When analyzing the WarnerMedia-Discovery deal, the Amazon-MGM deal came the week after. I was wondering what this meant for the WarnerMedia-Discovery deal? (Disclosure: long DISCA.) Want to read more about the Discovery-AT&T deal? Start here Part I, II, III, IV.
I was looking at what Amazon got for the $8.5 billion they spent for Metro-Goldwyn-Mayer Studios (MGM). Except for the James Bond franchise, I can’t really say it’s a collection of trophy assets. Sure they have some good second-tier franchises like Tomb Raiders, Rocky (a personal favorite), The Handmaid’s Tale, and Real Housewives. MGM has a catalog of more than 4,000 movies and 17,000 TV episodes. But how much would you pay for a MGM+ subscription? Not much. Their classic stuff was sold a long time ago during the Ted Turner era when he owned MGM. Turner sold the studio, while keeping the rights to many of its historic movies, which are now owned by WarnerMedia and available on HBO Max.
Under the quality of content approach, the WarnerMedia-Discovery merger looks cheap. WarnerMedia has arguably the best content library. HBO Max is first class. It has the Sopranos, Game of Thrones, the D.C. comics universe, the Matrix, Dunes, Harry Potter among others. Disney bought Star Wars in 2012 for $4. Disney also paid Marvel for $4b in 2009. The Marvel deal was considered a little crazy at the time. Prior to the Disney deal, Marvel sold the Spider-Man rights to Sony and X-Men to Fox. “No Spider-Man and X-Men!? Who cares about the rest of Marvel?” Well Disney bought Fox’s media assets for $70b and fixed the X-Men problem. As for the Spider-Man problem, Disney and Sony struck a deal. As for the rest of the Marvel Cinematic Universe (MCU), Disney took the IP and made something out of it. For example, under Disney’s wing, the MCU took more risks and explored other, less popular characters from Marvel Comics that ended up being a big hit, like Guardians of the Galaxy. Thanks to the MCU, Marvel is now one of the biggest names in film and comics. I’m sure Warner Bros. Discovery and Amazon/MGM to turbo charge IP development.
Think Like Amazon
This is not a classic media deal. It’s hard to see immediate benefits or logic. But we are talking about Amazon here. You have to think outside the box. What does Amazon do? They think long-term. They start with the customer and work backward. They invest and experiment a lot. A lot of their CAPEX won’t provide a return for years. They have a flywheel business model (lower price => more customers visit => increased the volume of sales => more commission-paying 3rd-party sellers => to get more out of fixed costs like the fulfillment centers and the servers => this greater efficiency then enabled it to lower prices further = accelerate feedback loop…you get the idea). They have AWS that subsidize every other part of the business. So when analyzing this deal, try to look at it from Amazon’s perspective.
First the money. Analysts and media think Amazon overpaid. Yes it is a lot of money for most media companies. But Amazon is not most companies. Again you need to look at it from Amazon’s point of view and how it fits in their business model. Amazon has a market cap of $2 trillion, so $8.5 billion is their pocket change. Amazon will eventually remove the content from other platforms once the license expires and lose ~$1.5b in annual revenues, a rounding error for Amazon.
This is not a move to boost next quarter’s numbers. The short-term reason is to expand their video library. Prime Video is okay and getting better. This deal improves its position. It’s one of the goodies that comes with your Prime membership (which you get for free shipping). An improved Prime video can lead to a boost in membership and membership price. Amazon’s subscription services generated $25.2 billion in revenue in 2020, representing 7% of total revenue.
The long-term reason is strategic. You are setting up the pieces on the chessboard. There’s a streaming war and the players are rushing to build their arsenal. Disney, Netflix, and NBCUniversal (Peacock) all want to become global streaming champions. CBS (Paramount+) is looking in. Amazon is muscling in. Apple has money and ambitions. To play you need the scale and resources necessary to compete. The players are buying content and removing it from each other’s platform. Basically the move is to get the IP and lock it up. In the process companies are passing up a big paycheck. By locking out the content, and making licensed content more scarce, you are increasing the value of all the other stuff out there. You have more dollars chasing more scarcity. Well in theory, but I know there’s more to it. By paying this much, you are creating a floor on the value of content.
Amazon has Fire, their streaming video distributors, like Roku and Apple TV. These platforms have achieved scale by bundling together the growing number of streaming video services into a convenient user interface. And aside from selling the hardware, they are generating recurring revenue by selling monthly subscriptions to premium video channels, and they are even creating their own ad-supported “channels” from licensed content (e.g. The Roku Channel). If the platform provider can capture a large enough global scale of consumers who are using it as a bundling agent, then they can exert some degree of leverage over the suppliers of the content (e.g., to gain a pricing advantage or some other access differentiation).
This is not just about television (or streaming to be more accurate). This is about taking IP and bringing it to the next level. It’s more than just a one way street. You need to leverage the IP in many different ways. You have to think about video games (Amazon has a game studio), Kindle/books, podcasts, music, licensing, merchandise, toys etc…Disney is the best at this. It would be stupid not to think that Amazon doesn’t have a plan to shake up some of the more sleepy assets. The real financial value behind this deal is the treasure trove of IP in the deep catalog that Amazon plans to reimagine and develop.
Competition for consumer attention is at an all-time high – including a wealth of well-capitalized video services, social platforms, audio networks and gaming services – with massive audiences and robust mobile engagement. This is the new galaxy in which the contemporary consumer finds himself.
The WarnerMedia-Discovery deal is expected to close in mid-2022. Analysts are divided on the prospects for the deal. And by looking at the share price investors are not confident. I think the combination is a compelling long-term opportunity. The combined assets offer a compelling direct-to-consumer offering. In terms of valuation, Discovery, trading 7.1x EV/EBITDA, trades at a significant discount to its peers. CBSViacom trades at 9x, Netflix at 54.4x, MGM at 39x, LionGates at 25x EV/EBITDA. At current levels, purchasing Discovery stock seems to provide an inexpensive entry point for playing the creation of Warner Bros. Discovery. If we assume pro-forma EBITDA of $12.3b, and a 10x multiple, there’s a 23% upside to Discovery.
In the long-term, to win the streaming war, I expect more consolidation down the road.
Article by Brian Langis