Price Point 040: Let's Take a Look at Warner Bros. Discovery

What should they do?

Nov 15, 2023

I feel like the press are constantly writing about Warner Bros. Discovery, usually with some sense of begrudging frustration (the latest, from NYT). I find myself usually rooting for them because I like HBO and it is probably the network most closely aligned with my own tastes (if you don’t count Amazon). I hesitate to write too much about specific companies, because there is usually much, as an outsider, that you simply don’t know about what can be done or why such and such could never take place. Nevertheless, what’s the deal at Warner Bros. Discovery and what are some options?

My main thought is that they have done what they had to do so far but, going forward, it is hard to shrink yourself into growth and they need at least one growth driver; a programming surge may be necessary to get where they want to go.

WBD has three businesses: cable, the studio and streaming. WBD’s cable networks brought in $2.4B in EBITDA for the quarter but that was down 9% y/y in a trend that is expected to continue. The studio, despite Barbie, threw off $727MM in the quarter in EBITDA, -5% y/y.

At the end of last quarter, MAX, the streaming service, wound up with 52.6MM US subscribers (-2.6% q/q, -1.9% y/y) with a U.S. ARPU of $11.29 (+1.8% q/q, +5.9% y/y) so it looks like they are experiencing some US price elasticity and they suffered from strike related content shortfalls. Internationally, they have 42.5MM subs (+1.7% q/q, +2.7% y/y) with ARPU of $3.78 (+3.6% q/q, +12.2% y/y). Total revenue was $2.4B (+5% y/y) and Q3 EBITDA improved from -634MM in ‘22 to 111MM in ‘23. 16% of the improvement in EBITDA came from increased revenue, the rest coming from reduced costs.

For reference, Netflix’s US ARPU is $16.29, 44% higher than MAX.

My concern is that we now have a streaming business that is essentially flat from a growth point of view, is exhibiting signs of price elasticity, and which is barely profitable (a 5% decline in revenue would make it break even).

If you do nothing and just try to cut costs here and there, your multiples will continue to get hammered. What are the key operational metrics we can improve — and other changes we can implement— that would turn one of these businesses, presumably streaming, into a real cash generator and grower?

I am not going to look at cable networks in detail. Zaslav and team know a lot more about this area than I do and i presume this is a matter of managing a declining business in such a way as to extract as much cash flow as possible.

THE STUDIO

The studio is more interesting. AT&T and, to be fair, some industry-wide shifts, really did a number on Warner Bros., ending its reign as the studio with the best team and the best filmmakers, which made big commercial movies — from Lord of the Rings to The Matrix to Unforgiven — that also felt like quality films. Now Christopher Nolan is gone and there is some question as to how Warner Bros. can be a leader again or what that might look like. Barbie feels like a one off. Warner Bros. doesn’t own Mattel and, as far as I know, doesn’t have an overall deal with Greta Gerwig and Noah Baumbach. Other than DC movies, what should Warner Bros. be doing and how can it be special and add value both to the bottom line and to MAX? I would say that it needs to reestablish a murderer’s row of great commercial directors on the lot and regain leadership as the preeminent producer of big movies you want to see in theaters.

Thinking to the future, I would also look for a source of IP that may provide tomorrow’s Barbie and Dune. There are always books that come out, and there is DC, but I would be investing in digital native cartoons and comics in an organized way. Webtoons and (obviously) YouTube and TikTok are huge and many of the next important properties will follow a CoCoMelon path.

That said, the studio is never going to be a huge growth driver. It’s in a mature business and mainly exists to maintain cash flow and serve the streaming service.

MAX

A good goal would be 70MM US subs at an ARPU of $15.00 ($12.6B/year) plus 70MM International subs at an ARPU of $9.00 ($7.6B/year) for total annual revenue of $20.2B. That would be a 127% revenue gain with an EBITDA target of $6B (15X increase versus current run rate). Right now the company is not on track to achieve these goals and the investments required to achieve them may seem daunting. But if MAX continues to achieve negligible growth and profitability while the rest of the company shrinks, WBD multiples will continue to compress as skepticism builds — and that’s what I’d call daunting.

MAX has a middle of the pack annual churn (customers who cancel) rate of 55%. This means that they have a quarterly churn rate of 18% (.45^.25). Which means that what happened this last quarter, roughly, is that they had 54.0 MM subs at the end of Q2 23, about 9.7MM churned out, and they gained 8.3MM new customers, leaving them slightly at a net negative. Their Sales, General; and Administrative costs in the quarter were $453MM (-46% y/y); much of that is likely cost of customer acquisition, presumably something like $50*8.3MM = $415MM.

If we could cut the churn from 55% to 25% (quarterly: 7%), which is below Netflix and therefore amazing, that would be a great goal and would free up about $240MM in cash flow that is currently going into acquiring and reaquiring customers.

What is driving 55% churn?

Very likely 55% of users are using the product too infrequently, less than ten times per month. Light users, predictably, have high churn rates.

The answer to achieve segment-leading churn rates has two parts: content and user experience.

CONTENT

First I do want to say here that I am not being critical of anyone. As I have said, I think the HBO programming team is excellent. Probably the best in the business. But in any business, you need a strategic review occasionally to make sure you are trying to achieve the right goals.

What are the major series releases in 2023?

The Last of Us
White House Plumbers (March)
Hacks season 3
And Just Like That s2
Gilded Age s2
Succession s4 (finished)
The Idol (cancelled)
The Other Two s3 (finished)
Love and Death
Black Lady Sketch Show s4
Our Flag Means Death s2
Winning Time s2 (cancelled)
Rap Shit s2
Julia s2
Barry s4 (cancelled)
Curb s12 (continually finishing)
Doom Patrol s4 (cancelled)
Perry Mason s2 (cancelled)

For the future—

*House of Dragons summer 2024
*True Detective
*Park Chan Wook’s The Sympathizer
*The Penguin (Colin Farrel mafia from Matt Reeves)
*Dune spin-off
*White Lotus 2025
*Euphoria 2025
Harry Potter 2025/2026

In general, when I think of the customer for that lineup, I think of someone who lives in Manhattan, maybe has a second house in Hudson, subscribes to the NYT, the Paris Review, the Hudson Review, and Air Mail, and has a hybrid Volvo at the Hudson house. I’m exaggerating, but that’s the idea. With exceptions, it feels older, sophisticated and a bit less buzzy than I would have thought before I looked at it on paper — in spite of House, Last of Us and Succession. This person probably still has cable. Also, note that a lot of the better shows are winding down.

I’d like to see more tent poles, more comedy, and I’d like to see a kids program -- and some of this is indeed on its way. Also, I’d simply like to see more volume and a bit more of a broad audience reach on average. Let’s break it down.

TENTPOLES

DC: MCU is having problems at Disney, but no need to assume WBD must have the same problems. I’d like to see two major, high quality DC series per year and this seems quite possible. Not the CW series but give me House of Dragons-level DC.

So now we have House of the Dragon, a Harry Potter show, and two DC shows per year. Amazing. Maybe we can augment this with two more franchises, maybe a space opera, maybe The Matrix universe so that we always have four per year even if there are production delays. This whole group should be an autonomous unit called the Franchise or Genre group.

The idea is: there is always a tentpole on now and another coming up. It’s not one a year.

COMEDY

There is a woeful lack of comedy here. And what comedy there is is a bit specialized. People like to laugh! I would like to see some red-blooded fun here, maybe partaking in a bit of the (now fallow) vibe of The Hangover, Cannonball Run, MASH, or a new Friends pulling from some of the younger comedic talent blossoming on YouTube now. Six comedies per year, please.

SOPHISTICATED DRAMA

This is still HBO and we want to maintain the tradition of great dramas like Succession and White Lotus. Keep it up. But if we cannot produce seasons more often than one every few years (White Lotus, Euphoria), then we need more of these so that we can deliver three or four per year. Right now volume feels too low. If this seems challenging, more overall writer-producer deals will be needed. It should be doable.

YOUTH

Occasionally there is a Euphoria season. But otherwise, it’s not a very youthful lineup.

KIDS

33% of households have kids. Why abandon them? Is there data suggesting these customers are over-served by the competition? Warner Bros has strong kids brands with Looney Tunes, Pinky & the Brain, Hanna Barbera, and Animaniacs. Someone could revivify this and make it a brand pillar.

GO LONGER ON AUTEUR FILMS

In general I am recommending to go broader, but HBO has a veneer of sophistication but it doesn’t have a Spotlight films or a Focus Films. Six sophisticated films per year and a strong showing at the Oscars could add something to the brand.

DAILY SHOWS AND MOVIE SERIALS

Something I have written about before is that to minimize churn, it would be good to have shows that either come on every day, or 52 weeks per year, or at least movies that are produced essentially as serials so you get one per quarter. But these have to be done so that they meet the quality bar. A team has to be assigned to figure this out. I’m certain the movie thing can be done. I am confident the 52 episode per year show can be done in kids. I suspect there is a solution for the other challenges as well (that isn’t All My Children).

TEAM SCALING

I don’t work at HBO and I never have. There is obviously something right about their culture since their record of success spans several leaders. But when a team encounters scaling problems (“we just can’t make any more than this!”) typically what has to happen is that separate, parallel pods need to be created to manage different types of output. Perhaps that would be helpful here. I don’t know.

CULTURAL TONE

I think we pretend that the gulf and conflict between politically divided groups of Americans can be ignored or that studios can maintain robust businesses while just serving one part of America. Looking at Disney’s recent experience, I am now not sure that’s the case. I think it will be best to be apolitical when possible, and to serve both sides sometimes, but not to just pick one side and oppose the other side. In any case, people have to start being more self-conscious about this.

USER EXPERIENCE

MAX does not have a great user experience in my opinion and I think this is a lever that can make a difference.

First, the MAX app does not do much and has a dead feeling. Nothing is currently happening anywhere on the app. It is like a USB drive with a lot of files on it. Boring. If your app experience isn’t funnish, I might open it second or third, considerably after Netflix and that will substantially diminish my visit frequency.

When I loaded MAX up today, here are the files it presented to me:

HERO WIDGET

1 Gilded Age

2 Eastbound & Down [10 year old show — why??]

3 Last Week w John Oliver [I never watch news]

4 Real Time w Bill Maher [again, I never watch news]

5 Albert Brooks Defending My Life [ok]

5 Gumbo Coalition (doc about black and Latinx civil rights champions joining forces against white supremacy) [I never watch docs and probably wouldn’t start with this one]

[These are weak reco’s and a waste of the hero widget. If everything at the top of the page is bad you’ll have a lot of people bounce out and just this can cost $50MM per year.]

“FOR YOU” [was the stuff above not “for me”?]

Gilded Age [again? — I take it this widget is not talking to hero widget?]
Veep [Great show but old]
Gossip Girl [older show/not for me]
Last Week [again?]
Rap Shit [haven’t heard of]
Sopranos [do you not make new shows?]
Friends [sorry, is this the wayback machine?]
Nathan for You [not an hbo show and not new]

FEATURED [no idea what this widget is but I think it’s “Discovery stuff”]

How We Get Free
Rap Shit [again?]
A Voyage of Discovery: The Ocean Race
Julia [again]
Fixer Upper: The Hotel
Living Single
Love Has Won: The Cult of Mother God
Gumbo Coalition

LIVE & UPCOMING

(Assorted Hockey and Soccer)

TOP 10 MOVIES TODAY [all old]

Elf
Polar Express
Christmas Vacation
Pitch Perfect
The Nun
Devil Wears Prada

JUST ADDED [always a totally random and low performing widget]

Dune
Beatles: Now and Then
Taking on Taylor Swift
Foot Fist Way
King’s Speech
Ordinary People
Lost in America
Defending Your Life

HBO HIGHLIGHTS

[No famous HBO series??]

TOP 10 SERIES TODAY [largely redundant with what’s being promoted above]

Gilded Age [again!]
Lost Women of Highway 20
Scavenger’s Reign
Last Week
Holiday Baking Championship
Rap Shit

Because you watched “Shiva Baby” Watch “Girls” etc [ok this is not bad but girls was a long time ago]

LAST CHANCE

Lost in America
Pee Wee’s Big Adventure

And various genre categories like “find your next classic on TCM”

CNN Beta

Totally focused on foreign news and then a list of documentaries. I’d give this an F.

In my ideal world, feels like there should be a mosaic of feeds we can click into here with live updates about all sorts of stuff. Maybe CNN Digital should even be substantially UGC or at least carry some other global services. The more the better is the point.

IDEAS AND RECOS

Ok so I realize there has been a strike. But the selection presented is very old and not great. Service feels dead. I have generally been recommending services raise prices but in MAX’s case I would hold off for a while.

Goals:

More selection is necessary (and to be fair more is on the way)
Reduce redundancy in recommendations
Increase reco relevance
Make it feel more alive

Ideas to A/B test:

I want a live feed of “what’s on now” that auto plays so it’s like something is happening now. Basically a linear channel.
Hero widget reco algo’s must drastically improve.
Simplify the widgets and avoid redundancies. It seems like the ML is weak on these reco’s. What we want is For You, New Shows, Classic Shows, New Films, Classic Films, Seasonal, and Genres (which is essentially browse), all informed by reco’s.
If “featured” = Discovery, just name it by Discovery brands, which at least are known and make sense to people.
Extend into new use cases and dayparts with audio content: podcasts, audiobooks, etc. Goal: people use every day or multiple times per day.
Add widget for daily new/live content: news, podcasts, ad-supported UGC.
Add “Amazon Channels” feature where people can buy other channels. This could make the app more of a first stop.
Add social features including comments and group co-viewing and chat: see BiliBili in China. People are constantly commenting on shows and it helps drive engagement. Can some of the fandom discussion be brought in to the app?

CORPORATE

If possible, it could be very helpful to merge WBD with PARA. This would not work with a substantial premium for PARA stock, but since the prospects for both firms are similar and the challenges are similar (one of them being scale), why not a simple merger of equals work with no premium on the stock? If the selection within the MAX app also included everything currently in Paramount+ (and Showtime and CBS), it would be much more robust, visitor frequency would likely increase, churn would decline and profitability goals should be achievable much sooner.

Similarly, there are subscale streamers overseas that typically serve a single market. I believe that MAX is largely leaving international until they feel they have sufficiently burnished their domestic business. But a good way to secure a much stronger foothold globally would be to explore combinations with some of these single country streamers before they are snapped up by someone else.

I think WBD has a bright future but it may have to up its game a bit in the next 2-3 years, which may temper cash flow growth in that time.

Roy Price was an executive at Amazon.com for 13 years, where he founded Amazon Video and Studios. He developed 16 patented technologies. His shows have won 14 Best Series Emmys and Globes. He was formerly at McKinsey & Co. and The Walt Disney Co. He graduated from Harvard College in 1989.

Price Point