When the two companies traded as separate stocks on Monday, shares of T were under accumulation, rallying over 7% to $19.60 after an upgrade to overweight by JP Morgan with a $22 target. The WBD stock was generally flat, trading around $24.50, even though Deutsche Bank named it their top media pick with a $48 target and Evercore ISI upgraded the stock to outperform with a $40 target.
The strength in T was a quick repricing of shares from a deep value situation. Overall, Wall Street likes the lack of business complexity and renewed focus on wireless. The valuation is palpable and the consistent, predictable cash flow is under-appreciated, a case I outlined for buying T on March 22. At the time, T was trading at the implied price of $17 ($23.20 pre-deal close). After the equivalent of a 15% rally in T, the stock can consolidate and a is buy on weakness.
An opportunity for significant appreciation in WBD is possible, but the risks are also much higher to realize that return. Over the coming weeks, the stock may be especially volatile due to the flow back of shares from index funds that don't have a mandate to own WBD or from other AT&T investors who have no intention to hold the spun-off shares.
Evercore ISI sees the stock overhang as the buying opportunity for their upgrade on Monday. The merger of Discovery with Warner Media, says Evercore, creates the second-largest media company after Disney (DIS) with 2021 revenues of $46 billion, a content budget of over $20 billion annually that supports a library with over 200,000 hours of programming, and the assets needed to successfully compete in the global direct-to-consumer video streaming opportunity. That last part is what Evercore says is most important.
"We think the shares are undervalued," says Evercore, with WBD having around a 14% 2023 levered free cash flow yield and a path to grow free cash flow/share at a double-digit rate per year thereafter.
"As the spin-merge transaction structure is likely to create a massive supply of stock, we recommend (long term) fundamental investors to take advantage of this technical aberration as our (year-end) 2023 price target of $40/share provides over 60% upside from current levels. As such, we upgrade WBD shares to Outperform."
The deal combines HBO Max's 74 million streaming customers with Discovery+, which has 22 million viewers. Evercore is also bullish on the future of HBO Max: "We believe the combination of HBO Max and discovery+ into a single service will be highly synergistic. HBO Max will bring the expensive, flashy originals needed to acquire customers, while discovery+'s unscripted content provides the large library of content needed to retain those customers."
Lastly, Evercore finds the valuation compelling, noting that "WBD is the cheapest media company on levered free cash flow yield (14%) and the second cheapest on EV/EBITDA (7.9-times)."
MoffettNathanson takes a more conservative outlook with a $27 target on WBD, but it also seeks an opportune entry to buy from the short-term technical selling. The firm believes the combined Warner Bros. Discovery has an improved gateway to expand internationally, since Warner Bros. has been more focused domestically, in contrast to Discovery, which has assets abroad that can be leveraged. The $3 billion in synergies will offer a pathway to huge cost savings leading to the No. 1 goal -- de-lever the balance sheet.
Any new WBD shareholder should be concerned with Discovery CEO David Zaslov's pay package last year of $246 million. Indeed, it reflects executive compensation run amok. On the flip side, Warner Bros. can potentially realize its full potential in the hands of more media-savvy management.
Warner Bros. Discovery represents a true media and entertainment company hit. The shares offer a compelling value, but will take time to form a new shareholder base and realize potential synergies. Buying WBD on merger-related weakness, likely to play out over the next few weeks, will provide a solid entry for long-term holders.