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Discovery - AT&T's Warner Media Merger


Discovery - AT&T's Warner Media Merger

Business Description:

  • 800 million monthly unique viewers globally

  • 250 million hours viewed daily

  • Operates under 2 segments: US Networks and International Networks, each divided into advertising and distribution subsegments

  • 65% of revenues in 2020 came from US Networks, 38% Advertising and 27% Distribution

  • 35% of revenues in 2020 came from International Networks, 15% Advertising and 19% Distribution

  • Since shows are factual, expenses are limited compared to competitors with 2020 operating margins of 25% vs 18% for Viacom and Netflix and 2% for Disney (20% in 2019)

  • Stock crashed by 60% after a margin call from Archegos Capital



Merger with AT&T’s (NYSE:T) WarnerMedia

  • Structured as Reverse Morris Trust Transaction, whereby AT&T will spin off Warner Media which will then merge with Discovery

  • Discovery shareholders will own 29% of the new company

  • AT&T will receive $43 billion in a combination of cash, debt securities, and Warner’s retention of certain debt


Catalysts:

  • Recovery from pandemic

  • Content creation/acquisition is less expensive compared to competitors

  • Olympics in 2021 could bring $175 million to $200 million in operating income before depreciation and amortization

  • Discovery+ ARPU expected to 3-4X US Networks Linear

  • Will make Discovery more competitive with non-factual networks


Risks:

  • Streaming business is very competitive with Netflix, Disney+, Amazon Prime, Apple TV+ and others

  • Streaming business might be a cash flow drain in initial years

  • Cable Networks businesses are in decline

  • Concentrated business

  • Will no longer be a fully factual network

  • Synergy costs might be bigger than expected

  • Will take some of the debt of AT&T on balance sheet

  • AT&T shareholders unhappy about the dividend cut from the company


Financial Analysis:

  • Revenues of $10.7 Billion in FY20 down from $11.1 Billion in FY19

  • Operating income of $2.73 Billion in FY20 vs $3.19 Billion in FY19

  • Net income of $1.21 Billion in FY20 down from $2.06 billion in FY19

  • Free Cash flow of $2.33 Billion in FY20 vs $3.11 million for FY19

  • Net income in 2017 and 2018 were unusually lower from impairment of goodwill


Discovery - AT&T's Warner Media Merger
  • Balance Sheet

    • Total assets: $34.0 Billion ; total liabilities: $22.0 Billion; book value: $10.4 Billion

    • Cash: $2.09 Billion, debts: $15.4 Billion, current assets: $6.13 Billion, current liabilities: $3.08 Billion


Valuations:

  • My personal Biases:

    • 5.0% of my portfolio

  • Assumptions for base case:

    • WarnerMedia was acquired by AT&T in 2018 for $85 billion

    • Below are the pro-forma financial estimates of WarnerMedia+Discovery for the last five years


Discovery - AT&T's Warner Media Merger
  • Revenues in 2021 will return to 2019 level with extra revenues from Olympics and Streaming

  • US Network Revenues will grow by 12% annually from 2021-2025 (17% in the last five years) with operating margins of 35% (average of 45% in last five years)

  • International Network Revenues will grow by 4% annually from 2021-2025 (4% in the last five years) with operating margins of 10% (average of 12% in last five years)

  • 4% of annual growth of WarnerMedia revenues

  • Operating margin of 25% for WarnerMedia

  • 80% of operating income conversion in FCF

Discovery - AT&T's Warner Media Merger
  • Discount rate of 15%

  • Terminal growth rate of 3%


Discovery - AT&T's Warner Media Merger
  • Use P/FCF as exit multiples for 2025 (range of 5-33 in last 5 years)

  • Bull case 15% more than in base case and bear case 15% less

  • Shares outstanding doesn’t change

  • We will consider only prices for shares of Discovery, ignoring the new company (since we don’t know anything about pricing yet)

Discovery - AT&T's Warner Media Merger

Conclusion

  • An intrinsic value of $73 billion for the new company means $21 billion for Discovery today

  • Undervalued with a market cap of $17 Billion for $23 Billion in intrinsic value in a conservative analysis

  • With a margin of safety, a fair value would be $20 billion

  • Exit multiples analysis shows an expected returns of 25% per year with limited downside of 20% and possible reward of over 400% in bull case

Read the full analysis on my Research Partnership: https://ishfaaqpeerally.teachable.com/courses/662813/lectures/32475061

Discovery - AT&T's Warner Media Merger

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