The question I frequently get lately is “inflation is here, what should I invest in?” Given record levels of monetary policy stimulus, central bank plans to let inflation run hot, and rising fiscal deficits, it’s a good question. Since we can’t hide from it there are things you can do to minimize its impact.
We are witnessing strong levels of inflation in categories such as labor, logistics and raw materials. Some of it we see everyday, like in food, gas, and lumber. There’s also the inflation we don’t see, like the cost of a shipping container that’s about 10 times what it was a year ago (and good luck finding one).
First I want to address the financial headline that’s making the round: Consumer prices continued to surge in June, up 5.4%, rising at the fastest pace since August 2008 and raising fresh questions over whether price inflation will be transitory. This rate more than doubles the Federal Reserve’s 2% annual inflation target. Ok, the number is “breaking news” but it was highly expected and that’s why the markets didn’t react much to the “shocking” headline. And once you dig a little bit you realize the number is highly distorted.
Some of the hot inflation readings in recent months have largely been attributed to the so-called base effect, where depressed pandemic levels from a year ago translate to artificially higher year-over-year rates. The latest CPI reading is a measure of the June 2021 number over the June 2020 number. But in June 2020 the country was still deep in the pandemic trough. It’s akin to taking a hot bun out of the oven and comparing it to a frozen one. Eventually the base effect will disappear and in another few months we will have more accurate readings.The point that headlines can be misleading. Either way, your grocery cart is costing more and that doesn’t make anybody feel better.
Back to the opening question. I wish there was a simple answer, a simple solution. As easy as asking your pharmacist for an ointment cream. “You have this symptom, take this and it will be gone.” The truth is that investing is not easy, despite the impression the TV people and the Reddit crowd gives. If it was easy, we would all be rich. And I wouldn’t be getting that question so many times.
Here’s what we are dealing with: Inflation: 5.4%, 10-year bond yields: 1.4%, Gold: flat over the last year, Bitcoin: 50% off its high. I’m mentioning Bitcoin and gold because they are both considered inflation hedges. As for Bitcoin, the narrative is constantly changing.
My point is that inflation hedging is not as easy as it sounds. So I decided to throw together a post to summarize my thinking on how to approach inflation. Please note that I’m not a pharmacist so my answer is more complex.
I split the post in two parts. The first part is a short 101 primer on inflation and interest rates. It helps to understand the relation between the two. The second part touches on the investment approach. Feel free to jump around.
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.
WarnerMedia-Discovery 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.
I think former President Obama nailed it with the blurb in the back of the book: “Wildly imaginative”. This is not a political endorsement or anything like that. I don’t put much weight on book blurb but these two words like I said, nailed it and should complete the post. The rest of is side dish.
Since I can’t use “wildly imaginative”, I found it eye opening. Surprising. Out there. Unusual.
Ken Liu did a excellent job translating it. Ken is also a legit accomplished sci-fi author himself. I’ve read acclaimed foreign work in the past and the translation can be clunky. I appreciated the English version of Metro 2033 (Russian), it felt that some of the original flow was lost in translation. I had the same feeling when I read bestseller Gomorrah by Roberto Saviano.
It was also very interesting to dive into Chinese culture and history. I had to google stuff about the cultural revolution to get fill in.
The book has been recommended in the past. And after seeing it on a few list, why not give it a shot. I was looking for something different and it delivered.
What is it about? Because this book is so out there (in a great way), I find it hard to talk about without ruining it. Or to even make sense. You just have to pick it up and go for the ride.
The Three-Body Problem is a complex work. It’s a blend of physics, science, astronomy, and technology with a dose a philosophy. Put all that stuff in the blender and you get a Hugo Award-winning.
This is the first book of a trilogy. I think it was setup that way because the first book doesn’t end. So I will need to read the second and third book. The body of work is over 1,200 pages. The trilogy have now sold more than nine million copies.
Netflix announced that Game of Thrones co-creators David Benioff will adapt Liu’s award-winning trilogy. I look forward to see how to adopt such a complex work. They already did a stellar job with the fantasy stuff, let’s see how they do with sci-fi.
Chinese sci-fi certainly seems to be having its moment in the spotlight. It’s definitely attracting Western attention.
The Wandering Earth, a collection of shorts by Liu Cixin, was adopted as a movie. Apparently it was the third highest grossing film of 2019, behind only Marvel Studios and Disney’s “Endgame” and “Captain Marvel” and nobody noticed. $700m of that was in China, so maybe that’s why. The movie was on Netflix, so I checked it out with English subtitle. The special effects are on par with anything Hollywood produce. However the script, or the subtitle in my case, was pretty bad. It reminded me of some corny action movie from the 90s. So watch it for the graphic.
Job openings soared to a record 9.3 million in April as the economy reopened but 3.5 million Americans are still on weekly jobless benefits and more than 9 million remain unemployed. The economy is still 7.6 million jobs short of pre-pandemic levels.
The numbers are very contradictory. This means the U.S. is experiencing high unemployment at the same time as a labor shortage. There are many reasons for the hiring scarcity like shifting employment choices, programs such as enhanced unemployment benefits, lingering COVID-19 worries, unqualified labor, and the need to raise wages. The last job report indicated that wages are rising.
I didn’t look up the numbers for Canada but I’m sure we are in a similar situation. A quick tour around town shows a number of restaurants, small businesses that have restricted their hours, that aren’t serving lunch, or aren’t open at all because of the workforce shortage.
The solution is a set of policies to help train more people for in-demand jobs, remove barriers to work, and attract legal immigrants. Also we need new efforts to connect employers to undiscovered talent.
Inflation is the big word on the block. I don’t need to remind you that prices are rising everywhere. The main question is will it stabilize, go higher, or go away? The answer to that will help determine the direction of interest rates.
There are different schools of thought on the topic of inflation. On one side, you have the Fed saying that inflation is “transitory”. The source of inflation is supply related. Solve the supply shock and you solve inflation. There is some truth to that. Take lumber prices, the symbol of inflation during the pandemic. It fell 14 of the last 16 trading days. It’s down 41% since its peak in May ($1,711 thousand board feet vs $1,009 yesterday). Copper prices are falling. The semiconductor shortage is getting fixed too. The only exception is oil. Oil continues to hold the line above $70/barrel. But oil was always it’s own different beast. Under Fed’s school of thought the inflation problem will solve itself once the supply shock is fixed. The market seems to have bought that narrative with the 10-year bond yield falling.
But that can’t just be it. It’s more than just supply chain bottlenecks. I think downplaying concerns about inflation is dangerous. Wages are increasing (see paragraph above), so this suggests that some of that “transitory” inflation is here to stay. The world central banks also flooded the market with cash with no indication of taking off the foot off the accelerator. 30%+ of the U.S. money supply was printed during the pandemic. The government is not reigning in spending any time soon. If history provides any indication, this will not end well, as an economic 101 textbook will tell you. What helps in this case is the U.S. is currently the world’s reserve currency. If it were to lose that status, to something like Bitcoin (I know outrageous thinking but cryptos are a thing), interest rates would increase and limit government borrowing.
The Fed has a big meeting today and a policy announcement later in the afternoon. Nobody expects a change in rates (now at 0.0%-0.25%) but the market will look for clues on when it will slow its aggressive asset purchase program ($120 billion/month). I think the market will really be looking at the set of economic projections mapping out forecasts for economic indicators like inflation and unemployment. The dot-plot chart shows expectations on when Fed officials expect interest rates to start rising. So far the economists consensus is around 2023-2024.
I find that hard to believe. Another 2-3 years of more gung-hoing? You telling me the economy can’t support a 0.25% raise in the next 2-3 years? With inflation gathering speed, a job market tightening, and the economy improving, I’m not sure what else policy makers need. Is this even responsible? Are they waiting for the market to overheat? If there’s overeating and rates start to spike, there will be enormous risks to an already fragile and over leveraged global economy.
The key here is for Powell to communicate clearly and not make any surprises (2013 taper tantrum due to sudden policy change). Powell needs to give advance notice of when it plans to trim its asset purchases. Also the Fed need to be careful on trying to paint themselves in a corner with their inflation is only “transitory” position. They should soften their stand on that.
Joe Biden is the fifth President to meet Vladimir Putin (Clinton was the first).There’s already a history between both leaders. Biden was VP and former Chairman of the Senate Foreign Relations Committee. He knows what’s up. If this meeting helps defuse the tension between both countries, then good.
Republicans have attacked Biden for giving Putin an undeserved audience. I don’t know about that. Russia is a major power with influence. Biden knows exactly who’s meeting.They both called each other “killer”. So it’s not like Biden is bringing roses to a tea and cookie meeting (plus the tea might be poisoned).
Politicians are hard to take seriously. It’s funny how the table changes when another party is in power. Where was the Republican criticism when Trump met Kim Jong-un without any conditions? Or Putin? I get it. They are playing political games. Democrats did the same thing (acting tough on Russia when Trump was in power).
Political games aside, there’s serious business on the table. It’s good that they meet face to face. I don’t expect much from the meeting. But if it can help defuse tension a bit, the better. The U.S. and Russia both have a lot to address (Ukraine, nuclear, cyberattacks, election meddling, Alexey Nalvany etc…). This is not a Hilary Clinton “reset” moment.
There’s no reset here. I think Biden will make it clear where the U.S. stands. If Russia wants to play cyberattack games, the U.S. can too. If the meeting ends with more stable relations and a roadmap to addressing major issues, then I would call that a good meeting.
The Cold War was what it was because of the almost non-existent communication between both powers. Both sides thought the other side wanted to blow them up.
I wrote an update on the big four American banks by asset size (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo). I also looked at crypocurrencies, govcoin, regulations, fintech like Stripe and Square, and Power Corp.’s reorganization.
Banks had fantastic results. The question is what follows?
The pandemic hasn’t made the banks weaker; it’s made them stronger.
The health of the banking system is akin to taking a blood sample of the economy.
Banks have deposit problems. They have too much cash and are not making enough loans.
Regulatory relief expected as banks are flush with capital. Buybacks and dividend raises are expected to follow successful Fed stress tests.
This is the opening of a front-page article in the WSJ on U.S. banks: “Everyone is clamoring for a piece of U.S. banks.” This is quite the sentiment change from my last article on the big four U.S. banks back in October 2020; nobody wanted a piece of them. But in stock market age, that was a really long time ago. At the time bank results and stocks were getting hammered. The mood was grim. Yet seven months later the banks are still standing and look better than ever. The bank stocks on track for what could be their best year on record compared with the S&P 500. The S&P Bank ETF (KBE) is now trading at about twice their pandemic lows and has risen 30.3% year to date, outpacing the 12.6% gain in the S&P 500. Despite the strong push, the banks remain cheap when compared to the rest of the market. Banks trade at around 13x their expected 2022 earnings, while the S&P 500 trades at more than 22x.
Banks’ Q1-2021 results have come and gone. I wanted to take the time to digest the results. With the backdrop of an improving US economy and strong results, the shares of JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC) have rallied higher since my October 2020 article.
Today I wanted to provide an update and insights on the big four, the banking industry, Credit Suisse (NYSE:CS), regulations, fintech, and crypto.
I don’t track quarterly earnings like a hawk. But I particularly pay attention to bank results. They give you insights into the economy. They are alternative data. Just like Walmart and Home Depot gives you an idea of the health of consumer spending and the housing market. Bank results are like taking a blood sample of the economy. If the banks are not doing well, or worse they fail, it can have massive repercussions on the economy, like we have seen with the financial crisis of 2008-2009.
Thanks to heavy monetary fiscal stimulus, the doomsday scenario didn’t play out, at least at the moment of writing this. Bank results came in better than expected and are healthy.
Who would have thought that a year ago when we were wondering how bad the pandemic fallout will be? Who would have thought to bet on banks? The question is what follows? Investors are waiting to see how the banks will fare long term, as reserve releases are a temporary phenomenon.
But first, let’s resume how we got here?
The pandemic forced central banks in many nations to lower interest rates to rock bottom level.
Savers were not the only ones affected. In practice, interest rates on deposits cannot be lowered much beyond zero (negative rates may lead to withdrawal of deposits). Low interest rates reduce the interest spread (bank margins), the difference between the rate banks pay their creditors (deposits) and the rate they charge their customers (loans).
Because of the low interest rates environment, banks have been making their profit outside traditional credit and savings operations. They have focused on trading fees, asset management, and their capital market arms. When markets are chaotic, traders can still turn big profits. When the economy is flailing, investment bankers can help nervous companies raise cash or sell themselves. Deal-making activity has been strong, thanks to SPACs and a rich IPO market. Banks earn money on both sides of the SPAC equation—underwriting the IPOs and advising on the mergers. Capital markets activity has been a source of strength for banks throughout the crisis, helping them offset declines in revenue from core banking functions such as making loans.
Another Discovery post. The more I write about Discovery, the more the price goes down (DISCA). So this is the last Discovery post for a while. Here are the previous posts if you are catching up Part I, II, III, IV). I started looking at DISCA after the Archegos fiasco and the merger with AT&T added content to cover.
Update since the last post: We have a name! The new company will be called Warner Bros. Discovery. This is playing it safe. Warner Bros. has a rich legacy and is culturaly entrenched. I also wonder if, strategically speaking, that going with Warner Bros instead of WarnerMedia is a way to rewind the AT&T chapter. But that’s just me overthinking.
We have a setup for Warner Bros. Discovery as the next big scale player in entertainment. Direct-to-consumer (DTC) is a content arms race, and scale is most necessary. More content leads to stronger engagement, which reduces churn, creates pricing power and drives margins. This is the playbook of Netflix and Disney. Warner Bros. Discovery. will be a top 3DTC player. Amazon is also a big player getting bigger but their strategy is different, that is expanding their prime business.
Why is the stock down? There’s a lot to digest in this massive merger. I think the merger announcement, the complexity of the deal, the different class of shares and AT&T’s bungling of their media assets leads to investors being turned off. The deal will only be consumed sometime next year, so it’s far away for an investor timeframe. The merger is a tough sell. There’s a lot of debt involved. You might also have Discovery’s investors being skeptical on taking on a massive media empire of scripted TV and movies. Discovery’s bread and butter is reality TV. Cheap to produce and addictive. Now you are alternating the DNA of the business. Basically, there’s a lot of uncertainties and it will take a couple years for results. So investors are not warm and are out.
I’m also trying to work out the numbers. If you can’t work out the numbers, how are financial analysts supposed to model out? If they can’t model out, they don’t have visibility on the outlook of the business. If you don’t have visibility on the business, you sell. That’s how the business works. They like that word a lot: ”Earning or revenue visibility.”
The numbers don’t seem to be good for AT&T, well for the shareholders. The only good part for AT&T is that they are getting out.
I said many times in the past, I don’t get AT&T. AT&T kept saying how great this Time Warner deal was everytime they had a chance and now they are celebrating the exit. I don’t get them. I also don’t get that 2-3 years after the merger they realized tha they don’t have the money for both their connectivity business and the media business.
AT&T Total Purchase Price (Enterprise Value) of Time Warner in 2018: $102b ($79b of cash and stocks + $23b of Time Warner debt.) That’s according to its 10K. The media are poor at explaining. They keep reporting $80b-$85b, that’s for the equity and they ignore debt. The real number is $102b.Merger (technically not a sale) involving something called a Reverse Morris Trust. Details of which haven’t been announced.
There are two part.
AT&T gets $41.5b cash and Discovery assumes $1.5b of AT&T debt
71% of NewCo. The shareholders are getting the stock. Not AT&T.
Estimated 2023 revenues: $52b (39b at closing)
Estimated 2023 adjusted EBITDA: $14b ($12b at closing)
FCF (60% conversation rate estimated): $8.4 b
Leverage 5x at closing. 24 months after closing 3x. Long-term leverage target 2.5x-3x.
Content spending: $20b (They already spend today close to $20 billion per year on content)
The company is planning to reinvest the $3+ billion of expected run-rate cost savings into content, which could bring the total content spend to $23 billion.
Expected Synergies: $3b
These numbers are questionable. There`s no way of really knowing. They are built on questionable assumptions, like the expected synergies. Deleverage is another. The market seems to be worried that leverage will reduce the company’s flexibility in terms of content spend.
Streaming subscriptions: David Zaslav said anything between 200m and 400m. It just sounded like something he pulled out of the air. No timeframe given. Not sure how it is based on. We know Discovery+ has 15m, and no clue regarding HBO Max (44m but those are mostly just HBO). So we can assume he expects at least 10x the current number.
What’s that 71% worth? There’s a lot of number shuffling here. Well let’s work with these loose estimations. Discovery is trading at 9.1x EBITDA. ViacomCBS at 7.8x, Comcast at 11x, Netflix 40x. But let’s work with 9x. The implied Enterprise Value is $126b. Remove $55b of debt and you have $71m of equity left. 71% of that is $50b. So $43+$50=$93b. That’s less than the $102b they paid for. Of course I’m ignoring the money they took out and the value of their stake will fluctuate. But because AT&T shareholders are getting NewCo shares, is it right to think that AT&T is getting a lot less, like $60b less than what they paid for? Am I getting this right?
The transaction is anticipated to close in mid-2022, so these numbers are highly subjectives.
Despite being down at the moment, once the chips fall in their places I think this company will do fall. In a sense, the lower it is the better the opportunity. Streaming is all about acquiring users, and then retaining them. You retain them with the best content. The stuff people want to see. And that’s the company’s strenght.
*5/20/2021 6:49pm Update: Small corrections and rearrangement
Following my latest posts on Discovery (Part I, II, III), James East reached out to share his thoughts on the AT&T-Discovery deal. With his permission and some light editing, I’ve shared our conversation. I think it provides a good pros-cons point of view. Like many, James is in the skeptical camp regarding the merger of AT&T’s media assets with that of Discovery’s.
The following is my response and comments to James’ concerns.
Disclosure: Me and James are Long Discovery (DISCA)
Thanks for reading and reaching out. I like reading your thoughts and feedback. You bring out some good points. There’s a part of me that’s skeptical. It’s a massive deal, there’s a lot of debt and a lot of details to draw out. So fear and uncertainty floats in the air. I think AT&T could have gotten a lot of money in return through an auction, but the taxes and the regulatory approval process would have stalled things. This deal is much faster to approve I think, than having NBC or CBS going for it. My comments in blue.
James: Mixing cultures from an entrepreneurial culture of DISCA with a staid/ideological culture of TNT/CNN looks like a disaster coming
Culture is an issue. Yeah you are marrying two different personalities. WarnerMedia went through a lot “reshuffles”, so morale is low and it’s hard to feel positive about any corporate announcements. It won’t sound like a convincing argument, but whatever problems they will have in this new marriage, WarnerMedia is better off with Discovery than AT&T.
The market didn’t react well to the announcement. It’s not a “sweet” deal for both sides. It’s more of convenience. It’s just one of these things where they are better off together than not.
Unlike CEO John Stankey, the LA-NY media circle, that’s David Zaslav’s world. He knows these people, the Hollywood folks, the culture. He knows some of the senior leadership at WarnerMedia. So he’s not a real outsider. Oddly, he feels more like an insider than Stankey.
At the end of the the day it’s about content people want to watch, when they want to watch it, on whatever device they want to watch it.
The bet is on Zaslav. He has the Hollywood connections and relationships. Producers will pick up the phone and listen when he calls. Spielberg and company are friends with him. He needs a good team to surround himself. I think he can do that. WarnerMedia’s Jason Kilar has pissed off a lot of folks. He turned off a lot of directors and producers by his approach. Stanley is not the media guy.
Zaslav has a contract until 2027.
Zaslav is better for WarnerMedia than Stankey.
I liked Richard Plepler, the guy that ran HBO before being acquired by AT&T. He left about 27 years. He built the best network on television and my guess is that he got tired of being lecture by Stankey and how he wanted more from HBO’s employees.
Everybody hates AT&T. The hate runs deep. Consumers hate them. Their own employees hate them. Former employees hate them. Their own investors hate them.
AT&T has destroyed so much capital. WarnerMedia is a victim of their incompetence.
AT&T is a utility. It doesn’t mesh with Hollywood.
What’s the synergy between phones and Hollywood?
Disney’s Bob Iger was one of the rare “suits” that was able to work very well with Hollywood. I read his book and he talks about that, working with the artists type. It’s a challenge and you need the right approach. To get a creative product out you need everybody.
AT&T’s thing was “bundles” of services to make them sticky, reducing customer defections. Good luck.
James: Zaslav has pounded the table of two years of reducing debt with long-term growth, how does that work with adding debt and 71% of NewCo with stagnate brands, seems like complete dilution of Discovery’s growth,
Massive deals don’t have a history of success. TNT/CNN (or TBS) are not engines of growth but good brands.
The trophy asset is HBO, Hollywood movies, movie studios, D.C. Entertainment. HBO has the best stuff on TV. They just never had a good streaming strategy. It’s way too complicated and constantly changing. Don’t try to reinvent the wheel. Keep it simple. Again today they came up with a new pricing for HBO Max. Something about ads. They just don’t get it. People on the Internet don’t want ads. Millenials and Gen-Z don’t want ads. That’s why cable TV is trash.
Netflix’s approach is to create 50 shows and maybe one will stick. HBO is the opposite. Instead of just pumping out stuff, their content is high quality.
They have sports right too.
CNN is broken and stupid. Nobody takes them seriously. It’s probably fixable but I feel like they don’t want to. It’s more in the entertainment section than news. It’s most likely a cash cow, especially during the election season.
Debt is estimated to be around $55b, 5x ttm EBITDA. High but manageable. If you work with $14b in EBITDA and $8b in free cash flow, it’s manageable.
James: In addition, did Discovery just lose most of its international upside exposure merging with WarnerMedia?
Not sure. I don’t think the market ever gave enough credit for Discovery’s international exposure. It’s huge and they are good but never given enough credit. I think they are #1 globally in terms of household reached but might need to double check that.
Maybe they can do it like Netflix, where they disclose a US number and global number when they talk about new subs. Netflix is both a US and global story.
Will NewCo pay a dividend?
No clue. They don’t even have a name for the new entity. They didn’t say anything about it. Heck they were sneaky quiet about cutting AT&T’s dividend. We will just casually mention it on page 15 of the deck under “attractive dividend”. I doubt they will pay a dividend at 5x Net Debt/EBITDA.
Discovery doesn’t. I think the point is to have a fresh start without the burden that AT&T carried. Any FCF after heavy investment in content will likely go to debt payment, then buybacks,
The current Discovery playbook is stock growth over dividend. I expect them to copy that.
Plus I don’t think Malone will play much of a role in this new entity, but he has influence, and we know his thoughts on dividends.
James: What is the narrative to hang your hat on now?
With estimated EBITDA at $14b and FCF at $8b, I think are looking at $40b to $55b in equity (7x to 8x EBITDA). Maybe more if this becomes a success.
Ladies love that Discovery stuff. A lot. Cooking shows, house remodeling, wedding dresses… It makes no sense to me. But hey reality shows are the crack cocaine of content. Cheap to make and addictive.
Ladies control the purse. I know households that won’t quit cable because of this stuff. Like my mother in law. Like my mom. Like my buddy’s wife. We don’t have cable so I don’t have this issue. But when my wife is at her mom’s, that’s her go to. Not ESPN, but Say Yes To Dress. It’s hard for us guys to get it, but it’s worth something (a lot).
The deal will take a while to close. And it will take while for the new company to get momentum. So it’s not a quick money play. AT&T shareholders will likely dump their new shares at first because of the lack of dividend, which most likely will depress the price, and make it more interesting. NewCo will have a different shareholder base than AT&T.
Mid-2022 is the target date for closing the deal. Add another 6 months of getting to know your new work environment, 2023-2024 is when you are going to see the fruits of this merger.
The deal should get through regulatory. It’s smaller than Fox/Disney. On the Discovery side you have two shareholders with 50%+ of votes. I don’t think AT&T shareholders get a vote because of the transaction type.
This is war, well streaming war. Don’t pick up your game and you get left behind. This deal will push a consolidation wave for media assets. If NBC and CBS are left behind, give it a 2-3 years of mediocre streaming growth, somebody will eat them.
AMC Networks is still on the block. Cheap and good too. Surprised it’s still around. I might have to poke the tire.
This is a deal for scale and content. Robust programming and deep libraries of TV shows and movies is key. This is about building a streaming juggernaut. Well it’s maybe cheaper to buy something established and to try to build it.
Netflix and Disney got it. Disney managed to reinvent itself. So it’s possible with the right leadership. It was easier for Disney to “pivot” because of their acquisition of BamTech (live streaming tech) a long time ago from MLB and their deep content library.
The true test: Can HBO Max become a true rival to Netflix and Disney?
People are abandoning cable. You want to catch them with streaming. If you don’t, they are going to Netflix and Disney. Peacock + Paramount are feeling the pressure.
There is an opportunity. Netflix has mostly mediocre content with the occasional hit. Disney is too kid/family oriented, my kids watch it. So there’s room for a 3rd player. There’s some people that want to cancel Netflix but don’t because of the lack of decent alternatives.
Prime Video (Amazon) has gotten good. I don’t know when that happened. It comes with my Prime membership. Would I pay for it as a stand alone? No. But it’s getting better and a competitor not to be ignored.
Once this is all done, NewCo will be a more attractive target (or acquiree)
Malone approves the deal. He’s not even asking for a premium for his shares. Malone: “In businesses like global distribution and creation of content, scale is the name of the game”
Zaslav is a deal guy, an action guy, and get things done guy. If something doesn’t work, move on to the next thing.
If growth is there + recurring revenue, you have a winner. Market loves this stuff.
Because of size, they can negotiate a bigger slide of all fees media companies get from monthly cable TV bills.
Since the Archegos fallout I’ve written two posts about about Discovery. Part 1 and Part 2. I initiated a position in the Class A shares at ~$41, which is now down 19% in six weeks since DISCA is trading at $33 at the moment. The current price provides a great entry point and I’m considering adding more at these prices.
Despite a good Q1-2021, the downward pressure seems attributed to things outside the business. The market has cooled off a bit due to rates and inflation concerns, Credit Suisse wasn’t done dumping massive bloc of shares to cover a bad loan and yesterday’s announcement of the AT&T-Discovery led to a pre-market price pop of 17%, $2 from break-even, and then the price pop popped. DISKCA dropped. Meanwhile Class B and Class are both higher. This is due to share “triage”, a reshuffling of different share classes. The NewCo will have one class of shares with one vote. Discovery has three classes of shares with different rights and a convertible pref. Let’s just say the NewCo capital structure will be easier and cleaner to understand.
You can see the presentation of the deal here. Below are some of my notes and thoughts on the deal. The new business is unnamed at the moment, so it’s going under NewCo for this post.
AT&T shareholders will own 71% of NewCo. It supposed to be a tax-free spin-off of WarnerMedia assets.
What is Warner Media: Mainly CNN, TNT, HBO, Warner Bros studio, D.C. Entertainment, but there’s more.
AT&T will get $43b cash, debt securities and WarnerMedia’s retention of certain debt. This will help reduces its $169b of net debt. That amount of debt does not leave much financial flexibility when you have massive investments to make in 5G and content. Will need billions to match Verizon and T-Mobile.
AT&T will readjust the dividend after spin-off. The future dividend will be around $8b-$8.6b based on 40% of anticipated FCF of $20b. AT&T currently pays $15b/year and froze it last December after 30 years of increases.
Future yield should be around 3%-4% range.
NewCo will spend $20b a year in content. That’s more than Netflix’s $17b and Disney is around there.
Originally, the DirecTV deal and Time Warner was supposed to challenge Comcast in the pay-TV business, steal digital-advertising dollars from Google, and mount a challenge to Netflix Inc. in streaming. It accomplished none of that. Now it’s going back to its roots: Wireless and broadband.
Why the deal? #1: The market was never sold on AT&T multiprong strategy of trying to be the king of connectivity/broadband/distribution and king of content. In the direction they are going they are the king of neither. Marrying media content and distribution is a tough game. Verizon tried to be a digital media powerhouse and back-off $10b in and poor results (AOL + Yahoo, come on, how much did you paid a consultant for that genius idea).
Why? #2: AT&T has a lot of debt, mostly from two massive deals (DirecTV $49b + Time Warner $81b). Net debt is $160b. The largest for a non-financial company.
Why? #3: AT&T will need a lot of money to invest in 5G and connectivity to be able to stay in the game.
Why? #4: AT&T realized that WarnerMedia is a different beast that needs a different kind of attention, and will need billions of dollar annually. They are short $2b on committed programming.
Why? #5: Never a smooth marriage. There was conflicts after the purchase. A clash of culture. A couple rounds of layoffs, and just bad headlines. Hollywood didn’t like it. Moral was low. A lot of key people left. Talent relation is strained due in part to decisions regarding the distribution of theatrical movies.
Why? #6: A lot of pressure to perform. They took on massive debt on two massive deals and the results aren’t there. DirecTV was a flop. Sold 40% for $1.3b. The verdict is still out on Time Warner but early results are not up to expectations.
I don’t get AT&T. Isn’t this like the 3rd reorganization, or reshuffle, or reset in the last few years? They bought DirecTV at the peak of pay-TV (2015), then fought the government for two years to approve the Time Warner deal (2018) and now the U-turn?!
NewCo will be a better home for WarnerMedia. A company purely focus on creating content.
I never understood HBO’s strategy. It’s confusing. HBO, HBO Go, HBO Now, HBO Max, then they had a 3-tier paying system, then one. Consumers want one HBO.
Credit to CEO John Stankey for admitting that this wasn’t working instead and looking for solutions. It’s not easy to step back and re-evaluate.
The deal is good for both parties. AT&T can attribute resources to what they now and NewCo will have more content to compete.
The two most successful players in direct-to-consumer streaming video, Netflix and Disney are almost entirely focused on entertainment, and don’t own cable systems or broadband businesses.
I like Discovery CEO David Zaslav. He’s a media guy. He knowns what he’s doing. He understands content.
Zaslav is a deal maker. He’s been acquiring content for the last couple years.
NewCo will have one share class with one vote.
NewCo will hold $55b of debt.
I like the disclosed around Discovery+. They have 15m consumers in five months and provide a good breakdown of the data/key metrics.
They disclosed that engagement is approximately 3 hours per day per viewing subscriber. 3hr!!!! This is the kind of stuff that you disclosed only if it’s positive. Nobody says they watch the 90 Day Fiancé for 3hrs, they say they watch The Crown, but we know the true.
In contrasts, AT&T said that HBO has a 44m subscribers without breaking it down. It believed that most of them are HBO-only customers. No numbers on HBO Max, the center piece of the strategy.
Discovery+ retention is strong and monthly churn is trending towards low single digits.
According to Zaslav, an hour of non-scripted content cost ~$400k compared with ~$5m for a scripted show.
Despite the stocks being down from my initial purchase, I’m still bullish on Discovery/NewCo. Right stock is getting kicked around for short-term events and market noises. The stock is undervalued. It’s kicking ~$3b in free cash flow. Discovery+ is turning into a success story. Eventually the narrative will change from “declining TV business” to streaming behemoth, just like Disney was able to rebrand itself from an “ESPN” story to Disney+.
Three weeks ago I picked up shares of Discovery (DISCA) in the Archegos fallout at ~$41. I documented the purchase and did a quick analysis in the first post here. Since then I had more time to reflect on the company.
It turned out that Credit Suisse wasn’t done with the carnage and dumped more shares on the market. DISCA is trading around ~$38 and has recovered from their low $36. Still, I’m down 7%. To add insult to the injury, shares of the thinly traded Class B, DISCB, doubled the next day. John Malone owns like 92% or more of the Class B shares and the rest are insiders. There’s no float on 6 million shares outstandings. Basically you ended up in a situation where there’s too many buyers and not enough shares. Since DISCB has retrivered to its pre-Archegos level.
As for the Class A, it takes a while for the market to digest a massive amount of shares. My timing with stocks has never been great. I either show up early at the party or I miss it. And there’s market psychology. People want to buy stocks when they are red hot. Not when they are down. They want to jump on Gamestop when it was “cheap” at $350, not when it was $5. So sometimes the reason for lower share price is lower share price. The mood might brighten if Discovery delivers good results and provides a positive growth trajectory for Discovery+. Q1 results are expected April 28. Meanwhile Discovery’s shares are getting bought back at a cheaper price.
If you value Discovery, there are 3 classes of shares and convertible preferred shares. Ordinarily companies are valued based on their fully diluted equity value, taking into account stock options and warrants. So you want to work with the fully diluted number. For Discovery that’s around 679m shares.
Just a quick comment on Credit Suisse. What’s going on there? The bank has been involved in high profile scandals in the last couple years (Greensill, Archagos, York Capital among other things). It would have been one of Credit Suisse’s best quarters in history, though it turned out to be one of the worst. Revenue at the Swiss bank soared 31% to $8.3B due to client activity in robust markets, but it logged a net loss of 252M Swiss francs ($275M) due to the Archegos disaster. The damage isn’t done. While Credit Suisse has exited 97% of its trading positions related to the collapse of the investment firm, it still predicts an additional loss in Q2 of around 600M Swiss francs ($655M). Credit Suisse suspended their dividend and is issuing $2b in new shares to shore up their balance sheet.
And the questions: Are there more skeletons in the closet? What else does management not see? How do you have a client with such a sketchy past accumulate a position of $20b+? Sounds like risk management and internal controls are not adequate. Banking is built on trust. Without it it doesn’t work. They are intermediate of capital. When a bank fails they cause massive amounts of damage.That’s why there are regulations and watchdogs. The story is still unfolding.
Back to Discovery
Their Discovery+ platform will drive growth forward. If they succeed with streaming, the narrative around the company will change too. It will go from a “victim of cord cutting” to streaming darling.
If Wall-Street buys your story that you can grow, you will get a higher multiple. It’s pretty much all that Wall-Streer cares about. Demonstrate or sell the idea of growth and you will be rewarded. Nobody understood that better than Elon Musk.
Change the story.
Amazon is not known for selling books. It’s the biggest cloud operator.
Disney is not a cord-cutting ESPN story anymore. It’s now a streaming story just like Netflix is not a DVD in the mail company. Disney+ won’t break even until 2024 and HBO Max until 2025 but the market doesn’t care.
Even though GM is a massive polluer, they are pitching the idea that they are part of the solution with their Zero Emission factory and their EV Hummer.
Microsoft is not a Windows story, it’s a cloud story.
Just look at AT&T, a company with declining legacy assets. Thursday night they released their Q1 results and the stock jumped 7% because of streaming subscriber growth. That’s more than their annual dividend of 6.6%.
I know the streaming space is crowded. Netflix, Disney+, HBO Max, Peacock, Paramount and some. It’s hyper competitive. You can add anything that consumes your attention. Youtube, Tiktok, video gaming etc…basically they are raging a war for your attention.
Discovery+ has 11m subscribers and trending up. I believe they will succeed and here’s why: First, people love their content. They might not explicitly say it but people watch their stuff.
Viewers watch their content more than they admit. They don’t talk about it. It’s like Youtube or Tik Tok. People spend hours on that stuff. Nobody says I spent 2 hours on Facebook last night. It’s not intentional. I lost an hour watching a 5 minute video on Youtube and I didn’t even realize it.
So when people ask what did you watch over the weekend, people will say “oh I watch the Crown”. But the reality is they probably binged watch The 90 Day Fiance.
Second, Discovery’s competitors are in the scripted TV and movie business. Like I said it’s pretty crowded. Discovery is in the “real life” entertainment category. They dominate that space. They have been accumulating assets and content over the years. Their content library is massive. They also have an advantage. Their “real life” content is cheap to produce. If you have a $100m big budget hype up show and it flops, well you don’t have a $100m asset. It’s worthless. By producing cheap content there’s less risk of downside.
Three, I might have underestimated how sticky Discovery’s content is. My guy goggles are probably the fault. When a guy turns on the TV, what’s the natural instinct? Sports and news. Discovery has sports content too.
Discovery has four of the top 20 most-watched cable networks (TLC, HGTV, Discovery Channel, Food Network).
My mom has cable and she pays for these specialty channels. My mom is not cord cutting. And she’s always watching their property shows.
I suspect that’s the only reason my mother-in-law keeps cable is for these unscripted shows. That’s the only stuff I see her watch.
A talk with a buddy two month ago (pre-carnage) told me he wanted to get rid of cable but couldn’t because of his wife’s insistence on keeping HGTV and TLC shows.
We don’t have cable but I asked my wife what channel do you go to when you turn on the TV (at her mother’s let say) and she says HGTV.
My point is Discovery’s content is sticky and prized. Their content is unique and global. Their content is on every platform. I believe that Discovery+ will be a success story and will drive Discovery’s share upward.
It’s been a few months since my last write up on Seeking Alpha. Since October 2020 I think. You can read the full thing on Seeking Alpha. They hold the rights. Below are just quick notes and I suggest to read the full thing to get the proper picture of the company and opportunity.
I found out about Lumen Technologies through a Globe and Mail article discussing Francis Chou’s Stonetrust investments. Stonetrust Commercial is an insurance company in the U.S. and like most insurance companies they make money through disciplined underwriting and properly investing the float. It turned out that Lumen is a large holding. Who still has a landline? Why would Francis want to own a dying copper landline business? I had to look to deeper into this.
It turns out that the stock is a favorite of some other old school value investors such as Dr. Michael Burry from Scion Asset Management, Prem Watsa from Fairfax Financials, and Mason Hawkins from Southeastern Asset Management. Something must attract them.
Lumen Technologies has 1.1 billion shares that trades at $12.70 a share with a market cap of $13.9b. Lumen distributes a fat 7.9% dividend yield or $1 annually which indicates that the market is not too hot on the company. Lumen distributes a fat 7.9% dividend yield. It looks safe. It’s covered by free cash flow of $2.8b-$3.0. That’s enough to cover the $1.1b in annual dividend distribution. Management has reiterated their commitment. Of course that’s never guarantee, but more a signal of confidence to the market.
The market is currently valuing Lumen at 5x adjusted EV/EBITDA, 8.2x 2021E earnings, and 4.7x price to free cash flow per share of $2.74, my preferred metric. This implies a 21% FCF yield. When it comes to a company like Lumen, that has a lot of debt and D&A, measuring the right amount of cash left should take precedence over earnings.
The depressed valuation, a market revaluation of their core assets, an improved profitability profile and balance sheet, and potential growth is what probably attracted these value investors.
Lumen Technologies, formerly CenturyLink, provides communications and network services as well as security, cloud solutions, voice and managed services. CenturyLink and Quantum Fiber for residential and small businesses. Lumen for enterprises.
The firm owns 450,000 miles of fiber. It’s one of the largest fiber optics network in the world. Most of it comes from their acquisition of Level 3 in 2017. It’s a Tier-1 network. That’s the network with the most connections. You need to pay for access. This is their competitive advantage. Lumen sells (wholesale) high bandwidth fiber optic long haul links to other carriers.
Remember the old Internet as a “superhighway” analogy, well Lumen is one of the major highways. Lumen is among the largest network providers in the world. If their network fails, it takes jump a huge part of the Internet with them.
Their massive fiber network and infrastructure acts as a moat. It’s too expensive to build and to develop it against the experts in the field. Fiber businesses are attractive because once it’s built, the “maintenance” or “sustaining” capex is relatively limited, and that drives FCF.
The value of Lumen’s fiber infrastructure network is not recognized by the market given the FCF yield of 21.5%. Lumen is looking to monetize their recently completed 3-year investment program and the 7.9% dividend yield looks safe. The downside is protected by the value of its fiber network (the cost to build a similar network is probably hundreds of billions) and recent large transactions for fiber peers were at double-digit EBITDA multiples.
Lumen is the new name for CenturyLink since September 2020. The rebranding comes with a new business strategy that goes beyond just offering connection services. They recently launched the Lumen Platform to run cloud and edge computing applications. Lumen is betting that the platform will fuel growth.
The Lumen Platform is a move beyond providing basic connectivity. It has the capabilities that go beyond providing just internet service. With the Lumen Platform, it will level its fiber infrastructure to provide software or other needs “as a service.” Practically, what we are seeing is the evolution from telecom company (CenturyLink) to tech company (Lumen).
A lumen is a measure of the brightness of light and the name pays homage to their fast global fiber network foundation.
It’s a myth that 5G will not kill fiber. Instead it will enhance it’s importance. 5G requires a lot more cell towers, a lot more bandwidth, and will need to be connected to a wired network. The explosion in data use, particularly mobile, could make fiber assets much more lucrative. 5G needs a fiber network that can power it through multiple contact points, and help it reconnect through physical barriers.
Edge computing. Of all the new products Lumen is launching, the Lumen Edge Compute will be one of the main drivers of future growth. I think there’s a part of the cloud story that’s overlooked and that is edge computing. With the 5G rollout, edge computing is two words we will be hearing a lot more in the coming years. Edge computing places processing power closer to where data is being created in the physical world. Edge computing is a complement to the cloud by solving issues of latency, bandwidth, autonomy, or compliance.
One great driver for edge computing is reduced latency (much faster computing speed means reduced waiting time). The more processing can do at the edge level, the less you have to rely on the cloud, and the faster the computing
Lumen has a lot of debt and makes up most of the enterprise value of $45b. With debt there’s what you owe and what you need to pay. They have been aggressive to pay down the debt over the years. Q4-2020 long-term debt stands at $31.8b. In 2020 alone Lumen managed to reduce net debt by approximately $1.6 billion and reduced leverage to 3.6x net-debt-to-adjusted.
If I applied a price to sale multiple of 0.8x to 1x on depressed sales ($19b vs $20b actual), you are looking at a 9% to 36.4% gain. If Lumen manages to grow their sales, it will warrant a higher multiple.
If we assume a 15% FCF yield (6.6x FCF), Lumen would return 34%. If Lumen manages to grow, it warrants a minimum multiple of 10x FCF, and this would imply a return of 115%.
It won’t happen overnight. I don’t expect a significant short-term boom in revenues from their investments. This is a long term play. Instead I picture a slow rising trickle of revenue growth as the country upgrades the wireless network to support 5G standards.
Three-pronged approach to higher stock price:
Market revaluation of fiber network and assets to more reasonable level. The cost and importance of building it should be the floor.
An improvement of the business. Growth + more profit + more FCF + less debt = higher stock price. Right now the market is not confident in Lumen. The mood is bad. Better results will change the mood.
Financial engineering. Selling off assets at higher than market prices to pay down the debt. Refinancing expensive debt at cheaper interest rate. Synergies from Level 3 acquisition. NOL that’s in the bank etc…
Ultimately, results will drive the stock price. Even with a conservative approach, I think there’s material upside if Lumen converts on the opportunities it sees and little downside if it misses. The negative is already priced in. Meanwhile you have an opportunity to buy a company with irreplaceable assets that’s considered cheap on many different metrics.