The Ratings Game: Why Discovery’s ‘groundbreaking’ WarnerMedia deal may not help its stock


Discovery Inc.’s “groundbreaking” $43 billion deal for AT&T Inc.’s WarnerMedia business may make the career highlight reel for members of Discovery’s management team, but it also could complicate the company’s once-simple story.

That’s according to analysts at MoffettNathanson, who downgraded Discovery’s stock

to neutral from buy Monday, citing concerns about the combined company’s leverage position and its ability to stake a claim in the competitive world of streaming while trying to reduce its debt profile.

See more on the Discovery-WarnerMedia deal

The analysts were previously bullish on Discovery’s prospects, arguing that the company benefited from strong free-cash flow prior to the deal and that it wasn’t getting enough credit from investors for its Discovery+ streaming service. While Discovery+ was a somewhat niche product, the analysts also had some ideas about what a stand-alone Discovery could have tried if its streaming transition failed to work out as planned—including a merger with Fox Corp.

or “a return to generating high free-cash flow and returning capital to shareholders.”

A deal for WarnerMedia isn’t quite the strategy that the analysts had envisioned for Discovery as it includes the Turner cable channels. Taking into account those assets, “it becomes a lot more difficult to see how the Discovery-Turner domestic cable network combination can pivot to revenue growth,” they wrote.

“As such, the new combined company will need to push for revenue synergies beyond the guidance for cost synergies by capturing more advertising and affiliate share from a declining linear Pay TV ecosystem,” the analysts continued. “We expect the payoff for the combined company to take even more time than we did for stand-alone Discovery.”

In the end, the analysts also worry about the combined company’s leverage position. The company could cut debt to its desired levels two years after the deal closes by putting $12.5 billion of cash flow toward debt reduction, according to the analysts’ math, but that doesn’t leave much “wiggle room” if linear TV trends erode more quickly than anticipated or if the company needs to step up its streaming investments.

“With an immediate focus on reducing heightened leverage, investors will likely be concerned about the potential to starve content investment in this highly competitive arena,” they wrote, while lowering their price target to $37 from $51.

Discovery shares are down 0.2% in Monday afternoon trading after falling as much as 2.7% earlier in the session.

Read: ViacomCBS could be a takeover target amid media merger frenzy, analyst says in double upgrade

The analysts expect that Discovery shares could be “rangebound” until the deal closes, though the performances of Discovery and AT&T’s

streaming services could drive some stock momentum.

Ultimately, the combined company will have to decide how to define its streaming strategy once all the assets come together. The analysts see opportunities for both Discovery+ and HBO Max to grow internationally but “question whether more choice for the consumer by operating two services will be incremental.”

Adding Turner sports rights to the Discovery+ library might allow that service to benefit from the sort of “tentpole events” that Discovery’s management team thinks is necessary to attract streaming audiences, according to the team at MoffettNathanson.

Discovery shares have lost 39% over the past three months, as the S&P 500

has gained 7%.

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