Warner Bros. Discovery - Earnings Call - Q3 2021

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by and welcome to the Discovery Incorporated Third Quarter twenty twenty one Earnings Conference Call. At this time, all lines are in a listen only mode. After the conclusion of the speakers' presentation, there will be a question and answer session. Also, please be advised that today's conference is being recorded. I would now like to hand the conference over to Mr.

Andrew Slabin, Executive Vice President, Global Investor Strategy. Sir, you may begin.

Speaker 1

Good morning, everyone, and welcome to Discovery's Q3 earnings call. With me today is David Zaslav, our President and Chief Executive Officer Gunnar Videnfels, our CFO and JB Perrette, President and CEO of Discovery Streaming and International. Before we start, I'd like to remind you that today's conference call will include forward looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward looking statements include comments regarding the company's future business plans, prospects and financial performance as well as statements concerning the expected timing, completion and effects of the previously announced transaction between the company and AT and T relating to the WarnerMedia business. These statements are made based on management's current knowledge and assumptions about future events and involve risks and uncertainties that could cause actual results to differ materially from our expectations.

In providing projections and other forward looking statements, the company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see our Form 10 ks for the year ended 12/31/2020, and our subsequent filings made with the U. S. Securities and Exchange Commission. And with that, I'd like to turn the call over to David.

Speaker 2

Good morning, everyone, and thank you all for joining us. This continues to be an exciting and busy time here at Discovery across a range of business initiatives and strategic planning for the next year and the years ahead. I'm very pleased with our focus, performance, and strong operating discipline as we simultaneously ramp up our integration planning, strategic reviews, and approach ahead of the WarnerMedia merger. We are increasingly enthused about the transformative opportunity ahead by bringing together these complementary assets, talented creative leaders, and employees all around the globe. This morning, I'll provide some brief commentary on Q3 operating performance and update you on the progress we are making as we work toward the close of our transaction and integration of the businesses.

Gunnar will then take you through additional puts and takes on the quarter. Very briefly on q three, it was a solid quarter all around. Subscriber growth for our direct to consumer platforms picked up nicely post summer, and we added a healthy 3,000,000 paying subscribers around the globe, reaching a total of 20,000,000 subscribers. And we've seen continued growth thus far in q four. We were able to deliver this growth as well as driving double digit growth in both advertising and distribution revenues while converting a healthy amount of OIBDA to free cash flow.

This positions us nicely above our guidance of at least 50% conversion this year, and we see free cash flow is tracking to exceed 2,100,000,000 for the full year. And that's after funding very significant investments in our Discovery plus rollout. Additionally and importantly, we have had the opportunity to refine some of our transaction leverage assumptions after examining WarnerMedia's draft carve out financials. Though we took a conservative approach initially while modeling the pro form a transaction, we now expect our net leverage at close to be at or below 4.5 times versus the five times that we noted in May, and we are currently tracking below the 4.5. This is predominantly based on estimated contractual adjustments to working capital and to a lesser extent, an improved outlook in our operating performance.

Accordingly, we now see a path to reducing leverage to around three times, meaningfully sooner than what we articulated in May. More on this shortly from Gunnar, but this points to a stronger financial footing than we had anticipated as we stand up the merged company and accelerate the pace to delever, supporting our ability to make focused investments and growth initiatives even without any asset sales. On the regulatory front, echoing John Stankey's comments on the AT and T call, we are well on track for a mid twenty twenty two close and are engaged in the typical regulatory filing process in jurisdictions around the globe, including our plan filing with the SEC of a preliminary draft of our merger proxy expected out in late November. The transformative upside from the merger is, of course, the global direct to consumer opportunity. And while we appreciate some of the questions that a number of you have asked regarding clarity and specifics regarding the product, investment and go to market roadmap, it is still premature for us to provide details given where we are in the ongoing regulatory review process.

That said, having conducted further operational and strategic diligence, I can share with you some broad strokes around what underpins our confidence and enthusiasm in our global go to market attack plan. First, it's all about the content. From the start, under one roof will be a combination of two companies whose common culture of creative excellence, iconic characters, and franchises will result in a differentiated competitive offering. I believe the biggest and most compelling menu of IP for consumers in the world. Spanning comedy to true crime, kids and family, lifestyle to adventure, drama to documentaries, news and sports, and, of course, sci fi and superheroes.

I believe the most complete and balanced portfolio offered in one service in the world. And secondly, we view our ability and commitment to tactically invest in our content portfolio as a critical strategic driver, building upon our respective long tenor track records of producing relevant and complementary programming around the globe. This should help to make our service uniquely global and local at the same time. Third, given the breadth of our content offering, we expect the combined service will appeal broadly to all demographics, young and old, with strong male and female genres. Again, very complementary, such that our global total addressable market should be on par with the biggest streaming service.

Assessing the overlap in respective subscriber bases, at least here in The US, we believe less than half of Discovery plus subscribers are also HBO Max subscribers, which with the right packaging provides a real opportunity to broaden the base of our combined offering. And with our global appeal, infrastructure, and local market capabilities, our international roadmap is very much still untapped and provides meaningful upside over the coming years. Lastly, our ability to drive revenue and ARPU positions us well for long term growth, particularly given our plans to market with a lower priced AdLite service starting off in The US and later in key international markets, a meaningful distinction from some competitors where we see an opportunity to drive value. We gained confidence in this strategic direction from our experience with ad monetization on Discovery plus in The US, where advertisers covet the incremental reach, demos, targetability, and product flexibility, and pay premium rates to address this audience, helping make this tier our highest ARPU offering. The opportunity to scale an AdLite offering represents one of the most significant upside drivers for the company long term while offering a compelling value to more price sensitive consumers and will benefit from Discovery's depth in local ad sales infrastructure and teams around the world to help monetize.

It's quite clear that the winners in streaming are and will be those companies that can provide consumers with the best quality stories, the most appealing content choices, personalized and simple products, and all at a great value. We expect our highly complementary combination will drive such a winning value proposition and will be reflected across key operating metrics over time. A few words on the linear side of the house before turning over to Gunnar. As we think about what can be achieved in terms of bringing great networks and brands together under one roof, the analog to Scripps is a valuable benchmark, and we believe the opportunity is far greater here both on costs and advertising revenue potential. Ultimately to better support our core linear business and more broadly the entire traditional ecosystem.

This I believe is one of the least appreciated elements of this transaction. Consider with Scripps, the platform we created in aggregating female demos, the bedrock on which we launched Premier, our product that offers advertisers the unduplicated reach of a broadcast network across all of our prime time originals at significantly more efficient CPMs than broadcast. We can take that advertising platform to the next level by weaving in sports, scripted news, and mail oriented programming together with our existing core competencies. It's a true win win, generating significant revenue upside to us with improved options, efficiency and savings to our advertising partners by replicating the reach of a broadcast network at better value. Cost synergy opportunities are significant.

We draw upon the expertise of our transformation office, which since our merger with Scripps Networks in 2018 continuously challenges our management team and me to refine and transform how we conduct and manage our organization from top to bottom around the globe. Nothing is sacred and no stone is unturned. With Scripps, we ultimately captured more than $1,000,000,000 in cost savings, representing about 35% of all noncontent expenses and about three times our original synergy target before we stopped attributing incremental savings to the merger. A large chunk of the cost synergy opportunity that we have already conveyed speaks to the best practices and tailwind in place from the integration of Scripps. It's a great starting point.

As we refine and integrate global ops, enterprise tech, corporate functions, real estate, direct to consumer infrastructure and tech and streamline efforts across duplicative functions like SG and A and marketing spend, a process that we see broken down into three distinct waves over the next few years. We approached $3,000,000,000 in cost saves as a tangible and achievable goal, especially against the combined company that should spend around $35,000,000,000 this year and growing from there. Stepping back for a moment to reflect on our direct to consumer pivot, nearing a year since Discovery plus launched, I'm proud of what we have accomplished under the leadership of JB and the world class team we have assembled over the last few years. We continue to learn a great deal, challenge ourselves, sharpening our focus and gaining perspective for the next leg of our direct to consumer journey with WarnerMedia and HBO. And as we've noted recently, we continue to refine our Discovery plus plans, taking a more thoughtful and tactical approach to investing in the product and doing so in ways that also support our plans for the combined company after we close the transaction.

For example, we are moving forward in priority markets such as Canada, Italy, Brazil, and The UK, some of which are where HBO Max hasn't announced plans or in some cases has indicated that they cannot launch in the near to medium term for contractual reasons. As you heard from John, Jason, and the team on their earnings call, HBO Max continues to aggressively move forward with their global expansion plans, most recently in LatAm and last week in Europe. And we look forward to closing the transaction so that we can coordinate and maximize our marketing, technology, and content spend for the enhancement of the combined effort. Until such time, we continue to roll out new and exciting content to entertain and sustain our subscribers around the globe. And our metrics look great.

Role to pay remains near 75% globally. Churn, particularly in The US, continues to look strong and approaching peer group lows, while App Store ratings are firmly at the top, while monetization and engagement continued to exceed our expectations. All of which helps to solidify our Discovery plus base as we endeavor to roll into and formulate a more comprehensive and broader offering with HBO Max. In closing, this is an exciting and dynamic time for us as we plan our next steps. And we are as eager to share them as we know you are to hear them.

And we expect that will be in short order. While the opportunity for course capture and enhanced efficiency is both tangible and material, our North Star, our right to play will be in achieving long term sustainable financial growth resulting from the combination of these two great content companies. Helping to nurture our important linear presence while driving global scale across our direct to consumer platform, anchored by as rich and relevant a portfolio of creative franchises anywhere in the world. I'd now like to turn it over to Gunnar, after which JB, Gunnar, and I will be happy to answer any of

Speaker 3

your questions.

Speaker 4

Thank you, David. Good morning, everyone, and thank you for joining us today. Reiterating David's comments, I'm pleased with what the Discovery team has achieved since the Discovery plus Analyst Day not even a year ago. Over that time, we have added 15,000,000 paying direct to consumer subscribers globally, finishing the third quarter with 20,000,000 paying D2C subscribers. Since the start of our Discovery plus journey, we have launched in over 25 new markets, notably The US and The UK, and most recently Canada and The Philippines, with Brazil to come over the next few weeks.

At the same time, we have continued to drive growth in markets like Poland, The Nordics, Italy, and India, where we doubled down on our direct to consumer efforts with a renewed and expanded content offering. And our next generation revenues finished the third quarter with $425,000,000 for the quarter or a 1,700,000,000.0 annualized run rate, with global D2C ARPU of approximately $5 and $7 blended Discovery plus ARPU in The US, again, supported by our over $10 ARPU for the Discovery plus AdLite product, which continues to monetize very well. Investment losses for the quarter were in the low $200,000,000 range, slightly better than our guidance from last quarter, and we expect investment losses more or less in that range in the fourth quarter as well. As always, we maintain a disciplined approach with respect to investing in direct consumer initiatives. As both David and I have noted over the last few months, it is through this lens that we view the opportunity ahead, both leading up to the merger and beyond.

We are very focused on nourishing our existing subscriber base with an increasing content offering and new product features. At the same time, you should expect us to be guided by a rigorous analysis of customer lifetime value and subscriber acquisition cost to determine our marketing spend for new sub additions. And now I'd like to quickly review our reporting segments. Starting with The US, third quarter advertising revenues increased 5% year over year. Pricing was healthy versus last year, driven by scatter pricing that was up 40% year over year.

Additionally, we continue to see strong demand for our Discovery plus AdLite product, which contributed to the growth in the quarter. This was partly offset by weaker audience delivery year over year, some of it attributable to the Nielsen panel issues as well as the lapping of our very strong performance last year during the pandemic. Furthermore, some of our networks have lost share to the strong sports calendar this year. While scattered pricing still very healthy in q four, up 30 to 35% over both upfront and last year, the overall tone in the market is a bit more subdued than last few quarters as clients work through the constraints in the global supply chain. And though there is slightly less visibility as a result, we are very pleased with how our portfolio is positioned based on the strength from the upfront and contribution from direct to consumer.

Distribution revenues increased 21% year over year largely due to the continued growth of Discovery plus as well as linear affiliate rate increases, in part helped by successful renewals with DIRECTV, Verizon, Hulu, and Altice so far this year. As disclosed in our earnings release, PayTV subscribers to our fully distributed linear networks declined by 3% year over year, while total portfolio linear subscribers declined 4% excluding the impact of the sale of our Great American Country Network last quarter. Turning to international, which I will, as always, discuss on a constant currency basis. International advertising increased 26% versus last year as the global advertising marketplace continued to recover from the pandemic. We also benefited from the Olympics in Europe across our linear and digital platform, although as we've noted in the past, advertising for the Olympic Games is less consequential in Europe as compared to The US.

All of our international regions, including many of our key markets like The UK, Germany, Sweden, Norway, Spain, Australia, New Zealand, and Mexico were up meaningfully compared to last year as well as compared to 2019. We see momentum continuing into q four even as needless to say, the year over year comps get tougher from here on out. International distribution revenues grew 6% during the quarter, primarily due to the growth in direct to consumer subscribers, which have nearly tripled over the past year across our footprint outside The US, in part aided by Olympic sign ups. Turning to operating expenses. Total company OpEx increased 50 during the quarter or 17% excluding the Olympics, for which the overall AOIBDA losses were in line with our guidance of around $200,000,000 for the quarter.

We continue to focus on driving efficiency in our core linear networks, and we remain on track to reduce core linear OpEx in the low to mid single digit percentage range for the year. Turning to some housekeeping items. Net income for the quarter was $156,000,000 or $0.24 per share on a diluted basis. A couple of items to note. First, we recognized a $0.12 per share noncash gain from the $15,000,000,000 of notional interest rate hedges that we recently implemented to mitigate interest rate risk for future debt insurances to finance the cash portion of transaction.

The hedges provide additional security and visibility towards our overall cost of deal related debt financing, which is now trending better than our initial expectations. And the final note on this, as the derivatives do not qualify as hedges for accounting purposes, we are required to report the changes in fair market value on our income statement, which could result in some additional variability to our net income until the WarnerMedia transaction closes. We will, of course, call this impact out each quarter. Second, the impact of PPA amortization during the third quarter was $0.30 per share. Adjusted for the above, EPS would have been $0.42 per diluted share.

Our effective tax rate during the quarter was 15%, and we continue to expect the full year effective book tax rate to be in the mid teens range. For cash taxes, we continue to anticipate a rate in the high 20% range for the year, excluding PPA amortization, though this is subject to change as we are carefully monitoring ongoing tax legislation. And we expect FX to have roughly a negative $15,000,000 year over year impact on revenues and a negative $10,000,000 impact on AOIBDA in the fourth quarter. Now turning to free cash flow and our leverage. We generated $7.00 $5,000,000 of free cash flow in the quarter, obviously a very strong conversion rate of AOIBDA, notwithstanding the continuing investments we're making as well as the return to normalized content production levels.

Year to date, our EBITDA to free cash flow conversion rate is over 60%. And with a few months left in the quarter, we see free cash flow topping $2,100,000,000 for the full year and clearly ahead of our 50% conversion guidance. And to expand on a point that David made earlier, we now expect our net leverage to be at or below 4.5 times by the time we close the WarnerMedia merger. Over the past few months, having had the opportunity to dig further into WarnerMedia's draft carve out financials and with better visibility on estimated working capital, in conjunction with our better p and l and free cash flow performance, we now believe that we will have a healthy amount less net debt at closing than originally anticipated. While naturally, these metrics are preliminary and the function of working capital at close, we now do expect to be in a position to reduce leverage to 3x meaningfully sooner than what we stated in May.

Our long term target net leverage range for Warner Brothers Discovery remains at two and a half to three times. As we work towards closing the WarnerMedia transaction in mid twenty twenty two, we have redirected our experienced integration and transformation office to hit the ground running. And as we refine our strategic review and integration plans and as we develop our synergy capture plans further, we are as enthusiastic as ever about the prospects of combining these two world class portfolios and franchises. With that, we look forward to sharing a lot more in due time. And for now, I'd like to turn the call over to the operator to start taking your questions.

Speaker 0

Thank you, sir. And we will now begin the question and answer session. Your first question is from the line of Doug Bichelson from Credit Suisse. Your line is now open.

Speaker 5

Doug?

Speaker 0

Mister Doug Mitchelson, your your line is

Speaker 5

now open.

Speaker 6

You're I said he

Speaker 2

said responds when he's addressed as mister Doug Richardson. Okay. Sorry, Doug.

Speaker 6

You know what? Yeah. A 100 earning seasons, still can't figure out the mute button. Look, David, I appreciate the update of the merger and and and the lower debt leverage. Can you talk about the content vision for the combined company and how that's evolving?

I guess it's kind of a three part question, David. The first is Warner Bros. Investing enough now in content under AT and T while they're sort of focused on the merger. How are you thinking about how much content spend should be to win in global streaming versus how much the companies are spending today? And do you have visibility on what Warner's making that's going to be coming out in late 'twenty two and 'twenty three and 'twenty four since moving particular as a two or three year cycle?

Any thoughts on that would be helpful. Thank you.

Speaker 2

Thanks, Doug. First, this is something, that John Stankey and I talked about as we created this vision together of this company being what we believe is the best media company, with the with the greatest and most comprehensive content offering. And as part of that, we're spending more money on content and leaning in, and, WarnerMedia is spending more, money on content and leaning in. We both committed to do that to keep both of our ecosystems nourished and strong and growing. So when the deal when and if the deal gets approved, then we come together, we'll come together with strength.

And you see that with, on the Warner side where we we're cheering them on with the success of Dune, around the world, with Anne and Toby on that side and Casey Bloys having an incredible run at HBO with Succession, White Lotus, Hacks, mayor of Easttown. It's just, if you look at the culture and the impact of of that content, together with the extraordinary library they have, us leaning in on our side with more original content. And so, you know, for us, we're also spending a lot more on the international side to get ready. We think that's a strategic advantage. And when you look at the content, we think, you know, in terms of the demographics that that we will appeal broadly to every demo.

I mentioned this, but we're very strong with with with women. That's a particular strength of discovery where where where during many quarters, we're the leading media company, in America for women, together with length of view of women watching our channels, whether it's food or HG or Oprah or ID, and TLC, and that's continuing. In addition, we look around the world. It's not just local content, but we're the leader in sports in Europe. They have sports in Latin America.

And CNN is the leader in news with the most compelling news brand around the world and one of the few global maybe the only global news service that has the kind of resources around the world in news gathering. And so as we go out and build this service and make this offering, and I do think it's the best content wins, There's a great product in in Netflix and entertainment. There's a great product with with Disney, with with Chapek is building, with entertainment. And we think we have a comparable product, maybe even more diversely attractive in entertainment. But on top of that, we also have sports, which we're using in in Europe and learning a lot from.

And in markets like Poland where we're doing news and sports together with broad entertainment and nonfiction, we're finding, you know, real meaningful traction and real reduction in churn. And so I think we have a lot to learn, but we have a terrific product. And, we're working on our go to market. We have, brought on a a an an old friend of mine, who I've known for for fifteen years, one of the most talented people, I think, in in the business. He's he's busy with a lot of other things, but we we do have, a commitment now that Kevin Mayer, who built, Disney plus, will be, in the car with, as a consultant with JB and I and Bruce and Gunnar and the whole team as we've already built, as we've talked about, a go to market strategy.

We're gonna be honing that. Kevin, has a big brain. He's learned a lot about this. We've learned a lot in Europe. And with Discovery Plus, we've been at it for a long time.

But he he had a lot of success at Disney. He's super excited about getting in the car with us and helping us with everything, that he's learned, a lot of knowledge about, about windowing, about about how different pieces of content, whether it's movies, perform. We're anxious to get in a room, with Anne and and and, and the team at Warner. I was there last week meeting for the first time with Anne's whole team, but they're super smart over there. And so we think adding Kevin to the overall team is gonna be helpful to us, and, off we go.

I they you know, who's got the best menu? Think we got the best menu.

Speaker 4

And, doctor, just one point I would add, obviously, so we scrutinize with each other's investment plans as part of the, the the deal discussions. And as as we said, before, all the financial guidance that we've given around the deal is always assuming a pretty significant step up in content investments over the coming years.

Speaker 7

Great. Thank you both.

Speaker 0

Your next question is from the line of John Hodulik from UBS. Your line is now open.

Speaker 3

Okay, guys. Thanks. Couple of quick questions on on advertising. Obviously, a lot of sort of trends going into the fourth quarter. You got the step up from the upfront, but potentially some slowdown from supply chain issues.

Dave, is there any way that you guys could sort of characterize what you see going forward on that side and maybe break out what you're seeing in terms of the linear business versus the DTC business? Thanks.

Speaker 2

Sure. Well, I I would just start with this is the most successful upfront that I've seen in my career. I think from an industry perspective, it was up 20, and it was very very materially big bigger upfront for us because of Premier and because of the length of view and the the certain advertisers wanting to be aligned with the brands that we have and the characters that we have. And so I think it's a big, big helper to us that we had a very strong upfront. There are supply chain issues.

There are pot level issues, but, we're still seeing that there will be material growth in advertising. And, you know, we can't predict what's gonna happen in the future. But as I've said before, I saw a lot of people in the mid nineties saying that it's the end of broadcast television. It may be a transition away from a lot of the younger demo being on there, but we see huge numbers. And we're, you know, we're not getting credit for it, but I think one of the reasons why the ad market was up so much for us is the advertisers know there's a massive audience 55 watching food, watching h g, watching discovery, watching ID, and they get those.

Right now, they get them for free. We talked about in the upfront, a number of us in the industry independently were out there trying to get credit for that. But I think that the linear platform is is here for quite a long time, and there'll be ups and downs on advertising. But advertisers, they find it's very effective to be in in in linear video, much more effective than others. And then we have the complement of Discovery plus, which is just, you know, a a huge driver for us in terms of the demo compliments and attractiveness.

Now, Gunnar?

Speaker 4

Fine. I don't really, have a lot to add to that, David. I mean, we're feeling very, very good about our position, the upfront, the the continued contributions from from D2C. But I did wanna point out, a little less visibility, and for for for for the known reasons. So but we'll we'll we'll be growing very healthily in the fourth quarter, I believe, from today's perspective.

Speaker 3

Great. Thanks, guys.

Speaker 0

Your next question is from the line of Jessica Reif Ehrlich from Bank of America. Your line is now open.

Speaker 8

Hi. Thanks. I have two questions. On the integration, I appreciate all the comments you did make. What what is the most challenging areas?

And one area of opportunity, and you've you've actually gone through it at Discovery already in in waves. But, you know, on your technology stack, on your tech stack, can you talk about you you know, you you transitioned off of, oh my god, the Yeah. The Major League Baseball. StamTech. Sorry.

You off of MamTech, created your own. So as you look at combining with with HBO Max, like, what are the challenges, and what are the ultimate benefits and cost savings? And then a second question, David, you said in your prepared remarks, that you can make acquisitions without asset sales. I'm just wondering what what pieces do you think you're missing in the combined company?

Speaker 2

K. Let let me start by saying look. I I don't think we're missing anything, and the first thing we're gonna do is look to drive all the tremendous assets and the differentiated IP and the great library, and local content that we have, pull it all together and and go to market, we think we have something quite strong. I'm I'm just making the point that there there will given that we're gonna be delevering quicker, given the fact that we're we will be, much lower levered than than expected, that over time, as others are struggling, that there'll be an opportunity for us to look at IP and and to see where we need where we need more help if we need more help. On the integration side, we're really lucky.

We got two, big tent poles here. Well, one is Gunnar will be the CFO of this company. He did he's done an exceptional job. He led the initiative with, with Scripps where we said we'd be less than three and a half times levered two years later, and we did it in less than a year. And we said we delivered 350,000,000, and we delivered over a billion.

And all of that was just cost, not revenue synergy. He came up with these targets as and is quite confident in those targets. And so, Gunnar will be kind of the lead horse here. He'll talk to it. You know, we have a very experienced team here.

Bruce Campbell and JB and Adrian and I have been together for twenty five years. We're looking forward to bringing in some incredibly talented people at Warner. But when we acquired Universal, JB was the one for, for Bob Wright and for Jeff Emel that ran the integration of that entire transaction, both, you know, which was cable, movies, theme parks, with over a 146, you know, work teams and work groups and and did it and and did a magnificent job on that. And so we, we're we're fully deployed. We got we you know, there's a lot that that we can't do now.

But, Gunnar, why don't I pass it off to you and JB?

Speaker 4

Yeah. And I I'll let, let JB comment on the on on on the on the tech, part of the of your question, Jessica. But but, again, I mean, from the perspective of of challenges, again, as as I've, as I've been saying from from the very beginning, we've taken a conservative approach to this. We're very well aware of the of the size of the checks that we're writing here for for this combination, and we have been, you know, careful with our assumptions. So, yeah, all the work that we've done since gives me more and more confidence in in our ability to deliver or out against these strategies.

As I as as David said and as I said earlier in the in in the in the prepared remarks, you know, doing more work now, having, you know, transparency into, albeit, you know, draft carve out financials for for the WarnerMedia carve out group. As I said, you know, the the cash payment is gonna be a significantly lower one from today's perspective. That gives us a better starting point from a a leverage perspective. And and, you know, as we said earlier, you know, this this sort of below four and a half times leverage that we're seeing right now is, to a large extent, driven by by working capital adjustments. But to some extent, it's also driven by by our current performance, both for the P and L and the free cash flow being above what we assumed in our conservative agency model that we based our first communication on.

So again, it's, it's it's early still. You know, we obviously still can only do so much until we have regulatory, clearance. But as we said, the team is up and running. Simon Robinson, our our chief transformation officer, and his team fully redirected at this now so that we can be able to hit the ground running, and I and and I think we're in, we're in very good shape. You are, you know, pointing out, obviously, one of the key questions here with the tech platforms.

Jeff, you want you know, why don't you give a perspective on, on how we're looking at that?

Speaker 5

Yeah. Jessica, it's obviously a big opportunity for us. We look at it as a, one where we're undergoing right now, essentially an audit of both platforms. And I don't think necessarily the decision is a monolithic one. You know, we look at these, as multiple different modules that make up all the different components of both their and our tech platforms.

And, and we have a lot of experience, as you mentioned, in terms of the effort and the work, as a discipline required in replatforming either one to the other, you know, in one direction or the other. That decision we haven't made yet, but we're undergoing obviously a significant diligence process to, underscore which is the best in class, on both, and it may be a little bit of a combination of those depending on certain modules in the platform that we may apply. And so we think it's actually a great opportunity because Rich and Jason and the team on their side have obviously spent a lot of time and are investing a lot in in upgrading their, tech platform as we speak. We've obviously spent a lot of time and a lot of, money doing the same, over the course of the last twelve to eighteen months. And as the two groups come together, we will have essentially a choice of a what we think will be an incredibly attractive kind of tech buffet that we will look to bake the best of of both, to decide how we move into a common platform going forward.

Speaker 4

Jessica, maybe just one one yeah. No. I just wanna clarify one thing, Jessica, because if I if I understand your, your question correctly, you were referring to to acquisitions. That's nothing that we said in our prepared remarks. And just to clarify, we're not anticipating or planning for any acquisitions at this point.

Speaker 8

No. David was really clear. It just gives you opportunity. But just, JB, I just wanted to follow-up on the you know, does it take a long time? You've gone through this, as you said, already, you know, with Samtec.

Can

Speaker 0

you just talk a little bit or

Speaker 8

give us any color on what the cost savings will be from combining and what the benefits are from having one platform?

Speaker 5

Well, there'll be there will be meaningful cost savings, from coming, combining into one platform. I think there also will be meaningful, consumer benefits, from combining into one platform. And I think the other thing to keep in mind is, yes, you know, part of what in David's comments about us being more disciplined and tactical at this stage of of phasing the further rollouts of Discovery plus, for example, is also, a view towards we may be able to more quickly in markets where we may not have launched Discovery plus, to be able to quickly fold more quickly fold the content, offering into a joint platform at that stage versus having to replatform two existing platforms in a market into one. And so I think speed to market will be a variant of both, you know, where we have and haven't launched, number one. And number two, while we, the final decisions on exactly which parts of the tech platform, we we migrate to, will influence how long it takes us to get there.

But remember that there may be two phases to this where there may be an initial phase which allows for more of a quick bundling of services and a second phase which eventually, allows for, obviously, a common, service on OneTech platform. That's that's a timeline and evolution, certainly, Justin, that we'll talk to more in detail as soon as we can give you more color.

Speaker 4

But maybe if I can add one thing, Jessica. Again, what we what we said when we first announced this deal was, remember, there's, roughly $6,000,000,000 in technology and marketing spend between the two platforms. We're assuming growth. We we've brought together two companies with significant expansion plans. A lot of that spend is, by by by its nature, a fixed cost, relatively independent of the subscriber number.

Obviously, there's, you know, streaming related costs, etcetera, but a lot of it is is fixed. And so there's a huge opportunity to to completely sort of deduplicate that spend base. And to JB's point of multiple waves, especially on the marketing side, I, I have no, no doubt that we will, out of the gate, sort of even in the first phase before fully aligning, tech platforms, we'll be able to get a lot of leverage out of the the combined, marketing spend.

Speaker 8

Thank you so much.

Speaker 0

Your next question is from the line of Alexia Quadrani from JPMorgan. Your line is now open.

Speaker 9

Just a couple of questions if I can. How do you think about growing sort of local content following the success you've seen by others, you know, with that strategy? And then secondly, really on the news side, is it better to have sort of standalone news streaming service in your opinion or, you know, combine it with entertainment streaming?

Speaker 2

Thanks, Alexia. You know, one of the, real advantages of Discovery is for twenty years, we've been in market with local teams, selling locally, producing local content throughout Latin America, throughout Europe. In Europe, we expanded into free to air in a number of markets where we're the equivalent of NBC or CBS and some markets with the equivalent of, like, NBC and CBS combined, you know, in Northern Europe and Poland. We're quite big with number of free to air channels in Italy, and Germany. And we have a we have a library that's meaningful in each of those markets.

And, we have, you know, a a lot of data on what people are watching. We have a good sense of what kind of content they're looking at on the direct to consumer platforms because we've been at it for a long time. We also have sports in Europe, and we've, you know, we we we've tried a lot of things. Some haven't worked out as well as we as as well as we'd expect, and that's a good thing because we've learned that sometimes packaging the sports independently doesn't work as well as packaging it more broadly. Number of sports together reduces the churn significantly, makes the appeal higher when you put sports together with entertainment, together with nonfiction.

You know, we came out with the Olympics. You know, we had a million plus sign ups for the Olympics. And so we continue to learn. That's a good thing. You know, we're continuing continuing to invest, learn, and grow.

That's what, John and and Jason and and Anne and team is continuing to do on a parallel basis independently. But as we come together, we'll all be smarter. You look at at what people thought about windowing of just as a student of this in the meetings I'm having. What's the right windowing strategy? What works best for a direct to consumer product?

Is it better to to have to build up a a movie in the theater and then bring it? Is it stronger on the platform if it goes day in date? Is it stronger if it goes day in date at $30 versus free? There's a lot that we are learning just as observers, and there's a tremendous amount that Jason has learned and Anne and that Disney has learned, and that the industry has learned. And one of the great benefits for me is I have this ability to really listen.

And, also, this has been a great experiment in how people are consuming content and, you know, when people come on for a movie, you know, or series, how what's what's the reaction? A lot of what is on the Warner side, haven't seen because, you know, at this point, we can't see it. But the general industry knowledge and trends are things that we're noting aggressively and we're learning from. And, you know, we're continuing to experiment in Europe. On the news side, we've been we've been experimenting ourselves.

And in Poland, we we went independent. Now we're we're packaging it together. I think it's gonna it it it it is probably gonna depend on the market, and it depends on the offering. We have a very, very strong service in Poland, and it's been very helpful to us. We're the you know, we're we're we're one of the leading voices in the market, and we have a twenty four hour news channel there that's quite compelling.

We don't know what the right answer yet, but having news and sports you know, news is some the more people go to a direct to consumer product, the lower the churn. The more time they spend, the lower the churn. That's why we're so excited about how much time people are spending with Discovery Plus, you know, which has a library that's being broadly viewed. And, you know, it any idea that people spending hours on that product and the churn is low is encouraging for what bodes for the the combination of the two. But as people if you could put news or sports and people also go regularly for that, it's another reason to have the service.

It's another reason to value the service. It's another reason not to churn out of the service. And, Disney has been very effective in doing packaging of services where you don't put them together, bundling. And so, and, you know, that's that's the current plan right now for CNN as we've read about it. And so it's it's exciting, and we'll look and see.

Speaker 9

Thank you very much.

Speaker 0

Your next question is from the line of Katgan Maral from RBC Capital Markets. Your line is now open.

Speaker 10

Good morning and thanks for taking the questions. I wanted to ask about DTC investments for standalone discovery and then drill in a bit on the deleveraging comments. So first, given the deal, it clearly makes sense to take a more disciplined approach to your DTC strategy. I assume this will drive some near term financial benefits. So can you provide a bit more color on the DTC investment levels going ahead?

I know you called out the low $200,000,000 range for Q3 and Q4. Where are you seeing some opportunities here? And is that a good quarterly run rate through deal close, or can the losses continue to maybe narrow given the strong top line trends? And then just second, the accelerated path to deleveraging post deal close is very encouraging. Is there any more color you can provide on the drivers for both Discovery standalone where you continue to deliver robust free cash flow?

And then on the pro form a outlook, just, Gunnar, it's fantastic to hear about your continued role here, and I know you provided a lot of details already. But any more specifics on the improved pro form a leverage targets, particularly if there's an updated view on pro form a EBITDA given maybe some minor asset sales from the WarnerMedia side? Thanks.

Speaker 4

Great. Thank you, Kukun. So let me let me start with the with the with the delevering piece here and and give a little more color. Again, the there are two things that we have updated. One is sort of our model of how we how we look at pro form a combined, you know, financials for the company, and number two is just flowing through our current performance.

And that's, by the way, a link to your first question as well because we're just doing a lot better, and we're generating a lot more free cash flow than what we anticipated half a year ago. But if you take a step back, you know, the the challenge here is that WarnerMedia is not a stand alone company but is a is a is a carve out group. We obviously made certain assumptions about what the balance sheet of that company and carve out group would look like, but had to wait for some some still draft carve out financials to get full confidence in in in the financial setup of that combined entity. And accordingly, what we put into our model and what I presented to rating agencies for the rating discussion was a conservative model not fully flowing through certain adjustments, the most important one of which is the working capital adjustment. So we have always talked about the $43,000,000,000 as subject to adjustments, and that's the working capital adjustment.

From today's perspective, that looks like it's it's gonna be, you know, $45,000,000,000 lower in terms of, you know, what the what the net payment is gonna be with an impact on the net, net debt balance that we're gonna start this company with. And then that has obviously a a very significant impact on leverage. So the second thing, though, is about 25% or 30% of this improvement here is just driven by our better operating performance. Obviously, better AOIBDA improves the denominator of that leverage equation, and and and that's developed very nicely as well. And I I do wanna caveat this.

You know, as we said, right now, it looks below four and a half times. This number is gonna move around with with working capital. But what's not gonna change, in my view, is the the the very significantly increased confidence that I have in our ability to very, very quickly delever below the three times and to to very quickly get us into the the the long term comfortable leverage target range. And again, the other point I want to keep pointing out is we have already because I've a lot of questions on this we have already anticipated very significant reinvestments in in our business case. To your first question, on the D2C investments, and I'll let JB talk about some of the opportunities a little more because we we do have, you know, obviously, the Olympics coming up and and, you know, market launches kicking in here.

But but but you're right. In general, we've always, looked at and will continue to look at capital allocation through the lens of risk and return. The return side is is is is almost, you know, fairly easy in this, in this space because it's just the relationship between customer lifetime value and subscriber acquisition costs. And it is fair to say that I've, you know, asked the marketing teams to give us a little more cushion between the two in order to, you know, manage some of the uncertainties as we go into the scenarios for for next year. So you're right.

We should see lower investment losses, especially if you keep in mind that at the beginning of next year, we're starting to comp against the very significant investments that we made in the 2020 as we launched The US product. At the same time, I also do wanna point out we're we're we're continuing, and as David said it, we're continuing to to really nourish the existing subscriber base that we have. We're continuing to invest in in in content in a significant way. So keep that in mind as well over the next few quarters. We you will continue to see content expense coming up.

We're also, continuing to invest in technology and and and and product features, but just a little less focus, I would say, the mix on on necessarily driving for the for every last, every last subscriber. JV?

Speaker 5

Yeah. And the only other thing I'd add, Gunnar, is obviously as we approach the deal term, not surprisingly, many of the partners that we work with internationally, that have been a great part of our success, and that you've heard us talk about, are also asking the fair questions about how much money and how much, effort they should put behind, you know, launching in new markets as we go into 2022, given questions about the future brand, the future, product offering, etcetera. And so we are getting the same questions from partners, which is totally legitimate, and and sort of that, is making us, you know, in some cases, rethink when is the right time to launch. And a lot of that is largely when they're those things are being pushed off, is a pushing off of marketing and, in some cases, content expense to to later when we have a better view of what the the combined product, will look like, and we can come back to our partners with a more definitive sense of when and and what we will be launching together.

Speaker 10

That's great. Thank you both.

Speaker 0

Your next question is from the line of Rich Greenfield from LightShed Partners. Your line is now open.

Speaker 7

Thanks for taking the question. A few months ago, WarnerMedia left the Amazon channel platform. I think they've joined sort of Disney, Netflix, Hulu, even Apple TV plus. Basically, just looking at the d to c subscriber business and wanting to be a fully direct relationship versus sort of a wholesaling relationship with Amazon. So I think that sort of puts Discovery by common stars as sort of the three largest players on Amazon channels.

I guess, yeah, I'd love to get sort of, David, your perspective, big picture, how you think about the puts and takes of Amazon, whether going fully independent is something you can see in Discovery's future or whether you think companies like WarnerMedia and Disney have made a mistake not working with Amazon channels. So just be curious how you think about that. And then just lastly, it couldn't tell from your commentary. Are you planning on keeping more HBO Max and Discovery Plus separate? Was that sort of the bundling comments you were making, or is that decision of integration still not made?

That would be helpful on both fronts. Thanks,

Speaker 2

Rich. We have a go to market strategy that we feel that we're that we've built. I think having Kevin Mayer in the, in the passenger seat with JB and and Bruce and I and eventually with the Warner team with all of his knowledge and expertise having built, and driven, Disney plus globally, I think, you know, can a little, will will help to finalize and fully inform our strategy. But we're we're given where we are in the regulatory process, we're just not ready at this point to share all of that with you guys. We will we expect to and we will soon.

JB?

Speaker 5

Yeah. I mean, Rich, on the on the channel store question, the reality is they've obviously been a very good partner of ours on Discovery side. We're well aware that, as you said, HBO has taken a different position. I think, the the three questions that we'd have that we, we are waiting to engage further with the HBO side is number one, we we have found so far that he there's a the question about these channel stores bringing in a different customer base than what we might be able to address directly, is an ongoing question. And we've certainly seen some good incremental subscriber growth coming from that channel store ecosystem, and how much of that is cannibalistic versus what we could do direct or not.

It's an ongoing set of analysis that we have going, and, obviously, we wanna compare notes with the, with the HBO team at the right time. But that's a question because, ultimately, we wanna try and get our product out to as many consumers on whatever platforms, as necessary. The second is the data element and the customer relationship, which I think is a little less known. And I think as, some of the Amazon executives have talked about publicly now, we we, we do have access to customer information as part of our relationship, and that's an important differentiator that doesn't make this just a sort of traditional anonymized channel store relationship or where we actually have customer information on, the channel store consumer. And so that makes the equation a little bit different.

And so you overlay those two things, and and we say, you know, the third thing is, obviously, we wanna have more engaged conversations with, the Warner team, and look and see whether, the strategy that they're following today or the strategy that we're following today makes sense for the combined. And the the North Star will be two things, which is ultimately how do we get the product in front of more consumers, in aggregate, and how do we do it in a financially, strong way? And if we think we can deliver a a still get the customer relationship, but get in front of more people, with the with the right economics, I think it's one that we will certainly remain very open to. So we haven't made a decision definitively, but we are, we're remaining very open, and we'll certainly that'll be part of the story when we come back to you, Rich, and the team. We'll tell you more about it, at the right time.

Speaker 7

Very helpful. Thank you.

Speaker 0

Your next question is from the line of Steven Cahall from Wells Fargo. Your line is now open.

Speaker 7

Thanks.

Speaker 4

Maybe, Gunnar, thanks for the

Speaker 1

color on the lower leverage and the expectation for the merger. You also mentioned that you're having some pretty encouraging conversations raising the debt. So I'm just wondering, you know, if that's gonna come in a little cheaper. And I think you gave some steady state guidance of around three times for the combined company initially and getting there in about two years. Should we assume that you get there a little more quickly just because you're gonna be starting from a lower base, or is it more that you'll just have a bit more flexibility starting from that four and a half times or below?

And then, you know, maybe one for for JB on Discovery plus and NextGen. Is it logical for us

Speaker 5

to assume maybe just a

Speaker 1

little bit slower pace of net ads going forward as you take a more focused approach and sort of avoid stepping into places where HBO is strong and and be a bit more selective. And if that is the case, I'm wondering if there's some free cash flow benefit to that near term strategy just because SAC expense runs a a little bit lower. Thank you.

Speaker 4

Great. Yeah, Steve. So, yeah, I mean, I'll I'll start with the with the flexibility. I mean, as I said in in my prepared remarks here, I I am very convinced from today's perspective that we're gonna hit that upper end of our target range of three times earlier than we original originally mentioned. And it is the two and a half to three times range that I that I that I wanna see, going forward.

And, to your question about, you know, flexibility, we don't need flexibility because our deal model already assumes very significant, you know, reinvestments and further investments in in building out, you know, the d two c product and and growing content expenses over over the the the five year term here that we have that we have modeled. Yeah. So clear answer is yes. Very, very hopeful that we will be, you know, hitting that upper end of this two to two and a half to three times range earlier. Regarding regarding raising debt, again, we've mentioned the the $15,000,000,000 hedge that we have put on and, you know, pretty much in line with what I said earlier about the conservatism in our initial model.

The answer is yes. There is some there is some room. We have obviously, you know, taken some conservatism as well as we modeled out our our interest rates. We've we've locked in, you know, very attractive rates with this $15,000,000,000 hedge program. Again, you know, don't wanna make any promises.

We'll you know, it it it still will will be some time, before we, implement the financing, but a good part is hedged now. I will have to monitor, you know, the spreads as well, but, I I I believe that we're in a very, very comfortable position relative to what we put put out in in the in the original statement and in our in our deal models. And and before I hand it off to JB for the for the for the subscriber outlook here, you know, the the the the financial part of that question is, you should absolutely, assume, you know, further free cash flow, performance here as we as we move forward. I I do wanna have the balance sheet in the in the in the best possible shape, as we come up on on closing the deal. And as as I said earlier, I I I now explicitly guided to at least, $2,100,000,000 of free cash flow, so a significantly higher conversion than what we went into the year with and what we guided, at the beginning of the year, and that that's all part of our, you know, ambition here to be disciplined and and and and get this balance sheet in in in perfect shape.

Maybe? Yeah.

Speaker 5

And I think consistent with what Gunnar just said, you you we we should assume, obviously, we're continuing to obviously push and see good growth, in the markets where we're in, and we'll be launching, our newest market, in Brazil here, over the course of the next, two weeks. And so we're excited about that, and we still see healthy growth out of those markets. And we're spending at levels, to Gunnar's point, that we think are reasonable without leaning too far in. But the the sort of slightly more, conservative, fact LTV ratios that we're spending at plus the slowdown in some of the new market launches as we go towards the end of the year and into 2022, it does mean that the net adds numbers will be, a little bit slower than, than they might have been in the past.

Speaker 1

Great. Thank you. And I

Speaker 5

it may be worth just Rich, I realize we didn't hit Rich's second question, about the bundling clarification. I think David and my point on the bundling was purely that in, back to Jessica's question about the tech, rollout,

Speaker 3

it will take a bit

Speaker 5

of time, no question, to come to one platform. And so while that process is underway, there will be opportunities in a much quicker fashion, closer to day one to potentially do some very creative bundling propositions. That is a interim strategy, not a long term strategy, I think, at this point, is what we'd say.

Speaker 0

This will be your last question from the line of Ben Swinburne from Morgan Stanley. Your line is now open.

Speaker 11

Thanks. Good morning. I think the release noted renewals with DIRECTV and Verizon during the quarter. I'm just wondering if you guys could give us a little bit of color on sort of the key takes there and whether you see healthy affiliate fee growth coming out of that or any changes in packaging? And if the merger impacted how you approach those deals given, David, you made that point that bringing the Turner Networks in is a real maybe underappreciated asset and part of this transaction.

So that's my first one. And then I just wanted to come back, David. There's obviously a lot of focus on the merger including your management team that you're putting together. Congratulations on bringing Kevin on board. Is that I don't know how much you can say, but is there hope that that converts from a consultancy to an employee ship?

And I'm just curious if he's still gonna remain chairman of the zone, which I think is, is at least in some regard a competitor to you guys in Europe. Thanks a lot.

Speaker 2

Thanks. Len Blavatnik is is a very old friend, and he's out he is, he worked with me and Kevin in in providing, the opportunity for us to get a a good amount of Kevin's time. But, you know, he's fully committed to Lan and Dazon, and he's doing some other things as well. You know, he's he's driven down all of these paths, And he's a great entrepreneur, and he's got a number of really exciting things he's doing and working on. This is one of them.

And, I think he's gonna be, really helpful to JB and and I and Bruce. And and he's having a great time doing what he's doing, but he's super excited about, kind of really coming in and giving us the full, scope of his experience and brain on, on everything he's he's seen and learned. And, you know, working with Len has been a good thing. I think he's seen and learned more about Europe and sports. And, so, I think that's exciting.

The the the team at Warner and the way they're growing, the the knowledge, the capability there, the attack plan that they have is really impressive. You know, anti fossil, strong. If this you you look at the the the strength of that product. You look at the strength of our product. So I think we got a lot of really good people.

You've seen through the his for our history with Scripps that we're really about who are the best people. I think we're gonna have be able to build a really strong team, and bring in some outside experience as well. But it's it's, it's really encouraging how well they're doing and what we're learning along the way, and that's that's a big helper to, to us. On the affiliate side and, Gunnar, you could fill in some more. But, I think we we reached deals that were very favorable for us.

On the carriage side, very strong, And I think it's win win. They don't they they wanna commit to carry all of our channels. This whole idea that a bunch of our channels were gonna get dropped, that never happened. They're good value. I don't say I I don't say that with great glee.

But when you look at the overall package and and the viewership, you know, we're we're a great value, and they're making a lot of money selling our selling advertising on our services. So it went very well for us with with meaningful increases and and real security, and I think it went well for them and continuing to get really good products. And in terms of how do we you know, you know, how does this align with Warner? Has nothing to do with it. You know?

We're we're operating as an independent company, and, we're operating on the strength of the the channels that, Kathleen Finch and Nancy, have have been building here with Discovery and and Oprah and and and Food and HG. And so it's, we've been overdelivering. People love our stuff, and it's just a reinforcing of this narrative that despite the fact that the world is changing, that, that we were able to get deals with some of the toughest and strongest and most knowledgeable distributors on very favorable terms with with strong carriage commitments, you know, as we make this transition together. And so I think that's, it's a very good sign for the for the two sides. Gunnar, anything to add?

Speaker 4

No. I mean, you know, just obviously the the the caveat that we we don't call support the or we don't control the the subscriber trends, so that's always the you know, when we have as much visibility into that as as as as many of you on the call here. But I'm I'm very, very pleased with with the, you know, the distribution team's, you know, successes this year, and and we've gotten gotten so many questions about sort of the outlook, and, you know, we just continue to, to go through deal after deal after deal, with with with with very encouraging results.

Speaker 11

Great. Thank you.

Speaker 0

Thank you for joining us today. And with that, this concludes today's conference call. Thank you for attending. You may now disconnect.