Warner Bros Discovery

Warner Bros.' total revenue was down 11% year over year in the second quarter, mostly due to the loss of very costly NBA rights. Streaming revenue was up 10% while profitability again expanded. Studios performance disappointed, even with declines expected after last year's huge box-office hits.

Why it matters: Streaming is the future driver of Warner's financial performance, so growth acceleration to the highest level in three years and a record EBITDA margin of 16% were great news for Warner and for Paramount Skydance, as we still expect the firms to get merger approval. Though Warner no longer reports subscriber metrics, streaming strength was clearly driven by subscriber growth. Streaming distribution revenue was up 12%, while streaming advertising revenue was up 8%, a deceleration from last year due to the lack of NBA games. Management said its bundles with other streaming services and pay-TV distributors are lowering churn while improving acquisition efficiency, a contributor to the margin improvement. It sees these recent gains as durable rather than event-driven and is working on further bundles.

The bottom line: We maintain our $28 fair value estimate, which is based on our expectation that Warner's deal with Paramount closes within a year. Our stand-alone fair value estimate remains around $20, as the termination fee that Warner would receive is offset by marginal declines in our forecast and other costs incurred through its merger saga. The streaming gains and TV network losses were consistent with our 2026 forecast, considering the European expansion of HBO Max that occurred over the past year and the loss of NBA rights. Studios EBITDA of under $100 million, down from over $800 million a year ago, was terrible even after excusing the 40% sales decline—twice what we anticipated—due to the comparison with Sinners and A Minecraft Movie at last year's box office.

While the lack of the NBA playoffs underpinned networks revenue declining 17%, including a 27% decline in advertising sales, networks EBITDA declined only 4%, supporting our view that the firm was better off letting those rights go.

Free cash flow, however, is down this year, including by 20% in the second quarter. While free cash flow is often choppy due to the timing of payments, the firm incurred substantial fees when it was pursuing a company separation, something it only abandoned in February after it chose Paramount's offer over Netflix's.

Our $28 fair value estimate for Warner Bros. Discovery is based on a high probability that Paramount acquires Warner by the first half of 2027 at a price of $31.25-$31.75 per share. The exact price depends on the date the merger is completed, as defined by the merger agreement ($31 plus an additional $0.25 per share each quarter until the deal closes, beginning Oct. 1, 2026). If Paramount can’t close the deal, Warner Bros. will receive $7 billion, and we’d expect its streaming and studios business to again be a target. Our stand-alone fair value estimate remains $20, implying an enterprise value/adjusted EBITDA multiple of about 8.5 on our 2026 forecast.

We project linear networks revenue to decline in the low double digits in 2026 due to the loss of NBA rights in fall 2025. We expect advertising revenue to take a big hit and reset at a lower baseline immediately within that first year. However, given recent affiliate renewals for its networks with most major US pay TV providers, we now expect distribution revenue to remain on a steady high-single-digit decline throughout our forecast, rather than deteriorating further without the NBA, with the drop driven solely by the continuing decline in subscribers. Overall, we project network revenue to decline 7%-10% annually after 2026 due to ongoing cord-cutting and lower viewership of linear networks.

We’re optimistic about Warner’s streaming businesses, with opportunities to expand into more international markets and to gain greater domestic penetration. In both cases, we expect the firm to rely heavily on bundling, which will depress average revenue per subscriber but should lead to a much larger subscriber base, reduce frequent subscription cancellations, and create further opportunities for advertising revenue. Combined with a mix shift toward international markets, we don’t project much increase in average revenue per subscriber in our forecast. We project a decline in the next couple of years as more international markets come online and the domestic bundling strategy takes center stage, and then slight ARPU growth in 2027. We think advertising opportunities will drive overall average revenue per streaming subscriber, but we still expect an average of less than 1% growth annually. However, we expect a much larger subscriber base, with an annual average of about 3 million additional domestic subscribers and 8 million new international subscribers from 2025 to 2029, to support direct-to-consumer revenue growth in the low double digits over the next three years and in the midsingle digits for the rest of the decade.

We project studios revenue to average mid-single-digit revenue growth throughout our forecast, though this should be choppy, with dependence on film releases and success each year. We believe attendance at movie theaters has returned to long-term normalized levels following the pandemic shutdowns. We also think we’ve reached a bottom in licensing film and television content to third parties. We generally expect Warner to retain its most popular television shows and pay-one film window rights for the HBO Max streaming service, but we think it will become more open to licensing its less transformative and older content to other content providers.

We project cash content spending to stay in the $12 billion-$14 billion range annually throughout our forecast, with lower sports spending following the loss of NBA rights, offset by growing spending elsewhere. We don't expect much margin expansion for Warner, with the adjusted EBITDA margin remaining in the mid-20s. While we believe the firm still has significant profitability to make in streaming, the more rapid decline in networks, by far the firm’s most profitable segment, should offset much of the gains. We project free cash flow to average about $5 billion annually.

We assign a Morningstar Economic Moat Rating of none for Warner Bros. Discovery due to the decline in the traditional television business, uncertainty surrounding the industry shift to streaming, and the new competition streaming has brought. We believe several of Warner's advantageous attributes make the firm likely to be a survivor in a new media landscape. However, we don’t expect streaming to ever be as profitable for Warner as traditional linear television was. The continuing secular decline in the traditional television business will likely damp future financial performance, leaving us significantly less confident that Warner’s returns on invested capital—specifically based on the amount of profit it will generate per dollar invested to create content—will continue to exceed its cost of capital for the next decade.

Warner holds valuable intangible assets, including production studios that are topnotch in their ability to create popular content and a variety of wide-reaching distribution outlets that can reach consumers via streaming, traditional television, and movie theaters. However, the firm’s cable networks are not nearly as valuable as they once were. Although its networks still have wide pay TV carriage, we no longer see that as an advantage in an era when consumers can access programming, including video programming, in other ways, and we see little proprietary content that gives the networks significant value away from the declining pay TV universe. Widely distributed networks like CNN, TNT, and TBS may give Warner a competitive advantage in an industry driven by linear television, but linear television cannot support a moat, in our view.

Supported by its film and television studios and deep content library, we expect the HBO Max streaming platform to be one of the winners as the streaming industry matures and the distinction between linear and streaming television blurs. With over 130 million global subscribers, it has already separated itself from most peers, with only Netflix and Disney having bigger subscriber bases (excluding Prime Video, which is included with Amazon Prime). More generally, given Warner’s major film and television studios and the franchises it owns, we don’t see many competitors that will be able to replicate the quantity and quality of content Warner can offer.

Warner Bros.' studios are critical assets that smaller and newer competitors will have difficulty replicating. Even apart from the franchises and existing intellectual property that Warner can continue to monetize and build upon, major studios have advantages in developing brand-new content. Major studios have deep relationships with film industry talent and the widest distribution and marketing channels, giving them an advantage in attracting the premier owners and creators of content. Coupled with their relatively huge content budgets, major studios end up with the most shots on goal for major hits.

In film creation, smaller or independent studios typically partner with major studios to help with financing or distribution, and it’s rare for them to produce commercial hits without a major studio partnership. Even new competitors with tremendous financial resources, such as tech companies in recent years, haven’t shown themselves to be on the same competitive playing field. We believe the major tech companies can make further inroads if they are willing to continue investing in film production, but we expect the pace will be slow going.

Warner Bros. has also very successfully churned out new television shows, which it either shows on its own platforms or licenses to others. Apart from the long string of HBO shows it has created, such as megahits in the past few years like Succession or Game of Thrones, it has produced current hits on other networks or platforms, such as Ted Lasso and Shrinking for Apple TV and Young Sheldon for CBS.

Warner’s intellectual property and production studios can create value under any business model, and the variety of distribution channels the firm has is an asset in satisfying customers as the industry evolves.

HBO Max’s content and existing scale make it one of the few platforms that can stand alone and still attract and retain subscribers.

Separating global networks from streaming and studios could unlock significant value, as networks continue to generate significant cash, and streaming and studios are attractive for their future growth prospects.

Without a broadcast network or football rights, Warner Bros. linear networks aren’t as critical for pay TV distributors and will face increasing pressure as linear TV subscriptions continue to decline.

Major streaming platforms have been able to successfully create hit television shows, reducing their need to license content from Warner and creating more competition for HBO and Max.

Movie theaters and the film industry have been permanently changed by streaming and consumers’ preferences to view video entertainment at home, which will reduce the profitability of the film division.