S&P Lowers Warner Bros. Discovery Outlook to Negative, Citing Linear TV Decline and Studio Weakness

S&P Global has lowered its outlook on Warner Bros. Discovery from stable to negative and cut its 2024 and ’25 forecasts for the media giant due to continued challenges in its linear networks segment and weakness in its studios segment.

“WBD’s first-half 2024 financial and operating performance has missed our expectations largely due to the weak operating environment for linear television that continues to face a challenging advertising environment and ongoing subscriber declines,” the firm wrote in a Friday statement . “Additionally, WBD’s studio has experienced significant volatility over the past several quarters due to the lingering effects of the writers’/actors’ strike that concluded in late 2023 and the volatility at its gaming studio due to the lack of repeated success in 2024 compared to 2023 when the ‘Hogwarts Legacy’ game was a major hit.”

The firm said that the potential loss of the NBA after the 2024-25 season could be a negative for the direct-to-consumer segment and could further exacerbate linear’s challenges, noting it represents a sizable portion of the total audience ratings.

“While the company will replace the NBA programming with something else, it’s unlikely that it can command the same pricing from advertisers. In addition, we believe the company will have to take a haircut in its carriage renewals with the pay-TV distributors. TNT currently commands a premium due mainly to its carriage of the NBA,” S&P said. “The loss of advertising revenue and potential pressure to affiliate fee pricing in future distribution agreements would likely offset the cost of the NBA rights and could pressure EBITDA beyond 2025.”

S&P warned that its ratings on the company could be lowered by the end of 2025 or earlier that year if the company is unable to stabilize EBITDA, resulting in leverage remaining above 3.5 times beyond 2025, or if the ratio of free operating cash flow to debt declines below 10% on a sustained basis. Alternatively, those thresholds could be tightened if WBD’s business trends weaken significantly or if their ability to monetize content materially declines.

In the second quarter of 2024, Warner reported a net loss of $10 billion, compared to a loss of $1.24 billion a year ago, while its total revenue fell 6% year over year to $9.7 billion. Adjusted leverage during the quarter was 4.7 times.

The net loss included a $9.1 billion non-cash goodwill impairment charge from the networks segment, which was triggered in response to the difference between WBD’s market capitalization and the book value of the networks segment, continued softness in the U.S. linear advertising market and uncertainty related to affiliate and sports rights renewals, including the NBA.

Networks revenue fell 8% year over year to $5.27 billion, while adjusted EBITDA fell 8% year over year to $1.998 billion. The revenue decline included a 9% decrease in distribution revenue to $2.68 billion, primarily driven by a 9% decrease in domestic linear pay-TV subscribers and the impact of the company’s exit from AT&T SportsNet, partially offset by a 5% increase in domestic affiliate rates; and a 10% decline in advertising revenue to $2.2 billion, primarily driven by domestic networks audience declines of 13%. The soft advertising market in the U.S. Content revenue grew 5% to $299 million, primarily driven by the timing of third-party licensing deals, partially offset by lower inter-segment content licensing to DTC. Other revenue fell 1% to $84 million.

Studios revenue fell 5% year over year to $2.45 billion, while adjusted EBITDA plummeted 31% to $210 million. Distribution revenue was flat at $3 million, while content revenue fell 7% to $2.2 billion. Other revenue grew 19% to $209 million, primarily driven by the June 2023 opening of Warner Bros. Studio Tour Tokyo. Excluding the impact of foreign exchange, TV revenue fell 27%, primarily driven by the timing of initial telecast productions as well as lower licensing sales. Games revenue fell 41%, dragged down by the weak performance of “Suicide Squad: Kill the Justice League” this year, compared to the strong performance of “Hogwarts Legacy” in the prior year. Theatrical revenue grew 19% as a result of higher home entertainment revenue from “Dune: Part Two” and higher box office carryover from “Godzilla x Kong: The New Empire,” which was released at the end of March.

The direct-to-consumer division was a bright spot, surpassing 103 million subscribers during its second quarter of 2024, including 52.4 million domestic subscribers and 50.8 million international subscribers. However, the streaming division reported a widened loss of $107 million, compared to a $3 million loss in the prior-year period. The segment’s results include Max, Discovery+ and traditional HBO cable subscriptions.

Total revenue in the direct to consumer division fell 6% year over year to $2.57 billion. Distribution revenue came in flat at $2.2 billion, primarily driven by a 7% increase in subscribers following the launch of Max in Latin America in the first quarter of 2024 and in Europe in the second quarter of 2024, partially offset by continued domestic linear wholesale subscriber declines. Advertising revenue shot up 98% to $240 million, primarily driven by higher domestic Max engagement and ad-lite subscriber growth. Content revenue fell 70% to $123 million, primarily driven by lower volume of third-party licensing deals. Other revenue fell 67% to $3 million.

S&P Global expects WBD’s revenue for full year 2024 to fall 1.6%, compared to its previous forecast of 2.6% growth for the year. It also revised its EBITDA forecast for 2024 and ’25 downward and expects a modest decline in adjusted leverage to 2.2 times in 2024, compared to 4.6 times in 2023, and 3.8 times in 2025, compared to the firm’s threshold of 3.5 times. Additionally, it affirmed a ‘BBB-‘ issuer credit rating.

The firm said that WBD’s ability to grow its DTC and studio segments to offset linear’s declines would be a key factor to stabilizing earnings long-term and that its deep film and TV library and stable of IP give Max the tools to be a compelling offering.

“We don’t believe that streaming is a winner-take-all market. However, we believe there is a limit on the number of services consumers are willing to sign up for, which increases the cost to media companies to acquire and retain customers. Netflix and Amazon have positioned themselves as market leaders,” S&P continued. “We believe this leaves the legacy media companies to compete for the third, fourth or fifth service in many cases. This presents a significant challenge for WBD and its peers as they all need to scale their DTC businesses to meaningfully offset declines in linear.”

Max has launched in 65 international markets, but is still not present in over half of its global addressable markets, including Australia, Japan, the U.K., Germany or Italy. The company plans to continue launching in new markets over the next 18 to 24 months, with a launch in the United Kingdom slated for 2026. Executives forecast that the DTC segment will reach $1 billion in EBITDA by 2025.

“The company has added over 5 million subscribers in the first half of 2024 and its domestic ARPU growth is close to 9% given its increase in prices. It has also seen good growth in streaming advertising, albeit from its relatively small base, which doubled in the most recent quarter and is approaching a $1 billion run rate,” S&P said. “Continued momentum in these key performance indicators should allow it to expand DTC margin and earnings if it is sustained.”

S&P said it could revise WBD’s rating back to stable if its operating performance improves in 2025 due to stronger-than-expected DTC revenue and EBITDA growth and a moderating pace of decline in its networks segment, or if the company divests assets or uses cash flow or other balance sheet measures to reduce leverage.

In 2023, WBD reported free operating cash flow of $6.2 billion and S&P anticipates the company will generate about $4.4 billion in 2024, with its ratio to the company’s debt remaining at about 10%. In its latest quarter, the company reported $41.4 billion in gross debt.

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