatable, very authentic content that people have had a lot of interest in and have continued to have a lot of interest in. So we've been gaining share, not only in the U.S. but also globally. Number two, also related to content, we were able to keep producing. Maybe not entirely sort of the normal kinds of production, but we were able to very, very quickly turn around, do out-of-home shot content productions, et cetera, acquire some stuff to fill gaps. So we have been able to keep very, very attractive, fresh content grids on all across this entire year, which is something that our viewers have valued, again, gaining share globally, and we're seeing that we're now able to reap the benefits of that. Jon Steinlauf, our Head of Sales, has had a phenomenal upfront season, and part of the reason was that we're not only believing that we're under-monetized and there's upside, but we're also coming in with a full slate of fresh content for the fourth quarter, where everyone else is still resuming productions, being in repeats or even deprioritizing the traditional platform entirely. And so again, from a content perspective, it's been much better than expected. Revenue is much better than expected. And it's also, frankly, allowed us to take a fresh look at our cost base again. As much as everyone wants to go back to the office and meet colleagues and be together, I don't see us going back to a full-on 100% presence in the office kind of operating model. So there's a lot of cost savings that we've backed this year, but some of that might actually continue into the future.

Yes. Maybe just following up, Gunnar, on the engagement front. Everyone's noticed the strength in streaming engagement. I'm sure you guys see that on your platforms around the world. Do you think that's COVID driven? Or do you think that's a permanent or semipermanent shift or acceleration of consumer transition that was already happening as we think about -- as you think about running the business into '21, and, hopefully, beyond this COVID crisis?

Well, listen, I think there's no doubt that COVID has changed everyone's lifestyle this year in very significant ways. And I think that is a big driver of why not only we've seen so much more linear TV consumption, but clearly also a significant uptick in streaming. That being said, there's also no doubt that there is the underlying trend, and we've been monitoring that for a long time now. And we, frankly, heard a lot more also from our peers about leaning in and deprioritizing the traditional platform and focusing on streaming. And then as you rightly pointed out, we're going to be coming to the market in a very short order here with an announcement about our plans in that space. But again, I feel very confident, to your point, of what we're seeing on our platforms. Again, starting on the traditional side, a very, very solid position. David said in one of the earlier calls is really now news, sports and us and hopefully, maybe a little less focus on news going forward. Early to call that, but certainly, there is reason to believe that, that might end up being a helper. And again, we've been out there with a very attractive slate of programming. But also, if we look at our own direct-to-consumer or let's call it, next-generation platform, starting with our TV Everywhere offering in the U.S., a very strong performance through the crisis here as well. Millions of people coming and engaging with us, both authenticated and unauthenticated. So there's a lot of interest from those households that today, do not have full access to our content. And we've also been pleased, frankly, with our subscriber growth across the global direct-to-consumer portfolio. First and foremost, Dplay, which has had a strong year and is starting to contribute in a meaningful way to our international revenue line. But also the sports offerings, obviously, the toughest environment you could make up, but it's been coming back, and we're seeing meaningful pickup through the third quarter and right now.

Maybe just one last one on the sort of COVID implications. You mentioned cost, Gunnar. And obviously, I think we're all -- all businesses, ours included, rethought our real estate footprint, et cetera. But in the area of production, right, your biggest cost is content production. You have a very efficient model. So I don't think people think of Discovery as running a very high cost per hour. But from your CFO perch, are you seeing opportunities -- have you seen opportunities to produce more efficiently that will last beyond this period and help the margin profile of the business long term?

There's no doubt. I mean -- listen, I mean people in their home shop from an iPhone. I think there was a benefit of the specific situation. I don't think people are going to tolerate that in a normal environment. But what we did see is that if you just take a radical approach, there are opportunities to come up with very engaging, very authentic content with much less bells and whistles on the production side. That being said, there's also going to be some COVID-related expenses that come on top. I mean as you would imagine, we're now like 95% fired up again on the content side, but we're obviously taking very good care of our own personnel, of our production companies, crews, et cetera, there's a lot of testing going on, et cetera. So there are some expenses associated with that as well. But overall, I do think we'll -- we have an opportunity to continue to get more efficient as we look into the future.

Okay. Great. I want to dive into some of the specific regions and businesses at Discovery. But maybe before we do, can you offer us any update on sort of trends in the business sitting here right now in the fourth quarter, Gunnar?

Yes. Listen, I mean, when we spoke about our third quarter numbers, you've heard us confident and confident in further sequential improvement. And the reality is it's been getting better week after week after week. And again, I'm knocking on wood on my desk here because we all know that there is limited visibility, and we're monitoring those COVID case numbers. I would be optimistic and say what we've seen this year on the ad sales side, specifically, was sentiment-driven booking and cancellation behavior. And my hope would be that the sentiment stays somewhat positive because we now have a visible path to vaccines out there, 2 very successful pieces of news over the past 2 weeks. That being said, December is not in the bank. So there may be some impact there. But top to bottom, every driver is looking a little bit better than when we last spoke. If we want to go through them right now quickly, ad sales, as I said, we've had a very, very strong upfront. Our brands are in high demand. The categories that are core to our business are doing very well and our inventory is in high demand. Very successful upfront. Strong pricing. We held out and held back a little bit of inventory as well in expectation of a very strong scatter market, which so far is coming in as well, very significant scatter premiums. I had already said that October was pretty much flat. November looks like it's going to be in a -- around flat as well. So that's a massive improvement over what we've seen earlier in the year. I do want to caution December is the toughest comp. Last year, it was extremely strong in December. So taking all that together, we should see a healthy sequential improvement of a couple of hundred basis points at least over Q3. If we turn to international, obviously, much more complex portfolio. But what we had already seen in Q3 is continuing into Q4 as well. Some markets in Europe, specifically actually positive now. And overall, month after month, every forecast that we're putting together looks a little bit better. So as we had said before, certainly, some sequential improvement there as well, again, with the caveat on all of this of the limited visibility in December. What's really, really been encouraging for us, maybe the most important update here is domestic affiliate. I mean, you've all followed the announcements on subscriber numbers. Hulu maybe the most surprising positive to call out here. And that's been great. And we've spoken before about our success in recent renewals with very attractive deal terms. In some cases, additional carriage, strong pricing. So look, I mean, right now, fourth quarter is looking like it's going to be mid-single-digit affiliate growth, and that's very encouraging. And finally, on the international affiliate side, as I said, many more moving pieces there, but sports having started to contribute again to some extent, top and bottom line, but looking a little better than Q3 as well. So again, as I said initially, Ben, if someone had offered me sort of this kind of forecast in early March, I would have asked where to sign.

Great. Well, I'm sure all your shareholders want me to end the interview right now, but we have more questions to get through. That was -- it was good to hear. I think there was a lot of concern that the election -- there was just -- after the election it was sort of completely unknown. And now that we're past it, it sounds like the sentiment from advertisers, which is particularly interesting, is positive.

Yes. And I think this is -- this certainly is, to some extent, Discovery specific as well because, again, I mean, we've always been talking about the opportunity in pricing. We've got an extremely high-quality product in high demand, and we've made sure that we get our value.

Great. So let's go back and let's focus on D2C, which is, obviously, a big topic on everyone's mind, and I know you'll have more to say shortly. But Discovery, I think, as much as any other company in the space, has been quite deliberate in thinking about making moves into direct-to-consumer into streaming, particularly in the U.S. -- obviously, probably early internationally -- in the U.S. So why now does it make sense to take sort of a big step, what I presume will be a big step forward from a business model point of view without really knowing exactly what that step looks just look like yet, but taking the leap that you are?

Well, let me start by saying this is not easy, right? And we've been at this for a couple of years now. We've learned a lot. We've built out the technology platform. We've built out a globally centralized performance marketing capability. We've had to build out a direct-to-consumer team of significant scale, build the leadership, bring in some very, very capable leaders in that space. That's one thing that takes a while. Number two is, clearly, the ecosystem has evolved, right? And if you look at some of the announcements that our peers have made, there's a lot of clarity now about a lot -- many of them deprioritizing the traditional ecosystem in a way that we haven't seen previously. Again, we're going to continue to be great partners to this ecosystem because we think we have a lot more runway and a lot of growth opportunities still in that space. But it's also become clear that it's less of a radical move today than it may have been 2 or 3 years ago to think about those 30 million homes that do not have access to us. And again, we get a lot of questions, well, if people migrate from linear to D2C, what's your unit economics, et cetera, that's almost beside the point because the first fact is that today, we're not reaching 30 million people in the U.S. -- 30 million households in the U.S. with our products. We do know that there is interest in our content from that space. We have a lot of unauthenticated viewership on our TV Everywhere, our GO platforms. Remember, it's a combination of authenticated and unauthenticated. So we see there's interest. But right now, in a way, we're disappointing people because you can't sign up to the full thing. And that's a lot of potential. And that -- remember, every 1 subscriber we're generating out of those 30 million households comes on top from a revenue trajectory perspective. We've also seen that we can have a lot of success with aggregated product internationally. And that's been a big learning. Dplay has been incredibly successful. We're very pleased with the ramp of our subscribers across the global portfolio. And again, we're going to be saying more about this when we speak early December, we'll lay out more what the overall strategy is. But that's been very encouraging. And one thing to keep in mind is the big competitive advantage we've always had is not only being in that efficient content space, but also having the ability to exploit our content across an entire global footprint. If you think about an hour of content that we produce in the U.S., we exploit it on the traditional ecosystem, right? We then -- and that essentially covers our expenses multiple times. And then we go into TV Everywhere, we get additional very high value ad sales income from that. And we take it internationally, in the global pay TV ecosystem, every -- virtually every territory, and we're getting additional dollars from that. Then we found out that in some areas, there is an additional opportunity with free-to-air because if we have a market where we have 5% share, 95% of the people haven't seen the content in the pay TV ecosystem. We're exploiting it again in free-to-air. And then we've seen that with an offering like Dplay in a large part of Europe, Discovery Plus now in the U.K. is being launched this week, and a product in India that we have launched, that there's additional interest and additional willingness to consume and engage and pay for seeing our content again. That model is going to continue to be the same, whether it's happening predominantly on the linear platform or whether it's happening across a broader platform. And that's one of the reasons why we got the Olympics rights because we're able to extract a lot of value across multiple platforms.

Yes. Yes. Your answer there already makes me feel like this next question is a little bit lame, but I'm going to ask it anyway, which is about the margin profile of the direct-to-consumer business, long term. I remember when you started at Discovery, I remember talking to you and you were remarking on how profitable the business is, which is sort of a blessing and a curse to some extent. So do you think about, when you model out or forecast out these businesses, what they can earn long term? Or do you think that misses the higher level point that this is essentially a giant company that creates programming and monetizes it across lots of platforms, and at the end of the day, it's the business that we should be assessing versus these specific assets?

Yes. I think, Ben, there are sort of 2 schools of thought. One is, let's amass that subscriber base and that reach and then water will find its level, and there's going to be a way to monitor. I probably wouldn't be doing my job if I wasn't thinking about long-term margin profiles. And again, it's a tough one because no one has really sort of achieved a steady-state, long-term kind of level of maturity in that business. But again, if I take a step back, number one, we're opening ourselves up to additional market segments. So we're expanding our addressable market quite significantly. Number two, if you think about ARPU, I'm confident that we should be able to get to similar, if not better, ARPUs in the direct-to-consumer world, just assume everything just moved across, which it won't, right? And that's number three, it's going to be -- there's a transition phase, right? And the first step of that transition phase is we're going to get subscribers from a market segment that today isn't addressable for us. So that's a positive in and of itself. And then the question is, where does the linear ecosystem end, right? And I don't see that going away anytime soon. So we'll always have the opportunity to be continuing that very same model of exploiting our IP across all platforms, across all territories across different time windows, et cetera. And again, we've worked hard and spent a lot of time and money on building out that sort of global central technology platform, which is important because we need to get the economies of scale. But with all that being said, I think we're in a good position, certainly, again, given our global scale and given our content verticals, in a better position than many others.

Okay. I should have mentioned this at the outset, for those on the webcast, if you have a question for Gunnar, please go ahead and enter it into the system, and I'll do my best to make sure I relay it to Gunnar. One of the really interesting things that I think you guys hit on, on your earnings call is you've renewed with a lot of distributors in the U.S. recently. And now you have this direct-to-consumer offering coming. So it doesn't take a genius to figure out you probably had conversations with those partners about what you can and can't do with your programming. What can you tell us about going to market outside of the bundle in some form or maybe it's -- maybe not, and it's with partners -- and sort of the trade-offs that that represents because you, obviously, generate the majority, if not over 100% of your profits from the traditional -- in the U.S. from the traditional partnerships you have?

Well, yes, I mean, listen, we've always had a lot of flexibility. Certainly, recent renewals have helped there as well. But I also want to say, we'll always be a good partner to the traditional affiliates. And there's no doubt that distribution is one of the key success factors of any D2C product. So we'll always value that. What I will say is that the landscape has changed very significantly. I mean, a lot of the parties we're speaking with have launched their own product outside of the traditional ecosystem, right? So it's not -- we're not like 3 or 4 years ago, any more aware, this would have been like, oh my god, there's something -- to have something in addition to the traditional bundle. No, they've all done it. And I, again, I think what helps us here is I have no doubt that we are looking at an extremely valuable content portfolio and network portfolio -- and, frankly, that we're under-monetized right now. That -- I mean, that's the thing. It's -- if you just look at the economics from an affiliate perspective, we know they're making a lot of money off of our local avails on the advertising side. We know the pricing. We know they're getting a premium because it's local. We know they're getting a premium because they can apply their data-driven targeting, et cetera. So we know they're essentially making back the best part of what we're paying them -- what they're paying us in advertising, yet we're delivering 20% of their ad-supported cable viewership, right? It's just -- it's an extremely valuable partnership, and it's a win-win partnership. And that's why we have been able to get these deals. And I got so many questions about sort of, "oh, are you guys going to get [ peered with the long tail nits ], et cetera?" None of that happened. We actually ended up getting some more distribution in some of the recent renewals. And I mean, as you can see from our numbers, our pricing has been attractive as well and has allowed us to continue growing and even growing a little more next quarter here with some of those subscriber forecasts or reports coming in. So I think we're in a good position. There may be additional opportunity. Maybe there are win-win distribution partnerships. We want our product to be successful, and we're happy to share some of the success with others who help us out here.

Okay. I'd imagine that the margin profile across direct-to-consumer barriers, whether you're talking about general entertainment, whether you guys own your own programming or whether you're out there leasing it from -- renting it from somebody else, is that a fair way to think about it?

Yes. I think that's a very fair way to think about it. And that's been one of the strategic decisions that David and the Board have made years ago, to recognize that we need to be in that ownership position. Or in the case of sports, as close to an ownership position as we can possibly be. That's why we have engaged in those long-term deals with the IOC or the PGA Tour, et cetera.