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

Hi. I'm Jessica Reif Ehrlich, Senior Media Entertainment analyst at BofA Securities, and I'm thrilled to welcome Gunnar Wiedenfels back to our conference. Gunnar, of course, is the CFO of Discovery and soon to be the enlarged Warner Discovery, Discovery Warner.

Anyway, so Gunnar, you've been at the company for a little over 4 years, and so much has happened. I mean it's just incredible. Script -- sequence -- Scripps, you've optimized that business. You've launched discovery+, and now you're rolling it out across the globe. And then you just announced a tiny transaction, Warner Media, which we're really excited about. But before we get into kind of like all the details of your business, maybe you could just start out with like a bigger picture. What are your priorities until deal close?

Sure. Jessica and everyone, great to be here. And hopefully, soon at some point, in person, again as opposed to over video, but thanks for having us here this morning. Look, we have continued to push forward here with our key business priorities as we have before announcing the deal. Obviously, discovery+ has been a huge priority, and we'll talk more about that, but obviously scaling the business in the U.S., rolling out further market internationally. We've also made a lot of progress in our traditional core business. We've seen markets recover very nicely across the global footprint and international markets back to 2019 levels. From an [ S scale ] perspective, we've had a phenomenal year so far, I'm knocking on wood here, in the U.S., ad sales growth. At-the-market, very, very successful front. That sets us up for the fourth quarter and beyond. So that's been great. And we've also made a lot of progress on the traditional affiliate side, having worked through a number of renewals very successfully since the beginning of the year. So lots of progress, I think, on all fronts. And with the announcement of the Warner Media transaction in mind, of course, we're also working towards getting the balance sheet into as good a shape as possible as we come up on closing that deal, hopefully, soon in that first half of next year. So that's become an additional priority, focusing the entire team here on free cash flow again and then leverage. And then we have additional smaller events like 2 -- the games in for short sequence. So there has been no shortage of exciting topics here over the past couple of months.

Absolutely. So let's just start like with the Warner Media stuff. How are you thinking about the benefits of scale? And what are the assets specifically from Warner Media provided that made the company an attractive entity to merge with?

Well, the -- this transaction, as we said before, has such enormous benefits across the entire range of the businesses that we operate between the 2 companies. And again, maybe starting with the part that has gotten less attention and maybe comes across as less sexy, the traditional linear business. Again, we've -- this is the free cash flow engine for us. It's generating a lot of free cash flow for Warner Media as well. And the 2 businesses together, I think, create an even richer experience, an enormously attractive bouquet of content offerings for all of our affiliate and advertising partners, both domestically and internationally. And again, I mean there's -- I think everything has been said about the challenges for the linear business. But the bottom line is that business is still flowing off an enormous amount of cash, as I said earlier. We've been very successful this year regarding pricing, both with regard to affiliates and advertising. So I see this business throwing off the enormous free cash flow that is going to help us create shareholder value and drive the digital business for many, many years to come. And certainly, the completeness of the combined portfolio with news and sports on the Warner side domestically. And then there's a range of very engagement heavy content that we bring to the table from the Discovery side, I think, is a phenomenal competition. And obviously, internationally as well. We have a very strong footprint between the 2 companies coming together, a very complementary footprint as well. And if I just look back to given how the combination of Scripps and Discovery has helped us grow share year after year after year. We're still benefiting from the better monetization and better programming of that wider content output across our international footprint here. So very, very powerful outlook from the perspective of just that traditional business. But obviously, the most important point here is the direct [ issuance ] strategy. By bringing these 2 content portfolios together, I have no doubt that we are creating one of the absolute leading content powerhouses in the world. As a consumer, I cannot wait to get access to that kind of a combined content portfolio. There's enormous, creative output coming out of Warner Bros., HBO, et cetera. We've had a lot of success with discovery+. And I think as complementary as those 2 content portfolios are, there is a lot of similarity as well. We're both looking at products that are very much ARPU-focused, were high-value kinds of products. We're looking at return and engagement. People are spending a lot of time on the HBO Max platform and on discovery+, similar to what we're seeing in the linear world. So there's a lot there, and we've made more progress, and we have our go-to-market strategy essentially ready. And we're all very, very excited about bringing that to the market once we've been able to close that deal. So that's the B2C part of the house, the breadth and depth of the content offering. But we'll also be able to bring that to the market in a very efficient technology platform, which takes me to synergy rationale for the deal. One of the big drivers here is that right now, we're operating 2 full technology stack from the 2 companies. Both companies, as you wouldn't be surprised, have had very material increases in technology spend, marketing spend, personnel, et cetera, in our sort of individual, stand-alone, long-range plans. And the ability to combine that and create a leading team of software engineers, refining the technology stack. Starting from a very strong starting position today is going to put us in a very, very powerful competitive position. And it's also allowing us, at the same time, to significantly reduce the formerly planned cost for these businesses, which is one of the big synergy drivers beyond obviously sort of the G&A structural cost that you would tackle in any combination of 2 businesses of this size.

So let's get into some of the things that you just addressed. On the direct-to-consumer strategy, does it make more sense to you to bundle HBO Max and discovery+ to combine them into one service? If you look at the service, like HBO is already kind of premier price, premier content, but it's also priced at [ floor bed ]. And many of the competitors are going for lower price. So can you talk to us about your go to market? Like will it be 2 services, 1 service? Will it be bundled? How are you thinking about pricing?

Well, look, I mean, we've been hard at work over the summer here to sort of further refine our go-to-market approach. and I would say we're pretty much ready with maybe some tweaks here and there. Obviously, as you know, we're not in a position to speak about that right now, but I think David has a very clear view and the team here. And we'll both keep the same strategy. We'll be guided by what the consumer wants, the consumer -- the center here. And as I said before, between the 2 content portfolios, there's an enormous breadth and depth of content. I think we already know certain characteristics of our offerings, the 2 individual offerings regarding low churn, high monetization, both sides. I think we've had great experience with the introduction of AdLite versions of our product. So there are certain elements that are pretty straightforward. Again, we'll talk more about the specifics of the product outlook. But again, as I said, I mean, I think we've got our ducks aligned here. And again, I mean, if you look at it from the perspective of optimizing for customer lifetime value, we've got phenomenal retention. I believe we're going to be able to acquire stuff at a very profitable level. We've spoken about sort of longer-term margin profiles previously driven by the specific nature of the unscripted content. We've talked about monetization. So I'm really looking forward to coming out with more detail as we go along.

And how do you think about the opportunity between SVOD and AVOD?

Look, I think you're definitely going to see us look very hard at AdLite versions of subscription products. I mean, fundamentally, we believe that our content and the content of the combined company, for sure, will be valuable enough to merit a subscription payment on an ongoing basis. So that's going to continue to be the priority. We've spoken about the merits of an AdLite version many times. In fact, for discovery+, the total monetization, total ARPU is actually higher for an AdLite subscriber than for a pure subscription subscriber. And I would imagine that others are experiencing similar metrics and performance. So -- and as we said before, we've been looking into AdLite versions for our international markets. Obviously, a function of replatforming to be able to offer all the same product features around the globe, but it continues to be a focus area for us. And so I think that's certainly something that's going to be in the mix going forward as well. There -- whether at some point or may be a complete sort of AVOD-only, subscription-free product, that remains to be seen. Again, I can really only imagine that for sort of long-term -- long-tail library kind of content. It's not a huge strategic priority. AdLite, for sure.

Right. How much of an overlap do you have between the subs on both of your respective platforms?

Well, it's something that we can't talk about right now. But given sort of the popularity of the content of both platforms, of both content portfolios, you would actually assume a certain amount of overlap, but we'll be talking about that more and also as it relates to determining the new go-to-market approach and pricing, et cetera, as we move further along.

Yes. And does this deal accelerate or pivot to direct-to-consumer for you?

Look, I think it is no doubt that the combined offering here, combined content output, puts us in a much more sustainable, much more promising long-term position. Does it accelerate the pivot? I think both companies, Warner Media and Discovery, I would say have very clearly initiated the turn here and started the pivot. So from that perspective, I wouldn't necessarily say it accelerates at all the relative pivot, but it puts us in a much stronger position for each of the individual businesses between the companies coming together.

So what are the implications for the linear business? And I guess on that linear business, you did highlight that as one of the things that you can benefit from combining with Warner Media. Do you expect synergies similar to what you saw with Scripps in both the advertising and the [indiscernible] side?

It's early days. And as you know, we haven't factored any revenue synergies into our $3 billion synergy guidance. So I want to leave it at that for now. That being said, as I mentioned earlier, I have no doubt that Discovery's revenue trajectory in 2018 must have benefited from the combination of the 2 companies. As I said, in the international footprint, we have continued to grow share year after year after year. And there's a -- you always have your certain ups and downs. Sort of that continued outperformance is certainly -- to some extent, it's always going to be hard to quantify. But I think the ability to reassess the positioning in every network, in every territory and reprogram and rebundle this wonderful IP in our portfolio has created a better product, and that's great for the consumer. It's great for our affiliate partners. It's great for advertising partners, getting their brands into the right environment. And we certainly hope that between the Warner Media portfolio and ours, there could be certain upsides. As I said, there's a lot of complementarity. There's the sports, and Warner Media is pretty strong in LatAm, in Europe. We've got strong kids proposition, et cetera. So there's a lot you can look at. But again, it's very, very early days and it will always be hard to quantify it.

Right. So on the synergies, the $3 billion, which is all costs, could you talk about the cadence of the synergies in the context to your guide? And any other color you want to give on the $3 billion?

Well, look, I mean we're starting to set up our integration management office, and we're looking into, let's say, the next levels down into these synergies. Again, there's only so much you can do in terms of really detailed work for closing the deal, as you would imagine. But I'm very pleased with how the team has been set up. Remember, we still had our Discovery transformation office up and running, not as active as maybe in 2018 or early 2019. But we were still working off some of the longer-term initiatives, and it's great to see how the team is getting fired up again. There's a lot of muscle memory when it comes to how to approach these projects, so I'm pretty confident that we'll be able to take an efficient approach here again as we close the deal. And in terms of the timing. Look, I mean, as I said, I feel good about our ability to get significant synergy capture over a period of 2 years. There's always going to be sort of an initial kind of quick win wave. And then as I said in previous discussions, the ability to look at cost avoidance, just not spending against the scaling direct-to-consumer products, that's obviously going to unfold over time. But it's a very, very substantial opportunity.

Right. So you've been moving fairly aggressively to roll out discovery+. You had really success in the U.S. and you launched with Vodafone in the U.K. You'll be launching in more markets with Vodafone later this year. Can you give us some sense of how the rollout with Vodafone has gone so far? Any color you can give?

Sure. So the way we look at this is we've always targeted a combination of, let's say, pure play direct-to-consumer relationships and distribution partnerships in the mix, with distribution partnerships being much more heavily focused towards the initial launch of a product. It's a great way to accelerate your path to scale. Obviously, it comes at a price. You're obviously sharing some of the economics initially. But on the other hand, you're also able to save on marketing expenses to some extent. So that's why we've leaned heavily into distribution partnerships. We've been very pleased with the performance of the deal, both domestically and internationally. It's been very helpful to get the product in front of people and raise awareness in these territories. We're also very, very pleased with what we're seeing so far in terms of roll to pay from those partnership deals, specifically where they were covered by the distribution partnership from a subscription price point of view. We've seen a great uptake of direct-to-consumer sort of as a roll from that partnership deal. So we're very happy with that as well. There's no doubt that these distribution partnerships also add to the complexity of our rollout. It's taken a considerable amount of time for each one of those markets. We're launching in the market and we're partnering with, let's say, a mobile player and a traditional linear affiliates who are customizing the product to the set-top boxes, et cetera. So it does come at a price, but I think it's an important part of the mix. But needless to say, for us, still with all the new mobile, there's a lot of focus on big screen partnerships. So we're very interested in partnering with the more -- in the NAND line cable-based partners here as we roll out our products. And most importantly, we're very, very focused on quality. Whatever it is, whoever we're partnering with, we've made sure that we go out with the product once we are 100% sure we can deliver a customer experience that is adequate. And if you look at the views for our product launches, knocking on wood, we have done very, very well in all of the markets that we've launched. We've been very happy with the quality. So the way we look at this is, again, you can only make your first impression one, and we've really sort of focused on quality. And I do believe that that's one of the reasons why we're seeing that level of engagement, why we're seeing churn rates that continue to track, I think, certainly from what I can see, well towards the lower end of the industry spectrum. And we'll continue to make that a big priority in our journey here.

Can you talk a little bit about the benefits of scale in the AVOD marketplace? Like what are the key levels of subscribers or engagement that you need to enable better pricing, better monetization?

It's a great question. We, as you know, always had a foot well inside that AVOD cam with our TV Everywhere and Go product. But it is fair to say that launching discovery+ has taken us to a new level. We're seeing very, very significant demand for our direct-to-consumer and TV Everywhere eyeballs. It's been a big theme in the past upfront. We have significantly increased the volume in the digital space. And as you can see from our ARPU numbers, remember, when we presented in December, we were sort of going through that evolution of we're starting with linear TV CPMs and then we're getting a premium on Go because of better addressability or better targetability. And we were looking at a 3x premium for discovery+, and that's come through. And it's come through at very, very strong engagement numbers. And as we get better, as we grow more scale, we're obviously going to be able to offer even more benefit from better data to our advertising partners. They're very happy today already. But I mean, I think over time, we can only build better -- get better from here.

And what are your expectations for your international AdLite products? Do you think you can generate higher ARPUs on that product similar to what we've seen in the U.S.?

Yes. I mean, look, we're obviously speculating here because we haven't really launched AdLite versions yet, but I would be shocked if not because it seems to be a very consistent theme. And at the end of the day, this is a function of the type of content you're looking at. And again, the kind of content that we're putting out there is both in linear and the B2C is a very sticky one, high engagement kind of content, brand-safe, family-friendly environment. And so people are watching, and advertisers like the field. So from that perspective, I do think that this is going to be a nice upside for our ARPUs internationally as we go along. And again, I mean, as we -- obviously, the risk of reiterating what I said in the past. Clearly, internationally, our ARPUs are somewhat lower compared to the U.S. domestic side. But relative to the established linear ARPU, it's a much larger uplift. So it's a great opportunity, I think, as the D2C products mature.

You've talked about seeing a sequential improvement in next-gen losses from the $400 million in Q1 to $250 million in Q2 and seem encouraged by the traction you have in scaling and monetizing. How does the performance year-to-date track relative to your target of $400 million to $500 million in incremental EBITDA losses this year? And how are you thinking about investment losses in 2022 and beyond?

You got kind of cut out there a little bit, but I think I got your question. So yes, look, I mean, we've -- let's talk about discovery+ or Discovery direct-to-consumer stand-alone for a second. That's what we did, base our guidance on. And I'm still very, very confident that we will have seen the peak investment year for Discovery DTC efforts in 2021. As a matter of fact, I'm getting more encouraged as we move through the year, and I'm seeing sort of our plans work out. And again, I mean I don't want to reiterate all the reasons with the content economics, the great ability to promote our product at 400 million homes globally, linear and on the B2C side, the ability to play pingpong between the platforms with that great Olympics example, which just sort of was Exhibit A, again, of the value of that strategy perfectly playing off these free-to-air platform versus digital exclusive here, cross-promoting and sending viewers back and forth. So that's -- I don't want to reiterate all that. But we're also seeing the ability, obviously, now with our direct-to-consumer, go-to-market strategy for the combined company essentially done. We're probably going to be able to, frankly, spend a little less on marketing right now. As I said, focus a little more on the health of the balance sheet and then have a lot of dry powder as we come out next year, hopefully sooner rather than later, with a very targeted approach. So I feel very good about the level of investments and the trajectory that we've been guiding to.

Right. And then on the Olympics, what can you say -- what have you learned? And what do you say about the next Olympics, which is coming up pretty soon? And how big of a roll in general, do you see sports playing on the service over time as you integrate your sport into new discovery+?

Look, I think in terms of these Olympics and the next one, obviously, ironically, it has turned into a little bit of a benefit that the 2 are so close to each other. So I think we have a better shot at -- better deals with advertisers and better -- frankly, a better offering from a subscription perspective as well. As we said on our earnings call, we were very pleased with the product uptake. It is obviously different from one market to the next, the amount of free-to-air coverage, but we've again seen great benefit in some of the more niche kind of sports events that just don't receive coverage on the big free-to-air networks. That was one of the original promises that we made, that we will show everything. Whatever you're interested in, you'll get it from Discovery. And I think we've delivered very nicely against that in these past games. We're also happy with our ability to retain a large share of those customers, and we've made sure that we have enough for the cross-promotion capacity and ability to lock them in for sort of longer-term discovery+ subscription. So that was -- has worked very well. And as we come up on the next games, we're going to be even more integrated from a product perspective. So very hopeful that we'll see continued success. And then obviously, the last games in our deal are in Paris 2024, which the entire team is super excited about in our European time zone right in our backyard in Paris. So that's going to be a phenomenal event. And as JB always put it, the Olympics are by far the most emotional, the biggest global sports event, we're really proud of that. Sports in general, as I said earlier, I think we are -- combined company is going to have a more sports focused footprint than Discovery stand-alone, which is great. It's a bit of a complementary puzzle coming together here, with our core focus being Europe and Warner Media, obviously, being more focused on the U.S. and LatAm. Again, we haven't factored in any major synergy or contributions here. But there's certainly, I think, opportunity or efficiency and effective implementation of these rights. So looking forward to getting a better understanding of that overall combined portfolio. And again, I mean, look, sports, in many cases, are loss leaders, so you shouldn't expect us to start going crazy. I think, frankly, both Warner Media and Discovery has had a pretty rational approach to sports rights, finding deal structures that work, finding sports that have a more financially attractive profile. Maybe not going for the top-tier events that are massive loss leaders, but going for sports that have their place in a broader portfolio, bit of a viewer and subscriber locomotive still at a financially rational price point. And I would imagine that our position only gets better after combining these 2 companies. We may be able to strive for the global deals and different kinds of structures. But that's a little early, I think, to talk about at this point.

So let's turn to domestic advertising. What are you seeing in terms of third course data trends? What are the early indications for the fourth quarter?

Well, there's 2 things. One, in third quarter, I mean we -- as we pointed out in our second quarter earnings call, we have a little tougher comp, obviously, both domestically and internationally from the perspective of, number one, prior year COVID impact being most pronounced in the second quarter. And especially, international, there was like a significant recovery already in the third quarter. So we're comping against that. And especially in the U.S., some Olympics impact. Obviously, and then across the entire second half of the year, political spend that helped last year. Now all that being said, I'm very, very pleased with where the market is. And I do think that we're going to see some continued strength here. Again, the scatter market continues to be characterized by enormous demand, enormous ability to drive up prices, and that trend has continued very well throughout the entire year. But most importantly, I do think -- I'm super, super happy with how we came out of the U.S. upfront market. And John Steinlauf and the team, I think, have done a phenomenal job. We've been talking about the value of Discovery's inventory for many years. And we've been talking about the value gap, the monetization gap. And John was able and his team were able to significantly increase the volume of our Discovery Premier product, which is sort of our broadcast equivalent product. That's come up in a very significant way. We've been able to get very, very strong CPM increases. So let's see, but I'm very, very optimistic for the fourth quarter. I do think we're going to see a sequential acceleration over the third quarter. And I have every reason to believe that we're going to see strong performance through the next 12 months or so on the back of this front deal. And I do believe that we've done significantly better than the market here. I know everybody always declares victory on the upfront. Well, I think John will probably be willing to get measured based on his Q4 ad sales performance versus peers. I mean, I think the one caveat I should make is I think there's been enough discussion out there about the quality and the reliability of Nielsen ratings. That's continued to be a mess. And frankly, universe estimate and put level, and everybody is looking at the numbers. So I'm not breaking any news here, but it's continued to be a tough environment. But that being said, I do think that John and the team were able to secure some rate increases here that are going to help us to nicely grow despite those current trends. And as the affiliate side of the house, we're also seeing continued very positive contributions from our growing digital footprint that should also provide additional upside for the next year.

On Discovery Premier, can you talk a little bit about what's the differential on CPMs? And how much more additional inventory can you put into that product?

The CPM differential is very significant. It's 100% actually, in some cases, more than 100% markup. But again, it's not something that we're sort of forcing down sort of advertising growth. It's a very high-quality product with better performance than broadcast product, and that answers your second question as well. There's a certain limitation because we want to keep it exclusive, we want to keep it focused on the most premier programs in our lineup. But for the time being, there is -- there continues to be significant room for further growth. And again, I mean, John just doubled the volume in this year's upfront, which obviously helps us. Because of the mix contribution, high-value programming is a big part of why we're able to get to these kinds of rate of change that we're looking at.

Right. Let's talk about international advertising. And what are you seeing across your various regions, whether it's U.K., EMEA, LatAm, APAC?

Yes. So I think that's the right way to ask the question because JB always talked about international being the worst misnomer in the world because it's just such a bag of very different outcomes. And in terms of the advertising performance, it's actually -- it's pretty homogeneous across our regions. Within region, we have markets that are already, as I said earlier, above and beyond 2019 levels. So some markets have done very well. But overall, we continue to see healthy markets in individual territories in Latin America as well as in Europe, we're seeing a lot of strength. Asia, as you know, is by far the smallest market, but has been contributing very nicely as well in the second quarter and continues to do so in the third as part of the recovery and the basis of our New Zealand portfolio strategy. So we're, actually top to bottom, very happy with the performance. Again, as I said earlier, for the third quarter, as you know, we're not looking at the kind of a super recovery from a devastating second quarter last year to -- back to 2019 levels this year.

And then just moving along. On domestic affiliate fees, discovery+ launched in January. Can you talk a little bit about the relationship with distributors? Now that you have discovery+ in the market, has anything changed? And talk a little bit about your affiliate fee trajectory.

Sure. So international affiliate, let's start with some of the general trends. You know that when it comes to cord cutting and subscription or subscriber numbers, the market is still in a little better shape than the U.S. is. In some European markets, though, on the pricing side, we've -- especially in the context of us, our desire to launch discovery+, we have following deal structures with our affiliates that were mutually beneficial from the perspective of us giving a little on the linear side in order to get the flexibility and the support and the integration on the discovery+ side. And if you look at the affiliate trends for Discovery as a whole, on the international side, we had sort of dipped in our growth rate a little as we started engaging in these kinds of deals. And as we, frankly, last year, also walked for some deals -- from some deals where we weren't able to get the flexibility that we needed. And I think we've turned that corner. And if you look at our Q2 number and where Q3 is shaping up to, it's not to the level of the 18% underlying that we saw in the U.S. in the second quarter, but it's reaccelerating to solid mid-single digit. I do think that there is going to be increasing contribution from further discovery+ launches as we go along. So that kind of a mix shift is starting to play out. And obviously, only -- we're not really looking at, let's say, quarterly revenue numbers or quarterly profit numbers for those kinds of decisions, we're -- we will be willing to take a bit of a hit for longer-term value creation because it's so important for us to be able to clear those -- the rights in our go-to-market as we go to our own role here and also, obviously, with an eye towards a -- hopefully... [Technical Difficulty]

I've lost your audio, and I'm not sure -- okay. Did we lose him completely? Okay. Well, then, I'm sorry about that, everybody. But thank you for joining, and we'll be back with Sony at 1:25.