In mid-June, shares of Warner Bros. Discovery (NASDAQ:WBD) fell to a fresh low of $13.30 following the release of an analyst report that raised concerns about its direct-to-consumer streaming strategy. WBD stock has only been trading since April 11, after Discovery merged with WarnerMedia, but it is down more than 40% since then.
InvestorPlace’s Mark Hake believes WBD is one of the most undervalued stocks in the tech, media and telecom sector. If it is, the rest of the stocks in that sector are incredibly overpriced.
Or perhaps my colleague is overlooking the media conglomerate’s debt. But debt plays a big part in Warner Bros. Discovery’s valuation. There’s no way around it.
| WBD | Warner Bros. Discovery | $14.12 |
Factor Debt Into WBD Stock Valuation
WBD stock trades for just 8.7 times its 2023 earnings estimate of $1.62. In addition, the company’s projected 2023 sales of $50.7 billion value its stock at 0.7 times sales.
There’s no doubt these are attractive multiples. However, they don’t consider the massive debt Warner Bros. Discovery is carrying. In an environment with rising interest rates, debt is the last thing you want your investments to hold. It’s the kiss of death.
But, heck, at least CEO David Zaslav and his heirs will get rich. They don’t call Zaslav one of the most overpaid CEOs in the Fortune 500 for nothing. He’s been milking shareholders for years. But I digress. Let’s get back to debt.
If I have two companies trading at 8.7 times forward earnings, one with $1 billion in debt and the other with $10 billion in debt, I’ll go with the former every time.
In the case of Warner Bros. Discovery, it has approximately $55 billion in debt. Based on 2.43 billion shares outstanding, that’s debt of $22.63 per share, or 1.6x its current share price.
The JPMorgan analysts concerned with the company’s direct-to-consumer streaming strategy noted: “[W]e are not negative on WBD shares but prefer to wait for more clarity around the updated DTC strategy (timing, pricing, content) and pro forma financials before getting more excited – particularly at 5x 2022 leverage as integration efforts ramp.”
The company’s debt-t0-equity ratio is 1.2. It’s got to come way down. By comparison, Walt Disney’s (NYSE:DIS) is about half that at 0.57.
What If Customers Can’t Afford the Super Combo?
Everyone knows that Warner Bros. Discovery will merge Discovery+ with HBO Max to form a potent streaming service that will knock out the competition. Analysts know it. The industry knows it. But what if it builds the greatest streaming service that no one buys because it’s too expensive for the average person to afford in a recession? It could happen.
At the beginning of June, I discussed the company’s work on an ad-supported version of the super combo. I was generally optimistic about the ultimate success of merging the two streaming services. However, it can’t merge the two without a system to monetize all the great content. That doesn’t happen if it doesn’t have personalized ad offerings.
So, even if the company provides more details about its direct-to-consumer plans, it doesn’t mean everyone will buy what it sells. I don’t think it will be a bust, but investors won’t be in a buying frame of mind if it’s not a huge success.
WBD Stock: Wait Until Debt Is Less Than Market Cap To Buy
Warner Bros. Discovery’s debt is 1.6 times its current market cap of $34.3 billion. I believe investors interested in owning WBD stock should wait until its debt is less than its market cap before buying shares.
This means the market cap has to increase by 60%, or the debt has to drop by 38%, or $20.7 billion. Management expects 2023 free cash flow of $8 billion. Even if it committed all of its free cash to debt repayment, it would take almost three years to reduce its debt by $20.7 billion.
Unless it can get free cash into double digits in 2023, I just don’t see WBD stock getting much in the way of multiple expansion despite the promise of its future streaming service. Factoring in debt, WBD stock is anything but cheap.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.