WB Discovery39s Q4 earnings highlight warning signs that obscure the

WB Discovery's Q4 earnings highlight warning signs that obscure the good news

As the share price fell, investors cautioned David Zaslav and Co. that they would deliver on their post-merger growth promises

David Zaslav hit the market Friday morning with a fourth-quarter earnings report that delivered enviable free cash flow and put a significant dent in Warner Bros. Discovery's heavy debt load. But it wasn't enough to halt a 10 percent drop in the company's already battered share price that came minutes after the results were released.

Investors were clearly surprised by the extent of the year-over-year decline in revenue and earnings in WB Discovery's studio and linear network divisions. These are the company's profitable pillars, the revenue engines that keep the small bills paid while streamers Max and HBO burn through investment capital as both companies reinvent themselves for a new era of television.

Anyone who paid attention to Hollywood last year should have expected a difficult fourth quarter for the Warner Bros. studio. The October-December period marked the end of two brutal strikes by actors' and writers' unions that wiped out seven months of production and development activities. But a 30% drop in the studio's adjusted revenue and a 9% drop in revenue were bigger setbacks than most WBD watchers expected. This was signaled by the subdued tone that Zaslav, WBD's normally ebullient CEO, adopted in his opening remarks. He claimed that 2024 would be a year of strong “momentum” for the company, but had no choice but to add a sober postscript.

“This business is not without its challenges,” Zaslav said. No doubt he and other business leaders were watching the share price plummet in premarket trading as he spoke. “We continue to face the impact of ongoing disruptions in the pay-TV ecosystem and a disrupted linear advertising ecosystem. We challenge our managers to find innovative solutions.”

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Of course, there has been a lot of speculation in recent months that one of these solutions could be another merger for a company that has completed two major transactions since 2018, first with AT&T and then with Discovery. Zaslav downplayed the possibility of another round of corporate advertising. Analysts also didn't particularly press him on the prospect – a lack of research that speaks volumes given the greater turmoil in media and entertainment.

“We like where we are,” Zaslav said in his only reference to M&A activity near the end of the hour-long call. “We have the opportunity to examine other assets as well. But it will be a very high bar for us. We like our hand where it is and we like the particular strategy right now of building Max and really using all of our great creative resources.”

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WBD executives still have to put on hard hats when it comes to Max. The streamer, now taking HBO's results into account, was able to significantly reduce its overall loss (from $217 million in the fourth quarter of 2022 to $55 million). That was welcome news, as was WBD's final 2023 balance sheet, with free cash flow totaling $6.2 billion generated by its legacy businesses during the year. And WBD was prudent in the strike-plagued environment. The studio received an unexpected break on some of its financial commitments to creative talent, helping it pay off $5.4 billion in debt last year, including $1.2 billion in the fourth quarter. At the end of last year, WBD's long-term debt stood at around $42 billion, compared to $48 billion at the end of 2022. Even better: As WBD CFO Gunnar Wiedenfels explained, there are no big payments due any time soon to increase that Pressure on a company that already has high growth targets to achieve.

“We have a very manageable amount of debt over the next three years, which gives us real flexibility in exactly how to deleverage the company,” Wiedenfels assured analysts.

But billions of dollars in free cash flow and billions of dollars' worth of debt reduction efforts weren't spectacular enough to distract WBD viewers from worrisome signs of weakness at the studio and linear networks. Even in the year of “Barbie,” the results of Warner Bros. films were mixed. “Aquaman and the Lost Kingdom” and “The Color Purple” were disappointments, while “Wonka” achieved respectable box office returns worldwide, helped by the studio's co-financing deal with Domain Capital (which meant WB helped cover the film's estimated budget of 125 million US dollars) was supported P&A costs). “The bottom line is that the studio really underperformed,” Zaslav said. “It gave us a chance to have a lot of potential in the next two years.”

Wall Streeters generally like Zaslav and Wiedenfels for their clear manner and close focus on financial details. But after two years of cheering for the revamped WBD, the questions are getting sharper and patience for a turnaround in streaming is running out.

“All eyes are on how much leeway management has to manage costs and address challenges in a linear fashion (even if trends are stabilizing today) and, most importantly, what longer-term growth opportunities exist.” [direct-to-consumer] Sales and earnings,” MoffettNathanson Research analyst Robert Fishman wrote in a note published Friday. “Networks EBITDA benefited from billions of dollars in efficiencies. Sales trends could improve slightly in 2024, but it is unclear how much room there is for cuts to offset further declines.”

WBD is in the same leaky streaming boat as Disney, Comcast and Paramount Global when it comes to extracting profits from its direct-to-consumer ambitions. The solution for everyone seems to be moving away from the “direct” and “consumer” parts of the equation and back to the B word: bundling.

Zaslav has been under pressure over the TV sports project unveiled by WBD, Disney and Fox Corp earlier this month. The partners plan to join forces and offer a streaming package that includes ESPN, Fox Sports, TNT and WBD's TBS to reach sports fans who don't subscribe to linear cable or satellite television.

“We are able to take care of those we are missing, the subscribers that the traditional cable industry is missing,” Zaslav said. “We think it’s very consumer friendly. This is a unique product designed to meet very strong demand.”

Of course, that's pretty much what they said about HBO Max three years ago and Max a year ago. Max's subscriber total was buried deep in WBD's earnings release, and for good reason. The growth rate, whether measured sequentially or year-over-year, was unimpressive for a period in which Netflix added 13.1 million subscribers. Max's global subscriber base was 97.7 million at the end of last year, up from 96.9 million at the end of 2022. Domestic subscribers were 52 million, down from 54.6 million in the same period last year.

In Zaslav's view, the unnamed sports company is a sign that the media heavyweights have no intention of letting outside distributors drive the push to offer packages of competing channels (just like old-fashioned cable TV). The goal is to simplify a pay-TV programming landscape that has become confusing for industry insiders, let alone consumers.

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“I expect that there will be sensible bundling,” predicted Zaslav. “It will happen in two ways. Either it's bundling through an intermediary – a platform company like Apple, Amazon or Roku, or you know what's going on with Charter and Comcast [with their Xumo streaming box] This is very compelling and very helpful for all of us in the content business. Or we could do it ourselves. And I have always advocated that we should do it ourselves.”

Like its new and old competitors, WBD is betting big on international growth to improve Max's fortunes in the coming years. HBO has traditionally taken a checkerboard approach to international distribution. In some territories there were standalone channels, but in other major markets such as the UK and Germany the company licensed its shows or a custom HBO feed as part of a larger channel package. Max will launch as a standalone offering in Latin America this month and in France and Belgium in the second quarter, in time for the Summer Olympics. By 2026, WBD expects to separate HBO content from Comcast-owned satellite distributor Sky in the UK, Germany and Italy to launch dedicated streaming platforms in both markets. That sounds a lot like a unbundling measure. JB Perrette, CEO and president of global streaming and gaming at WBD, indicated that the company expects to leave euros and pounds on the table by not going it alone with Max in major European markets.

“Launching our own direct-to-consumer product in these markets is one of our core strategic initiatives,” said Perrette. “And we are already doing business aggressively in these markets.”

Strike-related production delays undoubtedly cost Max some subscriber growth in 2023, Zaslav claimed. Essentially, for a company that, according to its boss, is focused on “pure storytelling,” it’s the play that makes money. And so Zaslav periodically took inspiration from every other Hollywood CEO in history and expressed his high hopes for the hot titles coming to market this year. (Analysts or executives did not mention that a possible IATSE strike later this year could hamper this parade.)

“We feel like we're on a great path,” Zaslav said, listing upcoming film and television titles for the studio and Max, including the upcoming sequel to the “Joker” film and the sequel to the “Harry Potter” television series “. “The content offering for Max over the next two-plus years is the deepest, deepest and most comprehensive that I think we'll ever have… We're rolling out all of these franchises and shows over the next 12 to 24 months and it gives us a real Feeling of optimism.”

(Pictured: David Zaslav)