O'Keefe Stevens Advisory - Warner Brothers Discovery: The Future Is Bright

Mike Coppola

The pursuing conception was excerpted from this money letter.

Warner Brothers Discovery (NASDAQ:WBD)

Several positions wrong nan portfolio merit immoderate reflection; however, nan 1 deserving nan astir attraction is WBD. Not surprisingly, it was 1 of nan worst-performing stocks successful our portfolio complete nan past year.

One conception learned from Jeremy Raper astatine Raper Capital (@Puppyeh1 connected Twitter) is "when there's a monolithic pivot successful biz exemplary and under-delivery vs. clear IPO targets, it's mostly a large reddish flag." While WBD is not a caller IPO, it went done a melodramatic business exemplary change. I callback 2 examples of companies that pivoted strategies.

Angus "Gus" Kelly, CEO of Aercap (AER), preached really nan accelerated depreciation schedule of planes caused accounting net to understate economical profits and nan equilibrium expanse understated nan adjacent worth of assets. AER's assets, caller tech, and constrictive assemblage were immoderate of nan astir desirable successful nan industry. When Aercap acquired GECAS successful 2021, Gus discusses nan BV and accounting reasons down nan transactions and really they were acquiring these planes astatine little than BV, moreover though they could person repurchased shares astatine a discount to BV. They besides acquired 300 helicopters, historically a business statement nan institution did not find favorable. When AER acquired these assets, it was nary longer evident that nan company's accelerated depreciation schedule was unsocial and gave them an edge. Nor was nan institution acquiring assets that were successful statement pinch nan antecedently discussed business model. This alteration successful strategy should origin 1 to reassess nan thesis.

The 2nd was GAN's acquisition of Coolbet, a B2C Sportsbook. Previously, a high-margin, increasing SaaS B2B institution shifted into nan competitory user sports betting world. This pivot degraded nan business exemplary and early profitability. The go-forward business economics were apt overmuch worse than nan erstwhile standalone business.

Since nan sportsbook acquisition, GAN is down 93%. While I fishy nan B2B capacity has underperformed expectations, this business exemplary pivot played a role. AER has fared better, down only 8% since nan GECAS transaction closed. It's my correction to person not utilized nan lessons to tie parallels to a portfolio holding WBD.

WBD vanished a sadistic 2022, down 62%. In April 2021, Discovery announced nan acquisition of Warner Media for ~$100B. Today, nan EV of nan mixed entity stands astatine $83B. It's evident listening to David Zaslov talk nan challenges pinch nan merger, implying Discovery overpaid for nan assets. Discovery had erstwhile occurrence pinch nan Scripts merger. Our first guidance was to deliberation a akin consequence would occur. However, it should person been evident nan quality betwixt them.

Zaslov, connected nan Q4 2019 net call, 3 months earlier nan Warner Media / Discovery deal, said:

" …the economics of our model. Our contented is simply a mini fraction of what's taking spot connected nan different broadside of nan ledger. The overbid, competitive, spiraling out-of-control costs for scripted, caller and repeats is astounding. That is not who we are. We aren't paying hundreds of millions of dollars for content, original aliases repeats, that we can't moreover own."

Discovery would win successful nan streaming wars owed to unscripted content's costs advantage. Three months later, they acquired an almost exclusively scripted business, weighted complete 2x bequest Discovery, becoming what Zaslov said it would not.

Maybe hindsight is 20/20, and nan only logic to constitute astir this is really overmuch nan banal is down. A business strategy translator that opposed caller commentary should person raised much reddish flags than it did. Additionally, we were alert but did not recognize really important an effect nan bequest AT&T shareholder's waste down of WBD shares would be, creating a sizable headwind.

We proceed to ain and judge nan early of Warner Brothers Discovery is bright. The institution issued semipermanent fixed-rate indebtedness astatine absurdly low-interest rates, which is simply a redeeming grace. The banal is incredibly cheap, nan institution tin repurchase indebtedness astatine a discount to wherever they issued it conscionable a twelvemonth ago, and nan business should commencement gushing rate flows successful nan coming quarters. In a fewer years, I dream to constitute really ill-timed and successful this finance was.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Editor's Note: This article covers 1 aliases much microcap stocks. Please beryllium alert of nan risks associated pinch these stocks.

Single banal ideas excerpted from money letters published by Seeking Alpha.