Warner Bros. Discovery CEO David Zaslav’s top priority: Cash flow

A few months ago, after a lengthy and sobering review of Warner Bros. Discovery‘s business, Chief Executive David Zaslav gave his division heads a cutthroat mission.

Pretend your units are family businesses, Zaslav said. Start from scratch and prioritize free cash flow, he added, according to people familiar with the matter. Then, Zaslav said, come back to me with a new strategic plan for your unit.

Zaslav’s directive has led to what will amount to thousands of layoffs at the company by the middle of this month, said the people, along with substantial strategic changes at CNN, the Warner Bros. film studio and other divisions.

The CEO formed his plan after he took a hard look at the finances of the combined WarnerMedia-Discovery, a deal that closed in April. Zaslav determined the company was a mess. AT&T mismanaged WarnerMedia through neglect and profligate spending, he’d decided, according to people familiar with his discussions. The people asked not to be identified because the talks were private.

Warner Bros. Discovery’s total debt of about $50 billion was tens of billions more than the company’s market capitalization. About $5 billion of that debt is due by the end of 2024 after paying off $6 billion since the close of the merger. The company could push back the maturity on some bonds if necessary, but interest rates have risen dramatically, making refinancing much costlier.

To pay down debt, any company needs cash — ideally, from operations. But the near-term trends suggested Warner Bros. Discovery’s business was getting worse, not better. The company announced free cash flow for the third quarter was negative $192 million, compared to $705 million a year earlier. Cash from operating activities was $1.5 billion for the first nine months of 2022, down from $1.9 billion a year earlier.

Along with the rise in rates, Netflix‘s global revenue and subscriber growth had slowed, prompting investors to bail on peer stocks — including Warner Bros. Discovery, which had spent the past three years developing streaming services HBO Max and Discovery+. Moreover, the advertising market was collapsing as corporate valuations flagged. Zaslav said last month the ad market has been weaker than at any point during the 2020 pandemic.

Warner Bros. Discovery shares have fallen more than 50% since WarnerMedia and Discovery closed the deal in April. Its market value stands at about $26 billion.

In addition to job cuts, Zaslav’s directive spurred the elimination of content across the company, including scrapping CNN original documentaries, Warner Bros. killing off “Batgirl” and “Scoob 2: Holiday Haunt,” and HBO Max eliminating dozens of little-watched TV series and movies, including about 200 old episodes of “Sesame Street.”

The immediate decisions allowed Zaslav to take advantage of tax efficiencies that come with changes in strategy after a merger. Warner Bros. Discovery expects to take up to $2.5 billion in content impairment and development write-offs by 2024. The company, which has about 40,000 employees, has booked $2 billion in synergies for 2023. Overall, Zaslav has promised $3.5 billion in cost cuts to investors — up from an initial promise of $3 billion.

The underlying rationale behind Zaslav’s cost-cutting strategy centered on turning Warner Bros. Discovery into a cash flow generator. Not only would cash be needed to pay off debt, but Zaslav’s pitch to investors would be to view his company as a shining light in the changing entertainment world — a legacy media company that actually makes real money.

“You should be measuring us in free cash flow and EBITDA [earnings before interest, taxes, depreciation and amortization],” Zaslav said an investor conference run by RBC Capital Markets last month. “We’re driving for free cash flow.”

Zaslav is trying to give Warner Bros. Discovery a head start on what may be a year of downsizing among large media and entertainment companies. His strategy appears clear: Cash generation will coax Wall Street into seeing his company as an industry outperformer. But he’ll need to keep together a company made up of tens of thousands of ex-Time Warner and then ex-WarnerMedia employees who have been through round after round of reorganizations and layoffs.

“It isn’t going to be overnight, and there’s going to be a lot of grumbling because you don’t generate $3.5 billion of operating synergies without, you know, breaking a few eggs today,” Warner Bros. Discovery board member and media mogul John Malone told CNBC in an interview last month.

Malone has co-strategized and cheered Zaslav’s effort to focus the company on maximizing free cash flow, which is defined as net income plus depreciation and amortization minus capital expenditures.

“Whenever I talk to David, the first thing I say is manage your cash,” Malone said last month. “Cash generation will ultimately be the metric that David’s success or failure will be judged on.”

Even before Zaslav gave his directive to all of the division heads, the new CEO was already thinking about how to boost cash flow. That was at least part of the motivation to eliminate CNN+ just weeks after it launched, which had a spending budget of about $165 million in 2022 and an eventual $350 million, according to people familiar with the matter.

Warner Bros. Discovery owns streaming services, linear cable networks, a movie studio, a TV production studio and digital properties. It owns DC Comics, HBO, CNN, Bleacher Report, and oodles of reality TV programming. It has sports rights both internationally and domestically, including the NBA on TNT.

Zaslav hopes his reconstruction of Warner Bros. Discovery will deliver two results. First, it will showcase the company as a fully diversified content machine, featuring top brands and intellectual property in prestige TV (HBO), movies (Warner Bros.), reality TV (Discovery), kids and superheroes (Looney Tunes, DC), news (CNN) and sports (NBA, NCAA March Madness).

Second, he wants it to prove that a modern media company that’s spending billions on streaming video can also generate billions in cash flow. The company has estimated 2023 EBITDA will be $12 billion. Warner Bros. Discovery will generate more than $3 billion in free cash flow this year, about $4 billion next year and close to $6 billion in free cash flow in 2024, according to company forecasts.

That would give Zaslav a selling point to investors compared to other legacy media companies. Disney has generated just $1 billion of free cash flow over the past 12 months and analysts estimate the company will have about $2 billion in 2023. That’s despite growing Disney+, its flagship streaming service, by 46 million subscribers during the period and owning a theme park business that generated $28.7 billion in revenue for the fiscal year — up 73% from a year earlier.

The low free cash flow relates largely to the money drain from streaming services and Disney’s large investments in theme parks. Over the past 12 months, Disney had $4.2 billion in operating income from its media properties, down 42% from a year ago. Returning Disney CEO Bob Iger said in a town hall last month he will prioritize profitability over streaming growth — a change from when he left the post in 2020. Outgoing boss Bob Chapek put into place a Dec. 8 price hike for Disney+ and other streaming services to accelerate cash flow.

“Discovery was a free cash flow machine,” Zaslav said earlier this year of his former company, which he ran for more than 15 years before merging it with WarnerMedia. “We were generating over $3 billion in free cash flow for a long time. Now, we look at Warner generating $40 billion of revenue and almost no free cash flow, with all of the great IP that they have.”

When AT&T announced it was merging WarnerMedia with Discovery Communications last year, Zaslav immediately went on a Hollywood “listening tour,” sensing an opportunity to become the new king of Tinseltown. Many Hollywood power players thought Zaslav would dedicate his first year as CEO to currying favor with the industry given his lack of history with scripted TV or movies. He even bought producer Bob Evans’ house for $16 million in Beverly Hills, a sign some thought meant he wanted to be Hollywood’s next mogul.

A year later, Zaslav isn’t the king. In fact, many consider him a villain.

It turned out Zaslav’s top priority as CEO of a large public company wasn’t to win over Hollywood. Rather, it was to convince investors his company could survive and flourish as a relative minnow against much larger sharks, including Apple, Amazon, Disney and Netflix, in an entertainment world that’s quickly moving to digital distribution.

Zaslav’s focus on investors before Hollywood makes business sense. The company must be financially sound before it can make big investments. But he’s taken a hit, reputationally, with some in the creative community.

“HBO Max is widely acknowledged to be the best streaming service. And now the execs who bought it are on the verge of dismantling it, simply because they feel like it,” tweeted Adam Conover, the creator and host of “The G Word” on Netflix and “Adam Ruins Everything” on HBO Max, in August. “Mergers give just a few wealthy people MASSIVE control over what we watch, with disastrous results.”

One Hollywood insider who met with Zaslav to give him advice before he stepped into the job said the Warner Bros. Discovery CEO has ignored 90% of his advice on how to manage the business.

Time will tell whether Zaslav’s year-one decisions have lasting ramifications with a spurned Hollywood community. Critics of Iger at Disney initially said he lacked “creative vision” when he first took over as chief executive nearly two decades ago.

Zaslav can counter that Warner Bros. Discovery hasn’t decreased content spending. The company spent about $22 billion on programming in 2022. But he’s also made cost consciousness a point of pride.

“We’re going to spend more on content — but you’re not going to see us come in and go, ‘Alright, we’re going to spend $5 billion more,'” Zaslav said in February. “We’re going to be measured, we’re going to be smart and we’re going to be careful.”

The company’s content decisions have been based on strategic corrections, such as eliminating made-for-streaming movies and cutting back on kids and family programming that don’t materially entice new subscribers or hold existing ones, executives determined. Warner Bros. Discovery’s HBO continues to churn out hits, including “White Lotus,” “Euphoria,” “House of the Dragon” and “Succession,” under the leadership of Casey Bloys.

Perhaps Zaslav’s biggest dilemma is what to do with the NBA.

Like other media companies, Warner Bros. Discovery rents the rights to carry games and pays billions to leagues for the privilege. Warner Bros. Discovery currently pays around $1.2 billion per year to put NBA games on TNT. In 2014, the last time the league struck a deal with TNT and Disney’s ESPN, carriage rights rose from $930 million to $2.6 billion per year.

Negotiations to renew TNT’s NBA rights will begin in earnest next year. Zaslav has said he has little interest in paying a huge increase just to carry games again on cable networks — a platform that loses millions of subscribers each year.

“We don’t have to have the NBA,” Zaslav said Nov. 15 at an investor conference. “With sport, we’re a renter. That’s not as good of a business.”

The problem for Zaslav is keeping legacy pay TV afloat may be his best way to keep cash flow coming, and putting NBA games on TNT may be his best chance to do that. In the third quarter, Warner Bros. Discovery’s cable network business had adjusted EBITDA of $2.6 billion on $5.2 billion of revenue. That’s compared with a direct-to-consumer business that lost $634 million.

If Warner Bros. Discovery is going to pay billions of dollars a year for the NBA, Zaslav wants a deal to be future-focused. He has the luxury of having NBA Commissioner Adam Silver’s ear for the next three years because the NBA will be on TNT through the end of the 2024-25 season.

“If we do a deal on the NBA, it’s going to look a lot different,” Zaslav said.

Warner Bros. Discovery knows how to produce NBA games and airs a studio show, “Inside the NBA,” which is widely regarded as the best in professional sports. It’s possible Zaslav could strike a deal with another bidder, such as Amazon or Apple, which may allow Warner Bros. Discovery to produce their games while giving him a package of games that came with a lower price tag.

Ideally, Zaslav would like to do sports deals that include ownership of intellectual property. This is also appealing to Netflix, The Wall Street Journal reported last month. Acquiring leagues gets Zaslav out of the rental business. But while smaller professional sports leagues, such as Formula One and UFC, are owned by media companies (Malone’s Liberty Media and Ari Emanuel’s Endeavor, respectively), it seems unlikely NBA owners would agree to sell Warner Bros. Discovery a stake in the league.

Silver said last month at the SBJ Dealmakers Conference he was open to rights deals structured in novel ways.

“We’re in the enviable position right now of letting the marketplace work its magic a little bit, you know, to see where the best ideas are going to come from, what’s going to drive the best value,” Silver said.

It’s also possible Zaslav could walk away from the NBA completely. While “Inside the NBA” co-host Charles Barkley recently signed a 10-year contract to stay with Warner Bros. Discovery, it includes an out clause if Zaslav doesn’t re-up the NBA, according to The New York Post.

Live sports aren’t necessarily essential to most streaming services’ success. Netflix, Disney+ and HBO Max all have zero live sports — at least for now.

The one certainty is Zaslav’s decision will be squarely based on how a deal affects the company’s free cash flow.

“It’s how much do we make on the sport?” Zaslav said. “When I was at NBC, when we lost football [in 1998], we lost the promotion of the NFL, which was a huge issue. Then you have the overall asset value without the sport. So you have to evaluate all that.”

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