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

Attention, everyone. We're going to get started here. I'm Bryan Kraft. I cover media, telecom, cable for Deutsche Bank on the equity side. And I'm really thrilled to have everyone back in person at the breakers for our 30th Annual Media, Internet and Telecom Conference. So welcome to all of our institutional clients who are joining us, and welcome to all of our corporate issuers who are here. We're really excited to have everyone here. So with that, we're going to get started. Our first keynote today is Discovery, and I'm pleased to introduce Gunnar Wiedenfels, who's the Chief Financial Officer of Discovery, soon to be Warner Bros. Discovery. Gunnar, thanks for coming.

Thanks for having us.

So Gunnar, to start off, 2022 promises to be a big year for Discovery with the transaction expected to close relatively soon. Can you talk about the continuation of WarnerMedia and Discovery -- I'm sorry, how the combination of WarnerMedia and Discovery will transform your position in the industry?

Sure. It's been quite a year, and we made a lot of progress, and we're actually in the ninth inning now towards closing that transaction. It's really a very, very exciting story because what we're going to be building very, very soon is a fascinating story of a pure-play media company. There's -- it's a very, very large company, no strings attached. All we're going to do is storytelling. But at the same time, it's also a very, very balanced portfolio of assets. And that's really, I think, a point worth highlighting between the #1 TV studio in the world, a very, very successful motion picture studio, the games business, our combined traditional linear business with scripted and nonscripted entertainment, sports, news. And then most importantly, a great potential from the combination of our 2 direct-to-consumer products. We have a lot of balance across that combined portfolio. We're ready to generate a significant amount of synergies. We're very, very bullish on our ability to drive free cash flow and delever the company very quickly, and position us for sustained free cash flow growth for many, many years to come.

Are we still on track to close the deal early in the second quarter? What are the remaining steps you need to take?

We're really in the last inning now. We had a big week last week. We priced $30 billion of debt to finance the transaction here in a less than favorable market. But we got it done. We've got a phenomenal treasury team and great support from the folks on the AT&T side. So that was the biggest milestone. That was outstanding. As you know, our shareholder vote happened on Friday, and we got approval that was more of a formal situation because we had these shareholder voting agreements in place that already got us to 43% of the votes, but that's formally checked as well. So the teams are now working through some, again, more formal remaining steps, and we continue to believe that we'll be closing early in the second quarter.

Okay, great. And what can you tell us about the integration plan? What's the timeline look like? What are some of the significant areas you need to work through as you bring the 2 companies together?

Well my philosophy here is we've got to move fast. We've -- everybody knows uncertainty is a factor. It's tough on the workforces on both sides. So we will to the extent possible, move quickly through the integration. We have learned a lot when we combined Discovery and Scripps a couple of years ago. There is a lot that we can apply here. In fact, our transformation office that delivered the Discovery integration and transformation and sort of the hundreds of millions of synergy was still in effect, and we kind of ramped it up again. And so the teams have been working really hard on both sides, WarnerMedia and Discovery setting up integration management offices with work stream structures, exchanging data to the extent possible in those areas where we didn't have the ability to actually sort of work together from a regulatory perspective. We have applied clean teams, so sort of outside adviser teams that have had access to data so that by the time we close the deal, we can hit the ground running and have a bit of a head start, some prebaked analysis already. And look, there's going to be different time horizons. Again, a lot of the traditional merger synergies and the corporate overhead side, et cetera, are going to move fairly quickly. On the other end of the spectrum for the full extent of the direct-to-consumer synergies, we need to combine the products, need to combine technology stacks and then sort of avoid that cost ramp that both companies had in their plans. That's going to take a little longer, but I feel very good about it. The teams are standing ready and everybody is super excited to get going.

Yes. Aside from the direct-to-consumer piece, which is obviously different, when you look at the -- from an integration and cost synergy perspective, how is it different than the Scripps acquisition? And do the differences make the integration more or less challenging to achieve from an execution perspective?

Well, there are some areas that are very similar and some areas that are very different. And the similar areas are obviously sort of the entire corporate area, the linear networks. That's going to be a cut-and-paste application of our integration playbook from 4 years ago. And that's an area that's going to move fairly quickly. And I'm really proud of what the teams have achieved. When you look at how our linear business on a global basis in virtually every market have developed after we closed Scripps Discovery, there's been outperformance relative to competition on pretty much every relevant metric. And so there's an enormous potential there. The direct-to-consumer business is obviously further along now than what we had 4 years ago. There's a greater risk. You want to get that right. We're talking about -- between the 2 direct-to-consumer products, by the time we close, close to 100 million people who are going to be affected as we make those changes. So that will need some very, very detailed and disciplined planning. And then obviously, specifically from sort of my perspective as sort of ex Discovery if you wish, there's this big chunk of studio business that I personally have a lot less experience with, and that's going to be a different setup as the 2 companies come together.

How does the international footprint align with -- yours with that of WarnerMedia? And what kinds of opportunities and competitive advantages might that combined international footprint yield for the company? I know with Scripps, it was principally domestic. So if you could talk about that a bit.

Yes. The international footprints are actually quite nicely complementary. I mean we're both pretty strong in Latin America but with different focus areas. So that's going to be a great combination. In Europe, arguably, Discovery is more relevant and stronger in its presence with a lot of free-to-air operations in some of the key markets. WarnerMedia may have sort of a leg up in the Nordics. We're both pretty small in APAC, so that combination might get us to a different level there. So net-net, a lot of complementarity. And again, I think specifically, today relative to maybe 10 years ago, as success is more going to be defined by scaling a profitable direct-to-consumer business, that I would argue is impossible without a very, very strong international presence. So our vantage point here could not be better because we are covering virtually every key territory globally. And what's going to be very, very important for competing in these markets is that we have been producing local content across entertainment, scripted, nonscripted, news, sports for many, many years. So we're really getting a head start there when it comes to sort of expanding and ramping those capabilities.

You've quantified your expected merger synergies for costs. Are there also potential revenue synergies? And if so, what kinds of opportunities do you see there?

Now we've really, really clearly focused on cost. What I will say, though, is that the Warner Bros. Discovery story is one that's going to be characterized by growth as well. So clearly, initially, we're going to be focused on cost. But I -- the way I look at the business is I want to see this company sustainably grow revenues and free cash flow for many, many years to come. And again, going back to how our linear networks at Discovery have outperformed the industry for the past 4 years. There's clearly something there in terms of the optimization, creating a better product by optimizing our content utilization across 1 portfolio as opposed to finding suboptimal solutions for 2 separate ones. And I also -- again, I want to talk about the direct-to-consumer opportunity. The combination could not make more sense than what we're doing here. We have HBO Max with a more premium male-skewing positioning, and then you've got the female positioning on the Discovery side. You've got the daily engagement that people enjoy with Discovery content versus sort of the event-driven nature of the HBO Max content. Take that together, I have no doubt that we will be creating one of the most complete sort of 4 quadrant sort of old, young male, female product out there. And I really -- I'm really excited about -- I can't wait to see sort of the first combined direct-to-consumer metrics. Because in theory, the acquisition power of HBO Max, combined with the retention power of the Discovery content, I think, is going to make for a blowout D2C product, and that should certainly drive very healthy revenue growth for years to come.

We like when executives use blowout at the conference, thank you. What's the timeline for relaunching the streaming strategy and defining what the combined companies and new products are going to look like?

Look, I mean, I think we've already made clear a couple of points where there's, let's call it, broad agreement at this point. And one of the most important items here is that we believe in a combined product as opposed to a bundling approach because we do, again, believe that the breadth and depth of this content offering is going to be a phenomenal consumer value proposition. The question is, in order to get to that point and do it in a way that's actually a great user experience for our subscribers, that's going to take some time. So again, that's nothing that's going to happen in weeks, hopefully not in years, but in a few several months. And we will start working on an interim solution in the meantime. So right out of the gate, we're working on getting the bundling approach ready, maybe a single sign-on, maybe ingesting content sort of into the other product, et cetera, so that we can start to get some benefits early on. But the main thrust is going to be harmonizing the technology platform, building one, very, very strong combined direct-to-consumer product and platform, that's going to take a while. The other benefit that we're going to enjoy initially right off the bat is optimization of marketing. Obviously, right now, we're -- marketing is a major, major cost driver for both products, and we're competing right now. And so the ability to, after closing the deal, harmonize this huge cross promotion, use the linear portfolios to drive to the direct-to-consumer side, that should give us some very nice marketing synergy right out of the gate.

You've touched on this a little bit just now, but can you talk more, I guess, philosophically, how you think about all-in-one type services that include all genres including live sports and news versus having a few services that draws some lines between the 4 broad genres that you have, lifestyle, general entertainment, sports and news?

Yes. Look, I mean, when we first negotiated this deal, we were still open looking at -- you could argue Disney has been very successful with their bundle, Netflix has been very successful with an integrated product. So the further we've moved along, the more we've gotten conviction that we believe bringing the complete firepower of this -- I mean we're talking about a 200,000-hour content portfolio with some very, very valuable and successful new titles dropping at a pretty impressive rate. And putting that all into 1 is the way to go for us. We will -- the second point we've already made is we will most definitely come out with an ad-free and an ad-light tier. That's worked very, very well for us. I was glad to hear that Disney has come to the same conclusion. It's just straightforward. There's a certain part of the population that's willing to pay the premium price. There is another part of the population that's willing to pay a lower place and really doesn't care about advertising, which, by the way, that was one of the interesting things for me to learn, that really with 3, 4, 5 minutes of advertising, that's really not considered a nuisance by our subscribers. And so HBO Max has introduced that tier. We've been very successful with much higher ARPU for that tier. And so that's going to be very likely the structure as we come to the market. And we'll work out the rest.

When you announced the deal, you put this $14 billion 2023 EBITDA number out there with WarnerMedia and Discovery running at about $16 billion in combined EBITDA before both companies started investing in streaming. And if you assume half of the $3 billion in cost synergies are realized in '23, it implies about a $3 billion EBITDA loss in streaming in '23. Is that likely to be enough to fund the company's global streaming ambitions?

It's an interesting way to look at it. The way we've modeled it is really coming from today's starting position. You saw the combined pro forma financials for 2021 in our public filings, where we're just below $11 billion in profits, EBITDA for the combined company, that sort of includes peak losses for discovery+, includes loss that are as per WarnerMedia's plans, peaking in 2022 for HBO Max. And then as per our stand-alone plans, both those products would have started their trajectory towards a profitable business. As I've said in the past, I see sort of a minimum of a 20% margin. And I've also said that I view that as increasingly conservative, especially now with the additional scale that we're going to generate. And a lot of the $3 billion synergy target is really coming from efficiency against that D2C technology and marketing spend. So feeling very good about the margin profile there. And the point about are we doing enough is a good question. I think we have heard on the conservative side in what we put into our plans. I hope that we might be able to get away with less investment losses, but we will see. And again, we've made the point very clearly, we're in a balanced company with a range of different businesses. And the D2C business is one of them. I'm not a great fan of just sort of going all in, burning your entire cash flow just to sort of hope for some scale there. We're going to continue to manage this business across all territories, all different platforms, all exploitation windows. And I think we have a great opportunity here to grow that D2C business while still throwing off a very significant amount of free cash flow.

And how are you thinking about sports in -- having a role in your streaming strategy? I know you're finalizing the agreement with BT and you've got sports rights in Europe through Eurosport, you've got sports on Turner in the U.S. once the deal is closed. How do you think sports fits in the streaming strategy?

Yes. It's interesting, the 2 examples you mentioned, the Turner Sports here and the BT deal that we're just finalizing in Europe on the Discovery side, those are great examples of how sports can work. And again, the #1 premise is it's very, very hard to make money with sports rights unless you own the original event itself. You're renting the content, you're constantly battling inflation, et cetera. And that's why as a stand-alone business, it's hard, but there's enormous value as what I would consider a locomotive pulling an entire train of other offerings. And that's really what we're doing here. I think the WarnerMedia team under AT&T's leadership here has made very, very smart decisions when it comes to the kinds of rights that are structured -- they have structured here for the domestic market, partnering with others, sort of all under the logic of having enough to be very relevant, but not sort of wasting by getting too much at very, very high expenses. That's kind of a logic that we have applied in Europe as well. And you will always see us participate in every tender and every process, but you'll also see us pull out many times just because in many cases, you'll deal with irrational pricing. And this BT Sports joint venture is a great example because it really creates an opportunity for upsides, getting us access to very important rights, Premier League, UEFA Champions League in the U.K., and will create significant upside opportunity for a combined sort of sports and discovery+ package at a time when HBO Max is still encumbered by their sort of long-term licensing deal. So great opportunity strategically, but it also comes with very limited financial downside. It's going to be self-funding. Those are the kinds of deals that really, really makes sense. And we have had great success in Europe. Remember, we had the Eurosport Player as a stand-alone offering years ago. We've made that in those markets where discovery+ has launched a sports tier. And that combination of entertainment and sports is working very well for us. And we're experimenting with news as well in those markets where we have news. That's going to be a whole different story, obviously, with CNN, an iconic major global news operation. And that's going to open up a whole different set of opportunities.

Would you want to expand your sports rights portfolio either domestic or internationally? I know you said you participate in every process. I don't know how much of that is opportunism versus really kind of a strategic intent.

I wouldn't say no to that if we see the right business case. But again, we're going to be super disciplined. We've walked from a number of potential opportunities because there is risk, a lot of risk involved in many cases, but we've also been very happy with the work that -- deals like the Olympics in Europe have done for us. So I would not rule that out. But it's going to be in a very disciplined way with a clear ROI target.

Okay. Can you talk about the economics of direct-to-consumer retail distribution versus wholesale distribution subscribers? How do you evaluate the trade-off between the higher ARPU and higher gross profit for retail subs versus the lower churn in CAC for wholesale subs? What's the right distribution mix there?

You've already answered the question in your question. That's really the trade-off. Specifically, at launch, I mean if I think back over the past 15, 18 months, how we rolled out discovery+, getting into a market, getting a product off the ground is a lot easier if you have a powerful distribution partner. The amount of marketing that you would have to spend yourself would be enormous, and you still might not get the traction that an established big player in the market could get. And there's also an incentive for them because they're bringing their customers the new hot, shiny product. And so there's definitely sort of a change in relevance over time, for the launch, very, very attractive over time. Again, the ultimate goal -- and you'll always compromise in a way, but the ultimate goal would be to have direct-to-consumer relationships with the vast majority of your subscribers. And so it's a case-by-case discussion. And certainly, one where, over time, the focus shifts a little bit. We've been very happy with our progress. Again, we reached 22 million subscribers for discovery+ by the end of the year. Certainly, there are some launch partnerships and distribution arrangement in there. And now the work is to, over time, renew these, roll them into direct-to-consumer relationships, et cetera. But it's a great way to start a product off the ground.

Gets scaled quickly, okay. How should we think about the impact of the direct-to-consumer strategy on your international networks, affiliate and advertising revenue going forward? Is there going to be increased risk to pricing carriage levels as you continue to roll this out?

Look, I think to be fair, the answer is yes, there is that risk, and we've seen that materialize in certain markets. It's almost even the other way around that in some markets like Denmark, for example, where we couldn't agree on pricing with one of the traditional affiliates, and that led us to just double down on our direct-to-consumer rollout. And we're super happy with how that's played out. But in our international markets, pay-TV penetration in many countries is a lot lower than here. And as such, our penetration of those markets is lower as well. We're in a different competitive position. So what we have seen over the past, call it, 2 years is an evolution of our distribution deals towards a hybrid model, whereby we're making some concessions on linear pricing. And in return, our distribution partners with, again, an interest in getting access to discovery+, make marketing support and sort of minimum guarantee kind of concessions here to help us get this product rolled out in different markets. And the formula is working out. You see our distribution revenue line that's been growing pretty consistently because the growth on the direct-to-consumer side well offsets whatever compromise we have to make on the linear side. The point to keep in mind is when you think about those unit economics, it's important to remember that D2C internationally is going to be an exponentially better business for us than the linear world because we're coming from, again, a market that so far has been defined as, in some countries, 15%, 20% of households that have Pay TV, and then we had a share of that market. Now all of a sudden, direct-to-consumer, you're able to address essentially the entire population and also from a distribution partnership perspective, you're opening yourself up to mobile distributors, et cetera. So you get a much broader range of bites at the apple, if you will. And then the other point is, on a per subscriber pricing basis, in some of the markets you're talking about sort of sub-$1 CPS in a linear world. In some markets in Asia, you're talking pennies, whereas in many of the key international markets, SVOD price points are pretty much established in that sort of $5 to $10 range. So with every subscriber that you capture in that new world of a direct-to-consumer subscription, you're getting an enormous uplift in your per subscriber pricing. And that's why these economics work out. And that's why it's so important for us, such an important starting point that we have operations in all these markets and we have local productions in all these markets, that we have a broad range of productions across entertainment, scripted, nonscripted, sports, news in some markets. That puts us in a position to capture those subscriptions.

And you've talked in the past about your expectations that linear TV margins would decline gradually while direct-to-consumer margin increases with that long-term 20% margin you mentioned in D2C. How do you think about the relative pacing of the linear declines and the D2C increases? Or put it another way, once you pass this peak direct-to-consumer reinvestment, do you think you can sustain EBITDA growth year after year on a consolidated basis?

That's definitely our objective. And I mean, you've got our sort of long-term management case out there in our proxy statement which lays out we had 2 cases, a more ambitious one and a more conservative one. We've sort of used a more conservative case for all of our rating agency discussions, et cetera. But the way we've laid that out is sort of moderate declines, essentially an extrapolation of what we're seeing today in terms of the underlying drivers, viewership, universe estimates, pay-TV subscriptions, et cetera. We have also assumed sort of a certain ability to offset that in pricing, and we've just had the best upfront in Discovery's history for the past season here with enormous price increase. We're not anticipating that that's going to continue forever, but there is a certain offset there for sure. And if you look at our numbers that have been published, yes, I'm convinced that we will see that continued EBITDA growth over time as the D2C business grows in relevance and scale turns from a net loss maker to a net profit contributor. And the overlay here is that for the next couple of years, we're going to be adding at least $3 billion in profits on top from our merger synergies. So that's going to be a reset and then the ambition is to keep growing for the next decade or 2 off of that base.

Not long ago, most investors were focused on the question of who would be the winners and losers in streaming video entertainment. More recently, the debate has shifted with investors now asking whether streaming will be even a good business for anyone. So what do you think? Will streaming video entertainment be a good business in the future?

I think it will, no doubt, especially if it's part of a broader, more balanced asset portfolio. I'm actually glad that there's a little more rational analysis going back into that business. I mean it's -- we've always been convinced that at the end of the day, operating a business is about generating free cash flow and growing that free cash flow. And there's always fads and fashions, and all of a sudden, you get crazy valuations for someone who's putting up whatever definition of a subscriber number with 0 transparency into what a subscriber is. No discussion around revenue potential, let alone profitability, I think those days are over. And I'm actually very happy that we have more of a focus now. And again, as I said, I do think that we'll see dynamic revenue growth in that D2C business for Warner Bros. Discovery. I have confidence in the margin potential for the D2C business. But I also view this as 1 part, 1 revenue stream, 1 cash register here among many others. And the -- winning is optimizing the monetization of this premium IP and creative output across as many revenue streams as possible. That's what's going to make the difference. And that's why this idea of just outspending each other, as David referred to on the earnings call, we're not trying to win the spending wars here. That's not a game we're playing.

Well said. Why don't we shift to just the current ad market. Can you talk about what you're currently seeing in the ad market? And also, how has the war in Ukraine affected it more recently, both domestically and internationally?

Yes, I want to keep it short here. I mean we have guidance out for the U.S. ad market with a low to mid-single-digit growth. Obviously, reflecting some of that uncertainty. We also came out last week with an 8-K announcing that we've pulled back or that we're in the process of pulling back from our Russia operations. And in that 8-K, we also mentioned that we're right now, not seeing a material impact from that on our numbers. Look, this is an unusual environment, very sad situation with Russia's war in Ukraine, among many other sort of drivers for uncertainty right now. So we're very carefully modeling and monitoring the situation. But so far, so good.

You mentioned the upfront a few minutes ago. I mean can you talk about maybe the strength you saw there and what that tells us about the ad market or...

Yes, I'm talking about sort of the current sort of the ending of the current upfront season here. So what we negotiated sort of in the summer of 2021, where, again, it was the strongest in history. And from our estimates relative to where the market was, I think we grew prices in a significantly stronger way. And the scatter market is holding up against these upfront prices, and so that gives me a lot of confidence. Again, to my point earlier, I think there is a lot of longevity in that business.

Let's talk about the balance sheet. So your leverage ratio after completing the merger is now expected to be under 4.5x. Originally, you had expected it to be about 5x. Can you talk about the path to deleveraging after closing, what that timeline looks like and what your longer-term leverage target is?

Sure. So the closing leverage is, to some extent, going to depend on the working capital that this disposal group on the Warner Media side has at closing because there's an adjustment factor that's going to increase or decrease the cash dividend payment to AT&T. But yes, so my current estimate is sort of 4.5x or below. We have, again, on the basis of our more conservative of the 2 business cases, we have created a delevering model. And we've made a commitment just last week to the debt market here and ratings agencies that we're planning to bring leverage back down below 3x within 24 months after closing. And we have also in this process, changed our long-term leverage target. We were operating the company at 3x to 3.5x. We've taken that down a notch to 2.5x to 3x. And we mean that as a range. And so we'll not necessarily stop at hitting 3x, and we feel very comfortable because it is still giving us the opportunity to use our balance sheet and use cheap debt capital. But at the same time also reflect the fact that our debt stack is significantly larger following this combination. And again, our ambition is to at least hit that business case, if not outperform it.

And then getting to the 3x in 24 months, do you expect both repayment of debt with free cash flow and EBITDA growth to contribute to that?

Yes, it will have to be a combination of both. And again, I mean, we're anticipating a pretty significant synergy capture against our $3 billion target over those 24 months. And from a cash flow perspective, you should assume that 2022 is probably a little messy. We're closing the deal. There's a lot of costs related to closing. There's probably going to be restructuring cash getting paid out, et cetera. And then some moving pieces regarding a partial year for the WarnerMedia business within sort of the new group. But our longer-term ambition here, we've publicly stated, is a 60% free cash flow conversion target, which I'm very, very confident in as EBITDA ramps up. That's sort of the long-term target level that we should be operating at. And you can do the math of how much cash that spits out. And we've been very clear that initially, substantively all the cash is going to go into deleveraging.

Okay. To wrap up, can you talk about the company's appetite for additional M&A after WarnerMedia? Are there particular kinds of assets that might be of interest, for example, like a U.S. broadcast network to kind of help you on the sports side or anything at all that would be of interest?

Look, I think Warner Bros. Discovery is going to have everything it needs from today's perspective. And so there's no desire to add anything. The team is going to be heads down to run the integration. Again, this is this is going to be a major complex project, there's cultural differences that need to be managed. So we need the team's full attention on pulling off that combination and post-merger integration. That's what we're going to be focused on. I'm sure you will hear our name pop up in pretty much every M&A process out there because we should look at everything. But we don't need anything, and frankly, right now, the priority is elsewhere.

Okay, all right. Great. Well, why don't we wrap up? Gunnar, thanks very much for joining us, and it's a real pleasure.

Thank you, thank you.