Last week the Wall Street Journal ran a profile of longtime Discovery CEO (now Warner Bros. Discovery CEO) David Zaslav entitled There’s a New Media Mogul Tearing Up Hollywood, adding “Zas Is Not Particularly Patient”. After opening with an anecdote about Zaslav complaining about Warner Bros. backing a Clint Eastwood movie, even though they thought it would fail, the profile states:

Mr. Zaslav, who last month took over the company resulting from Discovery’s merger with AT&T Inc.’s WarnerMedia, has given every indication he wants to be a talent-friendly mogul, schmoozing with industry personalities at the Beverly Hills Hotel. But the 62-year-old cable-industry veteran, a protégé of the late Jack Welch, longtime CEO of General Electric Co., has shown he isn’t afraid to ruffle the industry’s elite.

He and his team have been scouring the company’s books, making it clear spending needs to be reined in. They have abandoned projects they consider costly and unnecessary. That included pulling the plug on CNN+, barely a month after previous management launched the streaming service, and canceling a DC Comics superhero movie in development. He has given an unwelcome jolt to executives in the WarnerMedia empire who were happy when AT&T decided to part with it in the merger, hoping there would be less financial scrutiny—not more…

Mr. Zaslav has few options other than drastic moves. The deal brought the new company—now home of Warner Bros. and cable channels including HBO, CNN, TNT, Food Network and HGTV—$55 billion in debt, and he has promised to cut at least $3 billion in costs. He has given executives a few weeks to provide restructuring and business plans. “We are not trying to win the direct-to-consumer spending war,” Mr. Zaslav said on an April earnings call. On the call, Chief Financial Officer Gunnar Wiedenfels called out the nearly $30 billion the company spends making and marketing content, saying: “We intend to drive the highest level of financial discipline here.”

The profile continued in the same vein, and came across as fairly negative; that is why I appreciated it, because I am otherwise extremely bullish about the potential for Zaslav’s new company.

HBO and Discovery Synergies

I wrote a year ago when the deal between AT&T and Discovery was announced that Warner Bros. and Discovery had excellent synergies:

Start with the cable bundle: yes, cord-cutting continues, but there are still a lot of households with cable, and this new company will have significantly enhanced bargaining power with distributors. WarnerMedia’s combination of live sports, news, premium television, and scripted shows was already quite strong; Discovery brings a highly differentiated set of channels from HGTV to Discovery to Food Network that not only attract distinct demographics, but also are particularly effective at driving advertising.

Another set of synergies come in the two companies burgeoning direct-to-consumer offerings. Once again the breadth of content is a good thing: HBO Max and Discovery+ have something for everyone in the household. The types of content are complementary as well; back in 2018 I explained in the context of Friends:

While most of the Netflix attention is paid to original series, the truth is that there are two types of shows on the streaming network:

• Original series drive new subscribers
• “Filler”, that is, content that is there when subscribers simply want something to watch, keeps people subscribed

Discovery content is excellent filler [while HBO excels at original series].

Zaslav and CFO Gunnar Wiedenfels made all of these points on Warner Bros. Discovery’s inaugural earnings call in late April. Start with the second point above, about streaming synergy. Zaslov, in response to a question about advertising (more on this in a moment), brought up the fact that Discovery+ has very low churn:

We’re in the market already with an ad-light product. We’re the ones that were out there very early saying ad-light looks really compelling, because it’s a great consumer proposition. Our users, the churn was very low; we were doing between two and four minutes of advertising and generating $5, $6 in incremental revenue, and as it scaled, we started to make more. And so, we said very early on, we’re going to switch to offer consumers what they want, a lower-priced opportunity with a small number of advertising.

HBO Max isn’t doing so well in this regard, at least according to Wiedenfels a few minutes later:

We have some work to do on the platform itself that will be significant. But we also think that one of the big opportunities here is going to be churn reduction. There is meaningful churn on HBO Max, much higher than the churn that we have seen. And so, the ability for us to come together is part of one of the thesis here that managing churn, and we’ve seen this because we’ve been added in Europe for eight years, as we begin to manage churn in a meaningful way, that provides a real meaningful growth.

The benefit of coming together is exactly what I noted a couple of years ago: hits may capture customers, but filler content — especially a wide range of it — keeps them:

What you need is a diversity of content for everybody in the home, and they may come in for Euphoria [from HBO], but our research shows that people watch Euphoria, their favorite second show to watch is 90 Day Fiance [from TLC]. Having a diversity of content is a reason why people are spending hours with Discovery+…when you put all of this diversity of content together, there is content for kids, there is content for teens, it’s basically everybody in the family, why would you go anywhere else. We have all the movies, we have all of the library content that you want…

If you look at HBO right now, what it really needs is precisely what we have. When they are finished with watching Winning Time, they can go and watch Friends or watch Big Bang or watch their favorite movie or go over and watch Oprah or watch some TLC shows just for fun. So, we believe and we see this in Europe where we tried to offer, we thought that the answer was just to offer niche high quality that you get high-quality shock and all content together with a lot of nutrition, in our case in Europe, together with sport and you offer something that everybody in the family uses, and the churn goes way down, it’s much harder to churn out of a product when your kids use it or your significant other uses it or your mom and dad are watching, but also if you find yourself watching it more often. So, I think it’s precisely why we did this deal. And I think everything tells us that it’s going to make us stronger and more compelling because of the breadth of the quality menu of IP that we have.

In short, HBO Max plus Discovery+ is a bundle, with all of the attendant advantages that entails (and which certainly did not apply to a standalone CNN+ service). Of course this also strengthens Warner Bros. Discovery’s hand in terms of the linear TV bundle as well; Zaslov said in his prepared remarks:

One of the company’s unique assets is the linear network group, and in 2021 taken together, we enjoyed the number one share in total television total day in all key demos and people 2+. And we have the greatest brands: HG, Food, HBO, Discovery, CNN, NBA, March Madness, NHL, Magnolia, The Oprah Winfrey Network. Our balanced verticals and content genres across scripted, lifestyle, sports and news provide us with significant opportunities to not only cross-promote for the benefit of the portfolio, but also to offer compelling reach and targeting campaigns for our advertising partners.

Don’t forget negotiating leverage; Wiedenfels noted:

US distribution revenues were up 11% year-over-year, largely driven by the growth of Discovery+ subscribers throughout 2021, while linear affiliate revenues were also up year-over-year as rate increases continued to outpace subscriber declines. Our fully distributed subscribers were down 4% as were total portfolio subscribers when correcting for the impact of the sale of our Great American Country network in early June last year.

Yes, cords are still being cut, especially last year, but the story of cable for the last several years has been the jettisoning of cost-driven subscribers in favor of charging full price for people who actually want linear TV, which, in the long run, means that the linear TV bundle is primarily the sports and news bundle. Warner Bros. is well-placed for this new world, thanks to its combination of sports rights on TNT and TBS, along with CNN. That, though, isn’t a guarantee of profitability; Zaslov noted in an answer explaining why news was more profitable than sports:

When it comes to sports, we’re very careful about sports. And the TNT and Warner team was clever about getting long term rights which we’re going to get a lot of benefit from, but sports are rented and news is scalable.

The unscripted content that Discovery specializes in is even more scalable, and far cheaper; now, instead of negotiating with cable providers like Comcast for a collection of channels that customers like, but don’t necessarily need (particularly since Discovery+ is an option), Warner Bros. Discovery will be negotiating for a bundle that includes sports and news and filler. Those sports rights may eat up a lot of TNT and TBS’s carriage fees; the real money will be made on the extra pennies added to the rest of the channels in the portfolio.

And then, of course, that money can be spent on streaming: sure, Netflix has the advantage of having a larger customer base, but no one — other than Netflix executives until a month ago — said that you could only use subscription dollars and nothing else to acquire streaming content.

Advertising’s Continued Strength

Then there is advertising. First — and in contrast to Netflix’s agonizing on the matter — I enjoyed how matter-of-fact Zaslov was about having ad-supported streaming tiers:

In streaming, we have a massive opportunity to reach the widest possible addressable market by offering a range of tiers, all with the most compelling and complete portfolio of content. A premium and attractively priced ad-free direct-to-consumer product, a lower-priced ad-light tier, something we have had tremendous success with and is our highest ARPU product, and in some very price-sensitive markets outside the United States, we can even offer an advertiser-only product.

Secondly, Warner Bros. Discovery can provide a one-stop shop for advertisers across streaming and TV; Zaslov said in his opening remarks:

The combined strengths of both organizations’ client relationships, advanced advertising, programmatic, sponsorships and direct-to-consumer, ad-light streaming services, all positioned the company with a unique hand. I’ve personally spent quite a bit of time with key advertisers and agencies, and I’m so impressed with the combined capability of our platforms and our ability to uniquely serve the needs of our clients, including integrating sports alongside our broad entertainment offerings.

The bit about integrating sports refers to the fact that Warner Bros. actually actually had multiple advertising teams (one for sports and one for everything else — but none for streaming); I’m not entirely clear how the company ended up in this position, but given the fact the company’s businesses were built in an era where ad agencies sat in the middle between advertisers on one side and inventory on the other, it makes a certain sort of sense. Today, though, the goal is to be as large and as integrated as possible, the better to share data and provide effective targeting at scale; that offering is particularly compelling given that streaming is the best place to reach all of those people that cut the cord.

Still, even with the cord-cutting, TV advertising continues to be a good business; Zaslov reflected:

We recognize that 4% of subscribers are down and viewership on the platform is down…Long-term, there’s no question that the business is challenging, but CPMs are increasing, advertisers still are looking for inventory, because it’s the most effective inventory in long-form video. And look, remember, broadcast for a period of 20 years was declining and CPMs were increasing. I was at NBC in the mid-’90s when Welsh was saying this can’t continue. We can’t have smaller and smaller audiences and make more and more money. And I think he was right or maybe he will be right eventually, but it’s almost 30 years later and the advertisers are still paying more than the hurdle rate of decline.

So, we will be leaning in with efficiencies and effectiveness to our traditional business, which generates an awful lot of free cash flow…We now have the same or in many cases, the largest reach on television in the US. And the ability to use our own inventory to promote to and from all of our products and the efficiency of doing that and the cost savings of doing it, I think is a big plus for us.

There are a few things going on here, and both go back to an Article I wrote in 2016 called TV Advertising’s Surprising Strength — and Inevitable Fall. The key insight in that piece was that huge swathes of the economy, from large CPG companies to big box retailed to auto makers, were all built around TV advertising, which meant they would prop up the medium far longer than people thought:

Brands uniquely suited to TV are probably by definition less suited to digital advertising, which at least to date has worked much better for direct response marketing. No one is going to click a link in their feed to buy a car or laundry detergent, and a brick-and-mortar retailer doesn’t want to encourage shopping to someone already online. So after a bit of experimentation, they’re back with TV.

Still, I think Facebook and Snapchat in particular will figure brand advertising out: both have incredibly immersive advertising formats, and both are investing in ways to bring direct response-style tracking to brand advertising, including tracking visits to brick-and-mortar retailers.

Six years on, and “Surprising Strength” remains correct, while “Inevitable Fall” is the prediction that is looking shakier: to the extent that brand advertising is going digital, a lot of the shift seems to be doing so primarily as streaming video ads, a shift that will only accelerate as Netflix, HBO Max, and Disney all launch ad products. The most privacy-invasive practices of Facebook et al, meanwhile, have been curtailed (and rightly so — products that cross over into real-world tracking are where I have always drawn a hard line).

Just as important, though, are the impact of changes like ATT on the small and medium-sized businesses that were threatening the biggest advertisers like a hundred duck-sized horses: by destroying their ability to effectively coordinate their advertising spend, ATT and similar regulations have breathed new life into the old ecosystem, which ultimately plays to the benefit of the largest advertising sellers, including Warner Bros. Discovery.

Reasons for Optimism

Like I said, I’m pretty optimistic about Warner Bros. Discovery, which is why I appreciated the Wall Street Journal article I opened with: it’s fair to wonder if the exact sort of clarity of thinking and explicit commitment to financial results that Zaslov demonstrated on that earnings call will translate into managing talent and navigating Hollywood, particularly given the huge debt load the new company is carrying.

That noted, the other reason to be bullish is that Warner Bros. Discovery’s strategy is, in contrast to Netflix, back to the future; Zaslov said at the beginning of the call:

These last few months in our industry have been an important reminder that while technology will continue to empower consumers of video entertainment, the recipe for long-term success is still made up of a few key ingredients. Number one, world-class IP content that is loved all over the globe; two, distribution of that content on every platform and device where consumers want to engage, whether it’s theatrical or linear or streaming; three, a balanced monetization model that optimizes the value of what we create and drives diversified revenue streams; and four, finally, durable and sustainable free cash flow generation.

This isn’t anything new: the Hollywood model has always been about creating compelling content once and then monetizing it through every possible means; in Zaslov’s view a self-owned streaming platform is just an addition to the old model, not a wholesale replacement.

Moreover, things like movies in theaters still have their advantages: they build IP and build awareness for the other content models, above and beyond the money they make. Oh, and to take this update full circle, they also make talent like Eastwood happy. To that end, I suspect in the long run that flexibility and pragmatism in content distribution, combined with real discipline about cash flow, will prove to be more compelling than the same combination in reverse.