2023-06-10 08:00:00 ET
Summary
- The Warner Bros. Discovery, Inc. CNN issues are making headlines.
- It is probably significant that management repaid credit lines and is now tendering for $500 million in debt to make about $2 billion in debt payment progress for the quarter.
- Warner Bros. Discovery is a lot more than just CNN Worldwide.
- It is unclear if the CNN issues just affect the United States or the whole corporation (and the financial significance of all of this).
- Of likely greater significance is the DTC cash flow improvement shown in the first fiscal quarter.
(Note: This article was in the newsletter on June 8, 2023.)
Warner Bros. Discovery, Inc. ( WBD ) has been making the headlines for some time due to the issues at CNN Worldwide. Now that Chris Licht has stepped down as Chairman and CEO of this part of the company, even more attention has been given to all the issues here. But Warner Bros. Discovery is a large company with a lot of moving parts. Issues with an acquisition as large as the one that formed the company should be expected as long as a course correction or two. Probably harder for investors to do is to realize just what the size of the problem is when that problem makes a lot of continuing headlines. This can lead to a misevaluation of the whole situation (and hence wrong investment decisions).
The Beginning Proposal
The original merger proposal combined a whole lot of things together besides gaining access to CNN Worldwide.
(Note: This presentation has since been taken down, so I got this from an older article.)
Just in sheer numbers , there is a whole lot to a company where the acquisition was expected to produce EBITDA of roughly $14 billion (at the time of the announcement. The immediate concern is the extent of the CNN issues. (It should be noted that the $14 billion back at the time of the merger is now a guidance of roughly $11 billion in the current fiscal year.) Much of what went on with CNN was clearly United States issues. But this is a worldwide company. If the problems were restricted to any one company, even the United States, that alone makes the financial issues probably very small.
On the other hand if it affects the worldwide company, then to what extent is that effect felt throughout the company? Blaring headlines do not necessarily imply a big problem when all of those items shown above are part of the new company.
Debt Repayment
One of the signs that this whole issue is just "a problem" in a large company is the announcement of the debt tender. Management announced that it repaid $1,550 million of borrowings before announcing the tender. The tender offer itself is for another $500 million. Therefore, management has repaid about $2 billion of debt when the tender offer is completed. That is quite a bit of progress for a company that is in the headlines with problems at CNN.
It also underscores just how much progress this management has made since taking over the company.
EBITDA And Free Cash Flow
There was a lot of disbelief about the progress of management when the EBITDA comparison below was presented.
The reason for all of this doubt was the negative free cash flow shown in the next slide.
Clearly, the market did not exactly buy the explanation:
Mr. Market has long had the unrealistic expectation that free cash flow should be evenly (and fantastically) distributed throughout the fiscal year. On top of that Mr. Market hates negative comparisons. This comparison as management stated was "apples and oranges", and the market still hated it.
It is true as more than one person has stated that "you cannot spend EBITDA." However, the evidence of that EBITDA producing useable cash flow is beginning to be present in the form of debt repayments in the second quarter along with the bond tender offer.
More to the point, management is redeeming the 2024 bonds by offering a premium. That does, to some extent reflect the faith of the bond market in this management that is not evident in the stock market. Now this is not the first time that has happened either.
This means that one or the other will be proven wrong in the long run. My personal bet or belief is that the bond market has the right idea and the stock market will come around. No guarantees of course.
One of the big ideas from the explanation above is that as the debt levels come down, the coupon payment in the first quarter will become less burdensome. So, if other things make no progress at all, the current debt repayments are likely to sooner (probably) or later make a material impact on that negative free cash flow.
The other idea is that the debt was structured so that much of it is not due presently. Any payments like the payments shown above are likely to result in progress in excess of market expectations. That likely means another pathway to lower debt ratios than the market expects.
Original Debt Structure
John Malone in an interview a while back noted that the debt was structured to give the company time to work out issues encountered. The emphasis on this discussion appeared to be time because Mr. Malone, a board member also mentioned that they wanted management to be able to work out any issues encountered including unforeseen issues (evidently of which there were plenty).
(Note: This slide was taken down from the company website, so I referenced an older article.)
The debt structure has obviously changed a bit since this slide was presented and it will change more with the tender offer underway. But the key idea is that most of the debt is not due for five years. Management has other lines of credit to handle any debt due in the immediate future should any one year be unexpectedly challenging.
However, that "unexpected" part should decline with passing time. Management is showing quite a bit of faith in the future by tendering for any debt at all (let alone the amount repaid shown above plus the news since then). This is what investors need to pay attention to so that the headlines can have the proper priority when considering investing in the company.
Obviously, the debt due schedule shown above was created with the idea that there would be some "problems." Otherwise, the debt would be due sooner than later. So, the CNN issues should surprise no one. What would have been a surprise would be major issues enough to call the debt repayments into question for more than a year.
DTC Swing Probably More Significant
We really will not know the financial impact of the CNN issues probably until the second quarter report, if then. However, it should be noted that cash flow was so poor that acquisition expenses basically wiped out cash flow for a while. Therefore, any progress is likely to result in cash flow because it was probably challenging to do worse overall.
However, the magnitude of the change in the cash flow for the DTC segment shown above has got to be a major plus. The size of the cash flow losses probably should not have happened in the first place. Fixing a problem of the magnitude shown above will likely lead to major EBITDA improvement going forward despite the headlines that CNN garners.
The cash flow of the acquisition was so bad that there are probably more of these major improvements on the way.
But really there will be major progress like what is shown above and then headlines that appear to either show no progress or a step backwards. Rarely do these things go in a straight line with good news all the way. That is especially true with a large acquisition like this one. Still the major EBITDA swing shown above will likely be behind positive EBITDA comparisons at the corporate level for much of the current fiscal year.
The last major positive factor is likely to be movies released in the current fiscal year. As the movie business recovers from the covid challenges and gets back to normal, that contribution is likely to be another major profit center.
Key Ideas
Just because the headlines blare there is a problem does not mean that the whole assimilation progress is in trouble. There will be positives and negatives with an acquisition of this size.
The latest talk about this company possibly heading towards an Amazon ( AMZN ) program has got the stock rallying. Never mind that anyone has yet to discuss profitability of such a venture and reasonable ness of it happening.
Everything discussed here is by no means comprehensive as there is too much going on to fit into one article. So, I kind of picked what I thought would be material highlights.
With all of that in mind, the assimilation of Warner Bros. and the rest of what was acquired from AT&T ( T ) still appears to be on track. It may be slightly ahead of schedule. I still think that EBITDA guidance is likely to be revised upwards because most managements are conservative enough to be able to do that a few times.
The company, Warner Bros. Discovery, Inc., remains a strong buy consideration because management appears to be on track to at least triple the value of the acquisition from their cost basis. The debt repayment announced is a huge plus and a big vote of confidence in the future. Otherwise, management would maintain a big cash balance "just in case." The tender offer implies that free cash flow will be growing quite a bit this fiscal year. Now let us see how the future unravels.
For further details see:
Warner Bros. Discovery: The Big Picture