Would Warner Bros. Discovery’s Problems Be Solved by Spinning off Studio and Streaming? | Analysis

Since the Warner Bros. Discovery merger in 2022, CEO David Zaslav has tried to persuade Wall Street that combining the Discovery and HBO Max streaming services would boost subscribers and engagement while reducing churn.

Two years later, that strategy proven insufficient for the company to catch up to the scale of streaming rivals Netflix and Disney+. And, like its other non-Netflix competitors, WBD has yet to turn a streaming profit over multiple quarters.

Now, six years after AT&T acquired Warners and two years after AT&T sold WarnerMedia to Discovery to create Warner Bros. Discovery, the company has once again become the subject of M&A speculation: Zaslav is reportedly weighing whether to split the movie studio and direct-to-consumer business into a standalone company from its linear television networks.

“It is becoming increasingly clear that the company, as it is currently constructed, is not working as a publicly traded entity, and transformative changes are likely required to unlock the considerable value embedded within these assets,” analyst Jessica Reif Erlich said on Wednesday in a note to clients, citing a spinoff as one possible option for the company.

A spokesman for Warner Bros. Discovery declined to comment to TheWrap.

Other analysts argue that a spinoff would starve the streaming business of linear TV’s cash flows and would ultimately be a complicated ordeal that could pose significant credit and debt risks. Instead, they said, WBD should double down on streaming by expanding Max to more international markets and forging more partnerships with its competitors.

“If you don’t climb that mountain and launch all these markets and get subs to scale, you’re going to be subscale, you’re going to be significantly disadvantaged against Disney and Netflix in the markets you’re operating in, and your linear business is going to melt and decay,” said Neil Begley, Moody’s Ratings senior vice president to TheWrap.

Recent moves by WBD — such as moving TV shows like “Harry Potter” from Max to HBO — signal a lack of faith in Max as a major streaming competitor.

Streaming isn’t the legacy studio’s only challenge. WBD continues to struggle with $39 billion in debt, a linear business that is in secular decline and a stock price that has fallen 65% since the 2022 merger to $8.52 per share as of Thursday’s close — which has prompted multiple rounds of cost cuts in an attempt to right the ship.

Zaslav, whose total compensation package jumped more than $10 million to $49.7 million in 2023 as the share price remained about flat, has warned that the media industry is headed towards consolidation. But that likely will depend on how the presidential election shakes out in November. When asked about his thoughts on Trump vs. Biden at Allen & Co.’s Sun Valley Conference last week, Zaslav expressed a preference for whoever ends up being more friendly to M&A. “We just need an opportunity for deregulation, so companies can consolidate and do what we need to to be even better,” he said.

WBD’s two-year ban on M&A, known as a Reverse Morris Trust, officially expired in April.

Max’s struggles since rebranding without HBO

Despite success with comedies like “Hacks” and “And Just Like That…,” Max has struggled to launch many originals that demand subscriber attention. While Max was one of four streaming platforms to report double-digit gains in the month of June, its total viewership share for the month sat at just 1.4%, far behind competitors YouTube (9.9%), Netflix (8.4%), Prime Video (3.1%), Hulu (3%), Disney+ and Tubi (2% each) and even The Roku Channel (1.5%), according to Nielsen’s latest Gauge report .

That was supposed to change with the upcoming “Harry Potter” TV series, mining arguably WBD’s most valuable IP for a long-running show that would anchor a fledgling streaming service.

But WBD essentially waved a white flag last month when it announced that “Potter” and upcoming shows based on the “It” franchise, “Dune” series and “The Batman” would shift from Max originals to HBO originals, airing on the linear network while simultaneously streaming on Max instead of serving as Max originals — or, exactly how HBO Max worked before the pivot to Max under WBD.

It certainly looked like a tacit admission from WBD that dropping “HBO” from the HBO Max streaming service’s name last year — one of WBD’s most maligned decisions — was a mistake.

On the film studio side, WBD had a mega-hit in last year’s “Barbie” and saw box office success earlier this year with “Dune: Part Two” and “Godzilla x Kong.” But despite creative goodwill from hiring Michael De Luca and Pam Abdy to run the film studio, the profit-generating fruits of their labor are still at least a year away.

One of WBD’s biggest creative assets, the DC superhero universe, is under new creative control by James Gunn and Peter Safran, but the first major film from that universe – the Gunn-directed “Superman” reboot – won’t hit theaters until next summer. And even then there’s no guarantee this DC universe will be more successful than Zack Snyder’s prior attempt that fizzled out.

There’s also a new “Lord of the Rings” movie in the works with the involvement of Peter Jackson, a boon to be sure, but that won’t be released until 2026 at the earliest – a long time to wait as WBD’s debt grows.

And in WBD’s latest blunder, TNT Sports is on the brink of losing the media rights to the NBA to Amazon and NBC, a massive blow to advertising revenue and negotiations with cable carriers. TNT, which received and is reviewing the finalized contracts from the NBA, has five days to decide whether it will choose to match or walk away. A spokesperson told TheWrap that the company is “preparing a response in view of its matching rights.”

The challenges of a spinoff

WarnerMedia’s last merger with Discovery only increased the new company’s reliance on fading linear television. More than half (51%) of WBD’s $41.32 billion revenue in the first quarter came from linear assets. Only Paramount Global, with 68%, is in a more compromised position.

That said, a spinoff would come with its shares of challenges.

“I have seen many, many examples of companies that are conglomerates in the media sector, and when they have a sub sector that is facing secular pressures, they oftentimes get sold or spun out because they’re a drag on the company’s overall valuation,” Begley told TheWrap. “But I’ve never really seen that happen where those businesses make up most of the company’s cash flow. Splitting the company they have is not going to solve their problem, which is essentially making a successful transition or pivot to direct to consumer.”

Erlich foresees a scenario where a spin-off of the direct-to-consumer and studio businesses would leave the linear networks with some or all of the company’s debt. The standalone linear business would then be used to generate cash to service upcoming debt over the next several years and could also provide an opportunity to “roll up” other distressed linear assets held by AMC Networks, NBCUniversal and Disney at attractive valuations and extend the runway of free cash flow through cost synergies, she said.

But doing so comes with its own substantial risk due to WBD’s complex capital structure and debt covenant language that if breached could be seen as a default event that would force the company to refinance its debt at much higher market rates, she added.

“In that case, the equity upside we are alluding to would be at least partially offset by higher debt servicing costs,” she wrote. “In a forced recapitalization, we also believe it would be challenging for the company to obtain necessary financing.”

In a Thursday blog post, Lightship Ventures’ Rich Greenfield said a breakup would be “nonsensical,” pointing out that linear generates virtually all of WBD’s combined cash flow. He also argued that HBO linear and Max subscriptions are “one and the same” and that it’s unclear how you would separate the studio and streaming from Turner/Discovery.

“Given the need to aggressively invest in streaming content, tech and marketing, creating a standalone studio/streaming business with very little cash flow generation would appear irresponsible,” he added. “You need the cash flow from Turner/Discovery to build a robust streaming business.”

Instead, Greenfield believes WBD should kill Max and abandon its global streaming ambitions while returning to HBO as its focus, while making great content for others and maximizing the cash flow of its linear assets.

Begley disagreed, arguing that doubling-down on streaming would be more beneficial for WBD in the long term, even if doing so could wreak havoc on WBD’s goal of reducing debt in the short-term.

A streamer’s only chance of replicating linear revenue and cash flows and mitigating that business’ decline, he argued, would be doubling its revenues and reaching what Begley calls tier-1 scale — at least 200 to 250 million global subscribers, which is still short of Netflix’s 277 million. He noted that linear generates EBITDA margins in the 40 to 45% range, while a profitable streaming operation at scale generates EBITDA in the low 20% range.

To further build streaming scale, Warner Bros. Discovery is looking to team up with competitors through bundles and is participating in Venu Sports, a joint venture with Fox and Disney slated to launch this fall subject to regulatory approval, which will offer the ability to bundle with Max, Disney+ or Hulu.

“Ultimately, if you choose to take your cash and just try to pay down debt and not build the streaming operation, that is likely going to result in the walls closing in on how much financial capacity you can have and you’re likely to see credit rating pressure over time anyway,” Begley said. “So you might as well double down in trying to get to scale on the streaming side.”

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