Questions about the WarnerMedia-Discovery Merger by

Thesis

Applying the Co-opetition framework to the new Google-Roku standoff helps to explain why neither company is incentivized to cooperate towards a resolution, and why Roku’s “win-win” business logic may not be the best model for working with tech giants in streaming.

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The Financial Times’ Anna Nicolau reported yesterday:

AT&T is nearing a deal to combine its content unit WarnerMedia with rival Discovery to create a media giant with an enterprise value of $150bn, just a few years after acquiring the owner of CNN, HBO and Warner Bros, said people briefed about the matter.

The board of directors of AT&T were meeting on Sunday to approve the deal, said two people with direct knowledge of the matter. The agreed deal is expected to be announced in the coming days, those people said.

There will be more to be written about the rumored merger of WarnerMedia and Discovery if and/or when the final deal is announced. I will do so for Members after the deal is announced, because the implications are too many to list.

Given the uncertainty of the ongoing deal talks, it is easier to focus on the moving pieces I find interesting from my vantage point. The biggest question is, why merge these two businesses? Or rather, what business objectives does a merger accomplish for both AT&T and Discovery?

Moving Piece #1: AT&T CEO John Stankey’s Objectives

First, one of AT&T CEO John Stankey’s fiduciary responsibilities is to maximize return on investment for shareholders. For a long time, AT&T’s spin on the Time Warner deal was content reduces churn, and “A reduction of 1 basis point of wireless churn across the base is worth about $100 million to us annually.”

But, AT&T’s ecosystem has not been optimal for HBO Max. As I highlighted three weeks ago in “A Short Essay: Churn and the Netflix and AT&T Q1 earnings calls”, for the past three quarters, “Domestic HBO Max and HBO Subscribers after we subtract Retail subscribers” has been steady:

34,408 (Q3 2020)

34,648 (Q4 2020)

34,490 (Q1 2021)

AT&T’s ecosystem has not been providing growth but HBO Max’s Retail DTC business has been. So WarnerMedia and HBO Max may be better off outside of AT&T’s ecosystem to grow and adapt than within AT&T.

Another fiduciary responsibility is reducing AT&T’s debt, which includes $23B of debt assumed in the original $104MM acquisition of Time Warner. A merger or joint venture around the two entities passes that debt off to a new entity, and gets some cash back, too, to reduce AT&T’s net debt of $168.9B by more than 15%.

Moving Piece #2: Does Discovery help WarnerMedia to grow?

Variety reported that “The two companies are looking to combine forces to add heft to the program offerings on newly launched streaming services, AT&T’s HBO Max and Discovery’s Discovery Plus.”

Library helps. But, as Discovery has learned with a library of content larger than Netflix’s, it does not immediately guarantee scale. At 13MM reported subscribers to Discovery’s DTC offerings, we don’t know how many were discovery+.

Marketing matters most, and in DTC, HBO Max has ~18MM subscribers at 3x the subscriber base of discovery+, and at 2x the price of discovery+’s ad-free tier.

Discovery and discovery+ could benefit from HBO Max’s DTC marketing, and HBO Max’s DTC marketing could benefit from Discovery’s library.

Moving Piece #3: Legacy Media Still Matters

WarnerMedia CEO Jason Kilar responded to a question about CNN’s linear future at the MoffettNathanson Media & Communications Summit last week:

The first thing, which is the CNN service that you see today on linear channels, absolutely, that stays kind of in that environment. We're very proud of that business. We think that's the right product for that distribution. And there's 85 million homes, for example, just in the U.S. market, that each month are saying, "This is the way I'd like to receive my news, my sports, my entertainment."

Kilar’s point is, as much as he was brought in to build out the streaming business, there is still an enormous opportunity in linear.

Partnering with Discovery - which remains “the most-watched pay-TV portfolio in the U.S.” and earns 67% of its $2.79B in 2020 revenues from U.S. networks - creates a media behemoth for extracting maximum value out of linear as a declining business.

Moving Piece #4: Marrying Kilar & Zaslav (& Malone)

Variety is also reporting:

Discovery CEO David Zaslav would be atop the combined venture. WarnerMedia CEO Jason Kilar would lead the company’s direct to consumer charge.

John Stankey hired Jason Kilar, but David Zaslav did not hire Kilar. After a big and exceptional Wall Street Journal profile of Kilar’s newfound power last Friday ($ - paywalled), this outcome would generate the opposite optics of a loss of power. Kilar loses WarnerMedia’s Theatrical and Basic Networks businesses to gain more specific oversight. Even if the intent is not to send a negative message, it sends a negative message.

That said, Zaslav has more credibility than Kilar in legacy media. He also brings a decades-long relationship with Liberty Media’s John Malone, who is the largest shareholder in Discovery Communications. If the objective is maximum value out of linear as a declining business,

Moving Piece #5: International

Discovery offers an international presence that AT&T does not offer WarnerMedia, including Free-to-Air channels in Australia and New Zealand. I’m not sure how that helps HBO Max’s international expansion, beyond free house inventory to promote the service.

I think international is more interesting for sports broadcasting, merging Turner Sports with Eurosport.

Moving Piece #6: AVOD

I have been bullish on HBO Max’s execution to the point where I was able to reason myself into being bullish on its upcoming AVOD bet in Member Mailing #262: HBO Max's AVOD, DotDash, and Unlocking Value Through Fewer Ads.

But the AVOD has not yet been released, and Kilar still refuses to confirm the rumored $9.99 price point. discovery+ offers WarnerMedia an existing AVOD at lower price points ($4.99 and $6.99) and without the complicated hurdles of monetizing Basic Networks content under the HBO Max brand.

Kilar will have more to play with here, but as ViacomCBS is learning with Paramount+, sometimes less is more.

Moving Piece #7: Investor Reactions

In an LA Times piece asking, “What Went Wrong?”, one clear sentiment emerged:

“What a dismal failure, and what an embarrassing chapter for what was once one of America’s most storied companies,” said telecommunications analyst Craig Moffett.

I happen to come out on the flip side of that argument: if a merger ends up creating a joint venture of which it is the largest shareholder, AT&T isn’t writing off WarnerMedia. Rather, it’s creating more value for shareholders outside of AT&T.

https://twitter.com/IncognitoJacob/status/1394050606101303298

But it would be demoting Jason Kilar for a job well-done, too.