Warner/Discovery challenge is to deliver streaming, cash flow success - Morgan Stanley
Jacek_Sopotnicki/iStock Editorial via Getty Images

WarnerMedia (T
+3.4%) and Discovery (DISCA
+3%) are set to close their transformative media merger in a matter of weeks - and Morgan Stanley says investors are focused on the tension ahead between investing in the streaming business and driving free cash flow.
The merger is a value-creating transaction for Discovery (DISCA
+3%), analyst Ben Swinburne and team write, but the firm is staying with an Equal Weight rating on the company for three reasons: Visibility into the pro forma financials is "low," and EBITDA revisions are trending down since the deal announcement; "the cost of being wrong on earnings expectations is elevated" since the new company's net debt leverage will be 4.5x to 5x; and "while we appreciate Discovery's confidence" that it can scale streaming while delivering $8 billion-$9 billion of free cash flow in 2023, rivals' experience suggests otherwise.
"Specifically, Disney (DIS
-0.1%), NBCUniversal (CMCSA
+2.6%), and Paramount Global's (PARA
+1.6%) streaming plans have all followed a somewhat similar cadence," the firm says. "That is: launching their respective streaming services and after a period of time deciding to increase investment levels to drive greater top-line growth."
It's early days, and the new Warner Bros. Discovery should be able to flexibly adjust its strategy over time, but free cash flow volatility looks more like a risk than a positive, the firm says.
Discovery has already hedged for interest rate risk against half the debt needed to close the deal; afterward, Morgan Stanley says, its focus is on the new company's ability to deliver the synergy targets and pay down debt to hit a target of 2.5x-3x leverage within 24 months.
In the wake of Discovery's earnings report Thursday, Morgan Stanley says the print was largely in line with expectations and that peak direct-to-consumer investments are in the rear-view mirror. Aside from some pockets of softness in the U.S. scatter ad market (due to supply chain), ad revenues are continuing to show growth with particular strength internationally.
It's boosting its forecast for stand-alone Discovery OIBDA by about 2% for 2022 and 2023 mainly due to lower international expenses; it has a $27 price target on DISCK vs. current $28.48.
Discovery has set its shareholder meeting for March 11 and expectations are strong for a close of the deal in mid-to-late April.