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

All right. Welcome back, everybody. I'm Brett Feldman, Goldman's U.S. telecom, cable and media analyst. For our next session this morning, it is my great pleasure to welcome back to Communacopia David Zaslav, the CEO of Discovery. David, thanks for being here.

Thanks, Brett.

All right. Let's jump right into it. This has been a pretty remarkable year for Discovery. You not only launched discovery+, you were able to maintain your production throughout a pandemic, you announced a strategic transaction, and all of this has happened while the sector you're in is undergoing sort of a generational shift away from legacy models towards your next-gen models. What do you see as the keys to success in this new landscape? And why do you believe Discovery is well positioned to compete as a global media company?

Thanks, Brett. First, I'm here in L.A., where I've been spending about 2 weeks a month. I'll be here for the next 1.5 weeks, having some great meetings, really doing everything I can to learn about the history of Warner, which is substantial, and the success they've had in the past, meeting with as many people as I can to try and understand all the different points of view about where the industry is. Because we are -- this is kind of a unique and disruptive time, and also meet -- trying to meet as many people as I can, many of whom I've been friends with for years, because I think there are great people at Warner, great people with Discovery, and we also need to bring some more great people into the company. So it's a very exciting time. And for me, at least, I think, having spent 16 years at Discovery and building Discovery in the U.S. and taking it around the world, this is a huge moment for us at Discovery and for me, the months we spent with John Stankey talking about why this deal makes sense, why our content together with the Warner content, we believe creates the most compelling menu of IP. And I think this business starts with IP. It starts with great content that people love. You have to build a great platform. You need a terrific algorithm. You need to have other resources. But ultimately, to be successful in the long term as a company that has sustainable growth, the most difficult thing is great IP. And so I think the thing that I'm most excited about is the more that I look at what Warner has, the more I look at how much time people are spending with our product, discovery+; the number of hours that they're spending with discovery+; the fact that our roll-to-pay is still 80% or higher; and the churn is so low; that we have great content; a library almost as big or bigger than Netflix; and then you look at what Warner Bros. has and what HBO has and what Ann and John and Casey and Jason have been doing, with all the great movies and series that, together, we're a -- I think we have the best IP menu in the world. And that's 2 great companies. And so I think we're really extremely well positioned for success. We've got a lot of execution to do. The deal right now, it feels very good. It's still on track for mid '22. There's nothing in the process that has surprised us thus far, and we continue to work constructively with regulators. And so we're already really working hard on what this company will look like. We -- aside from me being here, we had an off-site for several days. We did have some real time with some of the strong Warner leaders going through their business. There were lawyers there. There was a lot that we couldn't see and we couldn't talk about. What we already have on our side, we have our integration team. We have over 182 work streams going. We've been working very hard on our working capital and driving our free cash flow and positioning our company to be ready, so when this deal does get approved and we do close, that we're ready to go. And a big part of that, and we've been working on this for over 4 months now, is we've now finalized our go-to-market strategy, and it feels really compelling. We have been at the direct-to-consumer business for several years in Europe and in the U.S. on a smaller niche basis. We've learned a lot from the discovery+. We've learned a lot from how it's working in Europe, and we've finalized our go-to-market strategy. We think it's compelling. We think we have an offering that's unmatched with appeal to almost every demo. And it's not appropriate for us to reveal it now, but we have been working very, very hard on it. And now we're going to get ready to continue to position ourselves so that when we close, we can affect that strategy and drive ourselves on to every device around the world.

All right. That's a great update. Let's dig into a couple of operating trends here. As of early August, you had added 18 million discovery+ subscribers since its launch. And that was achieved with actually pretty limited global distribution because you're not done rolling out the service. The obvious question is, first of all, is there any update you can give to us right now in terms of the size of the base? You also talked about roll-to-pay. It sounded like it might be trending a little bit better. So I'll start with that, then I'll come back with a follow-up.

Sure. Now that we've finalized our go-to-market strategy for when this -- when our deal closes, we're starting to think of things differently. When you look at lifetime value of the subscriber, do we want to go into a particular market and spend a lot of money to aggregate subscribers and then 6 months or 8 months or 9 months or 12 months from now when our deal closes, then we go to market with a different, more compelling, more broader strategic offering? And so we're just being -- we're trying to be very thoughtful now about how we continue to go to market with discovery+. It's critical for us to continue to have -- make this product better. People are still spending several hours a day with the product. As I said, the churn is very low. We want to keep the people that have discovery+ extremely happy. We want to have them continue to do what they're doing, which is recommend the product to their friends as being their favorite product. But do we want to go out and deploy huge capital to try and gain near-term subs and then when the deal closes, go to market with a different overall approach, with a different overall IP configuration? And so we're just trying to be thoughtful about that. So I think we continue to do well, but the way that we're modulating it and the way that we're launching it, we're now being much more mindful of the fact that when this deal closes, we think we'll have the most comprehensive and most compelling offering, and we don't want to be confusing. But at the same time, we want to take advantage of the fact that right now, HBO's in 48 million subscribers in the U.S. and Netflix is in 60 million. And we have a lot of subscribers in the U.S. as well. And so when we do an offering together, we think after close, that we'll have a very significant footprint here in the U.S. How do we maintain that? I know that Warner is working very hard on continuing to build their engine, but we just want to be thoughtful. We don't want to be confusing, and we also want to put ourselves in a position for a shock and awe global strategy, when you look at the menu, the diversity, the power of the content that we have in one place when this company comes together.

I'm just going to follow up on that to make sure I sort of understand the messaging there because you had outlined some plans and some expectations for the remainder of the year on your most recent call. So for example, you had indicated there were certain markets you were going to be rolling out in like Brazil, Canada and the Philippines. And I think that you had also talked about the financial impact being that even though you were expecting revenues to continue to grow. The losses, the investment you were making in the business would be stable essentially because of the incremental marketing costs that would be associated with sustaining that momentum. Should we be sort of adjusting our view now on sort of the financial profile that we expect for Discovery at the back half as you really prepare yourselves to think about a broader launch as you get to the end of this process?

Look, we're still going forward. We're just being thoughtful and mindful of the fact that -- and we will share it with you at the appropriate time that here is our -- what we believe is a very compelling go-to-market aggregate strategy that highlights the strength of these 2 great companies coming together, and we're just being mindful of that. So we're on track for the new markets to come. But we're looking at those markets. We're looking at our approach, and we're looking at the way that we -- the way that we attack it with the idea that in mid next year will be a new company. We -- next year, we look at things like -- and we have this in our plan. The Olympics was very effective for us. As we look at how do we integrate this new product, the Olympics are coming up next year. We're having -- we continue to see that adding sports in Europe is very compelling for us. We're anxious to see how do sports work for Warner in Latin America. We don't have access to a lot of that data. But we're just being more thoughtful and mindful now that we have a clear strategy of what we will do, and we will do it quickly once we close on the direct-to-consumer side. Just one other point. Because I think what differentiates this company and gives it so much, I think, diversified strength is if we are able in this go-to-market strategy, if we're here 2 years from now and we're able to grow this product globally with 200 million subscribers or 3 years from now. So Netflix will be a global direct-to-consumer product that nourishes and appeals people in every language. We will be. Disney will be, and maybe others will be as well. But if you look at the Discovery -- the Warner Bros. Discovery company, in addition to that, having the Warner Bros. motion picture business on top, I'm here in L.A. and this week, I'm meeting with over 50 people in the business. And a majority of them, when I say, "Why are you here?" They came here because of the motion picture business. They came here because of the magic of going to the movies and the lights went out, the phone goes off and there's that big screen and its magic. In some, it affected the culture. It affected them in a way that they saw themselves, and they came here to tell stories to try and affect the culture. And when the power of having a company that has a strong streaming service, together with a motion picture business that will be 100 years old in '23, that has IP from DC Comics, Batman, Superman, Harry Potter; kids' IP -- maybe as good or better kids' IP than anybody in the world; a library as big or bigger in movies and scripted, Game of Thrones, HBO; or when you look at that, this overall company of streaming and Warner Bros. together, it's just extremely appealing. Ultimately, you need the best talent to continue to create the best IP so that you can nourish an audience around the world. And I think it is a unique and compelling combination of having a strong Warner Bros. So if you're talking to talent, writers, directors, producers and you can work with them on opening a motion picture everywhere in the world. You could work with them on a movie for a streaming service. You could work with them on a series to put on a streaming service and carry it around the world, or you could work with them on a product to your traditional business. It's a full ecosystem. And I think that makes Warner and Discovery as a combination really unique, real versatility and optionality. And finally, there are mostly 2 companies in the business. I was -- when I was at NBC, we had Must See TV on Thursday night. But Jack Welch said to me, after Don Ohlmeyer and Warren Littlefield, brilliant guys, he said, "This isn't Must See TV. It's Warner Bros. TV." And I met with Chuck Lorre the other day, and you look at the rating points from CBS that came from Big Bang, Two and a Half Men, Mom, that was all Warner Bros. And so Warner Bros., to John Stankey and Jason and Ann's credit, because they continue to be so successful with Ted Lasso, I believe they're the strongest maker of television in the world. Disney is a great maker. But ultimately, there are a lot of other media companies that are pickers. And so they can pick great content, but Warner makes great content. And that gives great optionality. Warner can continue to make content, and if there are 4 or 5 bidders, they can sell it for a lot of money, and that will generate free cash flow and EBIT. Or they also have the ability to move content onto their own platforms at much better economics because they're not bidding against anybody. They're putting it on -- they are able to put it on their own platform. Or finally, if the world changes and more people get like Disney, where they're producing their own content mostly for themselves, then Warner has the optionality of being the greatest maker of content with the motion picture business, a streaming business and an existing very strong and strengthened traditional business, and so it is versatile. They can module -- this company can modulate, and John Stankey and Jason and Ann are doing that right now. But also in terms of risk, if you're some of these other companies, then you're asking a lot of -- the few companies that are makers, "Are you going to continue to sell to me?" And Warner can do that, but Warner can also -- if people -- if the world changes, they have the factory of content that they can put on their own platforms, and that's compelling.

I want to come back and spend some more time talking about the discovery+ business. That was a great overview, by the way. If you look at your content strategy compared to others, a lot of the other services out there have invested a ton of original content, a ton in acquiring libraries. It's very important to their models. You have a somewhat different strategy in discovery+ because so much of what you produce for your linear business is also available on your streaming platforms. And as you pointed out, your libraries are huge. So you're not deficient in that category at all. Now that you have seen, for several months now, how your subscribers are actually engaging with the content, what are you learning? And how has that maybe helped you evolve your content strategy for discovery+ as you get ready for the next phase here?

I think the most important takeaway is that people absolutely love the overall bouquet of home, food, discovery, science, Oprah, Chip and Joanna Gaines, the characters that we have. They love the content, and it's easy to curate. If you love food content, you can watch Diners and Dives (sic) [ Diners, Drive-Ins, and Dives ] and you can watch Ina Garten. If you love home content, you can watch all day, Chip and Jo and the Property Brothers. So it's easy to curate. You can curate by characters, you can curate by brand, you can curate by niche. And if you look at how people are spending time with our product, they're going very deep into the library and they're watching it throughout the day. It's not a product that's being watched just at 8:00 at night or at night when the kids go to sleep. The length of view is very high. It's very high during the day. And so what we've learned is we have a product that people really like. And candidly, in all the research we've done, we find that the appealability of the content, how easy people can get around it, how much they like it, that's not our problem. It's off the charts. The question that we have is, do we have something that people are going to leave dinner at 8:00 and go, "I have to -- I got to go because I got to see this." Do we have enough of the explosive content that's going to bring a huge good number of people in? And the answer is, in the U.S. at least, we don't. We don't have Batman. We don't have Elvis with Tom Hanks. We don't have The White Lotus. We don't have Game of Thrones. And so the combination of the 2, we have all this unbelievable nourishment. So when somebody comes in, they're staying. And when we look at how much they use our product versus how much they use other streaming services, we're blown away by how much time they spend with us. And so one of the theories of the case for John and I in looking at this transaction is Warner has some of the most explosive content in the world. And what Casey is doing at HBO in terms of generating cultural heat, and I got to get home at 8:00 to see the next episode of Mare or Hacks or The Other Two or White Lotus. I was at dinner last night and what -- people are talking about White Lotus for half an hour, episode by episode. We don't have that at Discovery. On the other hand, people underestimate what we have. because maybe you're watching White Lotus at 8:00 at night, but you're watching Chip and Jo and you're watching Ina Garten all day long. And so the idea is that together, you have a much more compelling product and you have a product that's going to have very little churn because there's so much nourishment. That's one of the things we learned in Europe is you need a lot of content, and you need a lot of content that people love so that they go do it on a regular basis. So when they think about which service do I need to keep that we're at the top of the list. And so I believe -- we believe more strongly than ever that the combination and the fact that HBO is getting stronger and stronger, and you look at the slate of what Toby and Ann have coming up and Jason, that we think this combination is really, really going to be compelling. And that doesn't even speak to the other differentiation of this company, which is news and sports. And we have news in Europe, and we've been playing with news in Poland. We've been playing with it in our direct-to-consumer product. We've been trying to understand how is -- how do people relate to it in a subscription service. And as we've finalized our go-to-market strategy, in a number of markets, it does include -- it will include sports. And the question also with news, as CNN being the leader in news around the globe, and cnn.com being the leading web news service or digital new service, that gives great optionality. As we look to our left and right of who has what IP, in Poland, people are going every day to news. What does that do to churn when people go every day to see what's going on, on their product, on their phone? And so I think that the overall menu that Warner has together with Discovery, it's going to provide a lot of nourishment and a lot of optionality for users, but also for us to figure out new ways to nourish the audience and differentiate this go-to-market strategy.

I know you're not ready to give us the full product strategy yet, but it certainly sounds like you're enthusiastic about the breadth of what's going to be available to you. Is there anything missing still at this point? Or do you think you're going to have the ingredients you need to create the products that meet the demand you see?

I think we're going to start with the most compelling. We have as good or better of an IP library, and the depth of that library with our entire -- our library, they have one of the strongest and most compelling movie libraries, the HBO library, the documentary library. So I think the overall IP is as strong or stronger. And the other thing that we have is we have a 15- to 25-year library of in-language content in almost every country in the world, which was one of the big appeals for John in looking at our company. And we have teams on the ground all over the world. And we're able to promote because we have 10 to 12 channels in every country in the world, which will add to the overall strategy. So I think that we have some advantages because we have great IP, because we're on the ground everywhere in the world. If you need to talk to the Verizon of Italy or the broadband distributor in Germany or in Brazil, we have teams on the ground in every country in the world. We know all those players. And so I think those are advantages. The disadvantage is the fact that Netflix is already at scale. And Disney has gotten off, to their credit, to an extraordinary start and their product isn't rolled out, but they are scaling. Now the good news is that Jason and Ann are scaling as well. They're in 48 million homes in the U.S., and Netflix is at 60 million, and they continue to grow as we continue to grow. But I think one of the priorities is going to be, as soon as we close, and that's why I feel so good about the fact that we now have a strong and comprehensive go-to-market strategy that we're going to have to move very quickly, and we're going to have to move quickly also to get as many great people and great talent at this company as possible to continue to build that IP library so we have sustainable growth with great content.

We go back and just talk about the discovery+ product. I think arguably, one of the biggest upside surprises has been the popularity of the AdLite product and the strength of the advertising revenue that you've generated. I think you disclosed about $6 of advertising ARPU on that product, which would imply that the cheaper product has a higher ARPU than the tier that doesn't have ads in it. And you're doing all of this, I think, on 3 minutes an hour of advertising. And so the question is, how has this early success with that product shaped your view on the role of an ad-supported service in your portfolio relative to what most people are doing with subscription only?

Right. Look, on the ad side, we're doing between 3 and 5 minutes and we're experimenting with different times, different times of day, what creates a product that doesn't have any friction with the consumer. But you're right, if we have a product that's $5 and it's generating over $6 in ARPU, and imagine if it was even bigger in terms of scale. If it was bigger in scale, that could be $6.50 or could be $7. It could even be higher if we have more data, that this -- the ability to generate that kind of advertising revenue creates significant optionality. You have a $5 product that's generating over $11 and then you have a $7 product. So you're making more than 50% more on your product. That's AdLite. And Netflix, which has been so successful in terms of their brand and their likability, they've been firm in their strategy of no advertising. So far, Disney with all the success that they've had, they've been firm in their strategy of no advertising. The advertising market is quite strong. We've been getting a lot of encouragement from advertisers that want to be on a digital product. And so if a couple of years from now, we're here and we have 200 million subscribers around the world, but of those 200 million, there's a substantial scale product that's AdLite, that could be a very, very compelling product. But ultimately, as you look around the world, there may be some markets where we have subscription in AVOD, there may be markets where we have subscription AdLite and AVOD. So I think that the great thing about this company is that we have this massive IP library. The question is how do you monetize it effectively in a way that really nourishes and reaches as many people as possible? And so the subscription product is no question, there's a significant market for that. But I think the ad market, the AdLite market could differentiate us. And in some markets, we may offer a product for free as a massive funnel that if we could be generating $6 or $7 on our IP without charging, there's a big audience in markets around the world where people don't want to pay and we can scoop up -- scoop that up as well. So as I started with, the hardest thing to do, and you can't create it from scratch, is have great, great IT, even if you spend a massive amount of money. Look at some of these streaming services, some of the best streaming services. If you bare them down and say, "Okay, what sustainable IP do you have?" You might have a great series, and then the series is over. But do you have a Harry Potter? Do you have an Aquaman? Do you have a Batman? Do you have a Game of Thrones? That kind of sustainable global appeal IP that Disney has, that Warner has that's explosive, we have it maybe in a less explosive way. But when you look at Planet Earth and you look at a lot of our home and food and science content, it is well known all around the world. And so that's our job is to figure out how to do it. But I think that the AdLite product could be a very big differentiator and could be a huge EBIT and free cash flow driver for us.

You mentioned earlier you had essentially a record upfront sticking with the advertising theme. And you've had a lot of success, not just with your linear channels, but also your digital platforms. What was your take away there in terms of the way you can grow your wallet share with advertisers as you bring more than just linear inventory to that?

Well, I think it's 2 things. One is I've been saying for a while, and we continue to make progress, that the broadcast networks have had a historic advantage with advertisers because of their historic reach in getting a very big premium to us. And now that our reach is compatible and our audience arguably is stronger because the length of view is stronger, the compatibility of our brands and our content to certain products should allow us to have upside even in a flat market because we're underpriced. And so we continue to take advantage of that. But I think the big takeaway is an anomaly. And the question is, will the anomaly continue? People are watching more content than they ever have on more devices. That's encouraging for our business. But a lot of it is ad-free. And despite all of the digital opportunity, the advertisers find that being on a video product, while people are watching content that they love, moves product, sales product, brands content, brands product in ways that you can't get with digital click content. Both are good but they're different. And advertisers feel very strongly that they need to be on video platforms. And there's a diminishing amount of video content with advertising. And so I saw this in the '90s, I've mentioned this to you before, Brett, but I saw this in the '90s when I was running the cable group and yet the broadcast team would come up and would present to the GE Board and to Jack and reach was down, but revenue was up, and they did that. And then in the fourth year, they had this chart of reach down -- reach was down, but advertising was up. And Jack was shaking it going like, "This can't continue." And if you even remember there was an argument within NBC and GE that broadcast is going away. They were the only ones that were sort of saying it. It was that chart like how much longer can reach go down but CPM and price on advertising will go up more? And the answer was 20 years and still happening. Now I don't have a crystal ball, but we are seeing a disruption in free-to-air and cable around the world. We are seeing it in our cable channels domestically and around the world, less so outside the U.S. we're seeing and more so here, but you see it. But yet, the upfront was up over 20% for everybody. And scatter for a while was up 30%, 40%, 50% and so a diminishing inventory against advertisers that want to reach people in this medium in order to brand product and drive product. And so if it continues, it will be really helpful on 2 fronts. I think that the put levels are going to continue to decline. And advertising in the upfront, we will get an uptick in the next quarter because we did much better than the 20% because we way outperformed the market. And so if reach is down -- if our reach is down 15% and our pricing is up 25% or 28% or 23%, you'll see us -- we'll be growing. And then the question for you and for the advertisers and for us is, is that sustainable? Will it be the broadcast story where for the next 5 years, we're going to be fine because the inventory is going to decline, but the REIT, but the CPMs are going to continue to go up? And we'll be double dipping with AVOD and products and AdLite products to try and take advantage of kind of the fervor of wanting to be part of the advertiser video experience.

There were a lot of tailwinds in the most recent quarter to your ad business, which is not surprising. You were coming out of kind of the depth of last year. It certainly seemed like we were going to remain on that trajectory, but Delta has been a little bit of a wrench here. Can you give any update? Has Delta been meaningfully impactful to the advertising backdrop in the second half?

We really haven't seen it. I think that the challenge, I think, for the next couple of years is going to just be are people at the pot levels. What happens to the traditional ecosystem? Advertising market seems to be quite strong. The upfront is going to buoy and support the industry in a very meaningful way. Outside the U.S., we see good stability. We see -- we haven't seen COVID having the impact that it did last time. In fact, we're seeing internationally that our numbers are quite strong. In most markets, we're ahead of '19, so we're back. And our share happens to be up. The markets are more stable. So I think the bigger challenge is in the U.S. where cable is much more expensive. And it's one of the reasons why I think having this existing combination come together when it does on track for mid '22 is going to be very helpful to us for optionality. But also it helps us with -- it solidifies the legacy business for us. One of the exciting things about the Warner business is they have a lot of live content, live news, live sports. We're kind of everything else. And so together, I think it solidifies us on the legacy business side as well, and that will be helpful. And that is another differentiator. This is a big -- this will be a very big free cash flow company. And so yes, you'll have a streaming service. You have a great Warner Bros. We have a big maker of content that can sell or distribute to itself. But we also have a very big legacy business that isn't going away, that we're really good at, that we're driving efficiency in, that we're driving working capital to drive free cash flow. And when you look at that overall business, it generates massive free cash flow that we think within 2 years, we'll be able to get -- or 2 to 3 years, our leverage should be below 3, and then off we go. And so I think that combination, that stability of having a solidified legacy business that's generating efficiency and free cash flow, together with this new business that if we're successful, 20 years from now, people will be watching these go-to-market products, these go-to-market product or products on every device in the world in every language, and it will be the way my grandchildren are seeing a lot of the content that they love. But it's a very balanced factory, and it's a very balanced engine that you can diversify in terms of pushing or pulling. Even the ability over a period of years, if things stabilize and get better, you can put more money on the legacy business to drive value, if things -- if we're sitting here 5 years from now when things are declining quicker, you can take content from those platforms and move them to the streaming service. So I think it's great optionality.

It has been a great overview. It's hard to believe it, but we're basically out of time now. Thank you so much for being here with us, and we certainly look forward to having you back at Communacopia in person next year.

Great. Thanks so much, Brett.