Four months after closing the deal that created one of the largest content creators in the world, Warner Bros. Discovery CEO David Zaslav is messing with the magic, mixing new ingredients (a refined direct-to-consumer strategy) with some old ones (a commitment to theatrical film distribution and pay TV) that he hopes will bring the competition to its knees. But with a stock price that has been at best anemic and rival streaming services that have considerably raised the bar, Zaslav is under the gun and the clock to come up with the right incantation to bring the storied media brand back from its current realm of uncertainty.
I promise, the Harry Potter references end here.
In the days leading up to WBD’s Q2 results, the rumor mill was wild with tales of what Zaslav would do to the company that he bought just a few months before. Thankfully, Zaslav’s new direct-to-consumer path was not laden with the landmines that many expected. There were no massive layoffs, HBO Max isn’t going to disappear into the ether, there are no weapons of mass destruction hidden somewhere on the Warner Bros. Studios’ lot, at least for now. But there are going to be changes. Spending is going to be tighter. WBD is going to take a harder look at how it develops programming. Warner Bros. is going to recommit to theatrical releases for movies.
Some films earmarked for streaming won’t see the light of day. And there is probably more to come. While Zaslav and team laid out some of the streaming strategy on August 4, more details are expected at a planned Investor Day toward the end of the year, including the new name of the combined HBO Max/Discovery Plus streaming service.
So just what is Zaslav’s new formula for success? Here’s a look at five ingredients in the soup that is to be the new Warner Bros. Discovery:
1. Reformulate the way that it counts streaming subscribers.
WBD said total streaming subscribers (HBO Max and Discovery Plus) rose by 1.7 million to 92.1 million customers in Q2. That growth was mainly outside of the U.S. International added 2 million customers while domestic streaming subscribers fell by 300,000, to 52 million from 52.3 million in Q1. That appears to be a big miss from Q1, when HBO Max said it had 76.8 million total customers, and Discovery Plus reported 24 million customers. The Q2 results reflect a new way to count subscribers. WBD said the earlier subscriber count included about 10 million non-core Discovery Plus subs and HBO Max subscribers that were part of AT&T mobility promotions and never activated service.
“No one else is telling you how many subs they have that get it for free, whether they watch it or not,” FBN Securities media analyst Robert Routh said “They should really break it down on whether or not it is something that people actually pay for, and if it's something they actually watch. That’s a more valid metric, but we don’t get that metric.”
2. Scrap movies that were originally for streaming only — most notably Batgirl, which the company already spent $90 million on before it was ever seen publicly — as well as the animated Scoob! Holiday Haunt that was four years in the making.
Some saw the decision to shutter the Batgirl film as a financial one — apparently there were tax incentives to cancel the project this year — while others saw it as a move to erase the legacy of executives before him. Zaslav didn’t really address specific films on the call, but some reports have said that Batgirl fell through the cracks because it wasn’t a billion-dollar blockbuster, and the additional investment needed to market and distribute the film in the theaters would have more than doubled its $90 million price tag. To Zaslav, taking the tax write-off and moving on just made sense.
Aside from the Batman franchise, WBD has had little luck with the rest of DC’s characters on the big screen — certainly nowhere near the success of Disney’s Marvel Entertainment. But some believe it could be a matter of simply finding the right person to run that part of the studio.
“They have a DC Universe, and universes are really hard to create and cultivate,” said producer and filmmaker Gary Pearl, CEO of Aquarius Content who’s Flowers in the Attic: The Origin aired on Lifetime last month. “Look how many years it took [for the Marvel Cinematic Universe]. Kevin Feige [Marvel Studios president and chief creative officer Marvel Entertainment] had to be born and grow up. I remember when Marvel sold for $60 million. … How is it all of a sudden worth $6.5 billion? Because other people came along and made change.”
Pearl said that one sign that Zaslav is serious about turning around the studio is his hiring of two Hollywood veterans — former MGM chairman Michael DeLuca and former MGM Pictures Group president Pamela Abdy — as co-chairs of Warner Bros. Pictures Group. Both have long track records, producing recent buzzworthy and critically acclaimed films like Licorice Pizza and House of Gucci, as well as past box-office hits like Boogie Nights, Fifty Shades of Grey and Austin Powers.
“I can understand how people feel about Batgirl,” Pearl said. “I haven’t seen it, but I will guarantee you, it’s a bad film. He’s not going to dump $90 million just to make a statement. He’s saying we have a big asset in DC and it's been mismanaged for 30 years. And my definition of that is ‘I don't have my Kevin Feige yet.’ Maybe he hasn’t been born yet. That guy is that brilliant. So who’s the DC guy? I’ll bet you he thinks that is DeLuca.”
While some critics have accused new WBD management of trying to erase former WarnerMedia CEO Jason Kilar’s legacy, many forget that the decision to put the Warner Bros. slate on HBO Max endangered a lot of relationships with creatives. Dark Knight and Inception director Christopher Nolan told The Hollywood Reporter at the time that Warner “blindsided” the creative community and instead of working for the best studio, they are working for the “worst streaming service.”
Many of those creatives changed their tunes when they saw the generous bonuses Warner Bros. offered to compensate for missing out on theatrical box office. But there were still a lot of egos that needed stroking.
After the merger was announced, Zaslav went on a highly publicized listening tour to repair those relationships with the creative community. Committing to theatrical releases is just another part of that.
3. Double down on Warner’s commitment to theatrical releases of films and release no expensive movie on streaming services before theaters.
Kilar introduced the controversial decision to release Warner Bros.' entire 2021 slate day-and-date to streaming, it obviously goosed HBO Max streaming subscriptions and helped put the service on the map. But that was during a pandemic when theaters were closed and Kilar had let it be known that it was only a one-year experiment.
Nevertheless, some directors and producers were outraged at Kilar’s move, with some vowing never to work for Warner again, claiming that once the day-and-date cat was out of the bag, it would become the norm for the industry. They didn’t and it didn’t.
But it did cast a light on what can be bewildering Hollywood economics, where accountability can sometimes be murky. Zaslav, who according to some reports has been notoriously frugal at Discovery — asking some producers to take out loans to front their own production costs — said during the Q2 call that he can’t justify releasing an expensive movie online.
“We’re not going to release any film before it's ready,” Zaslav said. “There is no comparison to what happens when you launch a film in the theaters. This idea of expensive films going to streaming, we cannot find an economic case for it, we cannot find an economic value for it.”
Pearl said that while Kilar’s strategy worked during the pandemic, it is time for a more pragmatic approach.
“In a weird way, Jason’s approach worked, but it worked in a pandemic,” Pearl said. “I don't know how you call that solid business change. It was the right thing to do for one year. He was gaining subs. And what was he going to do with all of those movies anyway? Shut down Warner Bros. and not make anything?”
4. Combine Discovery Plus and HBO Max into one streaming product.
That shouldn’t have come as a surprise. WBD streaming chief JB Perrette told the ad community in May at the upfronts the company would do exactly that.
During the Q2 conference call, Perrette said the combined offering would debut in the summer of 2023, adding that it will first be launched in existing HBO Max markets in the U.S., followed by Latin America later in that year and in Europe and Asia in 2024.
Perrette acknowledged that both services have different audiences: HBO Max is more appointment TV than Discovery Plus, which is more “comfort viewing.” But he was confident that the two services would mesh well.
“These are two critical and powerful components of a strong and sustainable subscription business,” Perrette said on the Q2 call.
Some analysts wondered how the combined offering would be priced, adding that a combined HBO Max/ Discovery Plus might have some flexibility, especially with existing ad-supported versions of both streaming products. Zaslav said that coming soon are an ad-light service and a free ad-supported television (FAST) offering that should satisfy more price-conscious consumers.
At $14.95 per month, HBO Max is one of the more expensive streaming services. Netflix raised charges for its standard streaming service to $15.49 per month from $13.99 in January and others have followed suit. At the same time, these companies are launching less expensive ad-supported versions. HBO Max has an ad-supported service priced at $9.99 per month. Disney just unveiled plans to debut its ad-supported version on December 8 for $7.99 per month. Netflix plans an ad-supported version this year. Disney released other new pricing details last week.
Discovery Plus has been fairly steady (opens in new tab) at $6.99 per month for an ad-free service and $4.99 with ads. Just how that pricing will mesh with HBO Max charges remains to be seen.
5. Preserve the pay TV distribution relationship, even as cord cutting has accelerated to record highs.
One of streaming’s dirty little secrets has been that although it is without a doubt the future of content distribution, it is a huge drain on finances. Not one of the major content players is making money off of streaming— not Peacock, not Disney Plus, not Paramount Plus, neither HBO Max nor Discovery Plus. All of them are supported by traditional linear networks that are losing subscribers by the bucketful. So the biggest question among content investors is what happens when the traditional content cash cow, and its fat affiliate fees, dries up? The answer may come sooner than anyone thinks.
The pay TV business lost nearly 2 million subscribers in Q2, according to Leichtman Research Group, up from a loss of 1.2 million customers in the same period last year. So, as subscriber losses accelerate, it's only a matter of time before linear networks can no longer feed the streaming beast.
But it shouldn’t come as a surprise to programmers.
MoffettNathanson warned back in 2019 that pay TV subscriber erosion was having an effect on affiliate fee growth. While the pandemic may have slowed that erosion down slightly, cord-cutting has come back with a vengeance. In Q1, MoffettNathanson estimated that overall pay TV subscribers (cable, telco, VMVPD and satellite) were down 5.1%, or 2.1 million customers, in Q1, close to the record 5.5% decline set just prior to the pandemic. It is shaping up to be even worse in Q2, with Comcast and Charter alone shedding more than 700,000 subscribers in the period, and heavier losses at satellite and telco providers.
Zaslav has long been a proponent of keeping the affiliate fee relationship intact. In his early days at Discovery, he was one of the last remaining holdouts for keeping its content offline. While other networks were releasing episodes of popular series on their websites, Zaslav only allowed clips, adding that he didn’t want to dilute the value of the television subscription.
The 100-Plus Percent
In a blog post, LightShed Partners co-founder and partner Rich Greenfield said more than 100% of WBD’s trailing 12-month cash flow comes from its basic cable networks.
“Unfortunately for WBD (and everyone else in legacy media), cable network affiliate fees are no longer growing and appear set to enter secular decline (thanks to cord-cutting) and advertising faces increasingly stiff headwinds as linear TV viewership erodes along with the impact of a global recession,” Greenfield noted.
Adding to the concern is that as affiliate fees and ad revenue decline, sports costs are rising exponentially, placing further pressure on EBITA growth. WBD’s rights deal with the NBA expires in 2023.
“It appears WBD is now taking evasive action as their dramatically enlarged (via merger) cash cow cable network business is on its way to becoming a starving cow,” Greenfield wrote.
Disney’s Better, But Not Best
While WBD struggled with forces both in and beyond its control, The Walt Disney Co. made it a little worse by reporting much stronger fiscal Q3 results on August 10. Disney appeared to be firing on all cylinders in FQ3, adding 14.4 million global streaming customers, far outpacing analysts’ estimates of 10 million additions. Disney, with 221 million global customers, is now tied with Netflix for the top spot among streamers. Financially, overall revenue and cash flow growth beat consensus expectations. But Disney revised its subscriber growth estimates for 2024 to 215 million to 245 million from 230 million to 265 million, mainly because of the loss of cricket rights in India. Almost all of Disney Plus’s growth in FQ3 was in India, while its domestic growth was nearly stagnant at 100,000 additions.
That caused some analysts to fear that maybe Disney isn’t being conservative enough with its 2024 growth estimates.
In a research note, Barclays Group media analyst Kannan Venkateshwar argued that Disney’s revised projections should be lower. The top four streaming services -- Netflix, HBO Max, Hulu and Disney Plus -- showed subscriber declines or minimal growth in the last quarter, which Venkateshwar said “speaks to saturation levels in the marketplace.”
“Streaming growth domestically is increasingly becoming a zero sum game and will need distribution models to change for further growth,” he wrote, adding that while Disney’s FQ3 growth was strong, it was almost entirely outside of the U.S. “Domestically, Disney Plus barely grew and was just 100,000 and could see some slowdown in FQ4 due to price increases.”
Where Are My $3 Billion in Synergies?
When they unveiled the deal in May 2021 (opens in new tab), both AT&T and Discovery believed they could pull $3 billion in cost synergies out of the business in the first year. After a deeper look at the books, WBD isn’t saying that anymore. Cost savings, at least initially, will come from reduced content spending. Zaslav said HBO’s and Warner Bros. Studios’ budgets will grow, but everything else is fair game.
Pearl, who has more than 30 years in the TV and movie business as an agent, writer, director, producer and entrepreneur, said belt tightening is par for the course, especially during an ownership transition. And Zaslav is no different.
“Yes of course he’s a cost-cutter,” Pearl said of Zaslav. “Because it’s a business.”
And though the massive layoffs some expected didn’t come, it’s probably a fair guess that there will be some down the line. Discovery has a track record of stealth layoffs according to some reports, reducing its workforce in bursts of 30 employees or less, being careful not to trigger any disclosure requirements. So, layoffs could be a series of small cuts instead of one massive beheading.
That apparently has already started -- Variety reported Monday that HBO and HBO Max will lose about 70 employees (14% of its workforce) amid some other restructuring around chief content officer Casey Bloys.
Whatever form it takes, WBD is going to need to find some way to squeeze those synergies out of the business, because cash flow growth is going to be less than expected for a while. And they need to find something to help pare down debt.
WBD has about $53 billion in debt. EBITDA for Q2 was $1.8 billion for the entire company, down 31% from the prior year. While WBD has said previously it expects EBITDA to grow to $12 billion in 2023, down from previous forecasts of $14 billion, most analysts are guessing it will be even lower. Earlier this week MoffettNathanson analyst Robert Fishman estimated 2022 EBITDA will be $9.2 billion (down from his previous prediction of $10.2 billion) and his 2023 estimate to $11.8 billion (down from his earlier $12.6 billion estimate).
Waiting it Out
Wells Fargo Securities media analyst Steven Cahall downgraded his ratings on WBD to “equal weight” from “overweight” and reduced his 12-month price target on the stock to $19 from $42 per share. He sees WBD as undervalued -- its 7x cash flow multiple makes it one of the cheaper stocks in the sector due to above average execution and earnings risks, he wrote -- but suggests the best strategy for investors may be to wait it out.
“100 days on and the dust has hardly settled, and we thus think the best course is to let the internal work take its course for a bit,” Cahall wrote. “[Discovery] was a ~$45 stock prior to the deal, these assets are the best in content offerings, so when things do start to improve we think investors will be able to be late and still have plenty of upside.”
Routh added that WBD’s problems may be a combination of being first to publicly tighten its purse strings at a time when investment opportunities for investors are varied and plentiful.
“He [Zaslav] got penalized for being honest,” Routh said of WBD’s precipitous stock price drop. “We haven't seen the cost savings from this merger yet, [but] the integration of media companies takes time. Currently the Street has a lot of other options in terms of where they’re going to put their money.”
WBD shares were hit hard after the August 4 earnings report. The stock dropped by 16% on August 5, the first full day of trading after results were disclosed, and fell another 11% between August 5 and August 9. The price has been down all year, though. Shares got a little lift on August 11, rising 4.4% to $13.68 each, as some began to see a bargain in the world’s second largest content operation, but they were flat on August 12 and fell another 3% in early trading on August 15. WBD shares are down 46% since the deal creating the company closed on April 11 and are down 44% for the year.
While WBD’s decline has been dramatic, streaming stocks across the board have been feeling the pain for months. Before it released fiscal Q3 results on August 10, Walt Disney Co. stock was down 27% for the year. Even with Thursday's increase, the stock is still down 24% for the year.
Other content creators with a streaming presence have had similar declines. Paramount Global, parent of Paramount Plus, has fallen 13% this year. Amazon, parent of Amazon Prime Video, is down 15%. Even Apple is off 5% for the year.
“No one knows how to value the content companies,” Routh said. “Look at any of them, people are not giving any value to libraries, people are giving no value to current production, because they’re saying there are so many platforms now, what are the odds that what you make is actually going to become watched and monetizable and worth what you paid for it?”
So if everyone is feeling the effect of a slowing streaming business, why is everyone picking on WBD? The company is getting a lot of attention because of the merger and because HBO is one of the content brands most associated with quality, having received 140 Emmy Awards nominations this year, leading all networks. People just seem to expect more from HBO’s parent.
Zaslav will have to weather the criticism for a while, at least until Q3 results are released. My guess is he’ll be able to do it. There will be other reasons to panic from other companies, especially if Netflix misses Q3 subscriber targets.
In the meantime look for other streamers to tighten their belts, keep a closer eye on profitability and nurture relationships with traditional distributors. It’s either that, or blow the whole thing up and start over. Nobody wants to do that. ■
Mike Farrell is senior content producer, finance for Multichannel News/B+C, covering finance, operations and M&A at cable operators and networks across the industry. He joined Multichannel News in September 1998 and has written about major deals and top players in the business ever since. He also writes the On The Money blog, offering deeper dives into a wide variety of topics including, retransmission consent, regional sports networks,and streaming video. In 2015 he won the Jesse H. Neal Award for Best Profile, an in-depth look at the Syfy Network’s Sharknado franchise and its impact on the industry.
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