The last trading day of June came and went. It’s onward to July. Hopefully, the second half of 2022 won’t be nearly as bad as the first half. The last time the S&P 500 lost 21% in the first half of a calendar year was 1970.
The good news from 1970 is that the markets recovered in the second half year's second half a 26.5% return between July and December, resulting in a tiny 0.10% gain for the entire year.
Could it happen again? Anything’s possible, I suppose. However, with all that’s happening in the world at the moment, it’s unlikely.
This brings me to the topic of this week’s unusual options activity.
Using Barchart data from June 30, I found that Warner Bros. Discovery (WBD) had the two highest volume-to-open-interest call options of the day’s trading. So, I thought I’d focus on the media giant for this week’s installment.
I have two questions.
First, are the two contracts even the best WBD call options available? Secondly, is WBD worth owning over the long term?
What’s a Better WBD Call Option?
The two WBD call options are the Aug. 5 $15 call and July 29 $14.50 call. The former had volume of 13,369, 94.82x the open interest. The latter’s volume was 12,030, 78.12x the open interest. The bid prices were $0.53 and $0.50, respectively.
I'd go for the longer expiry provided by the $15 call if it were me, but I'm by no means an expert in the options market.
So, with the August call option, I’ve got 36 days to get beyond $15.53 and break even. As for the July call option, I’ve got 29 days to get to $15. If Warner Bros. Discovery is all that and a bag of chips, the extra 53 cents over an extra week ought to be a slam dunk.
Why the unusual options activity in the first place? Benchmark analyst Matthew Harrigan initiated coverage on WBD on June 29. He’s got a “buy” rating and a $26 target price.
Let’s assume for a second that Harrigan is right on the money and WBD hits $26 on June 29, 2023. The Jan. 20 2023, $25 call option’s bid price on June 30 was $0.26. It had volume of 110 with an open interest of 25,937.
Looking at the open interest for the 204-day expiry, the $30 strike price appears to be the most popular, 6x more than the $25 strike.
The only problem with a longer strike price is that a lot can happen between now and then. CEO David Zaslav could be hit by a bus and knocked out of his dream job. The possibilities are endless.
Perhaps something in between such as the Nov. 18 $17.50 makes more sense. You’ve still got 141 days until expiry and the ask is only $0.80. Currently 30.4% out of the money, it’s a much more realistic target.
Part 1: Is WBD a Buy?
I don’t believe it is, but I’m probably in the minority.
According to MarketWatch, 25 analysts currently cover WBD. The average rating is “overweight” with an average target price of $32.53. Further, the lowest target price is $18, 33% higher than where it’s currently trading.
Once the $43-billion merger between Discovery and WarnerMedia was completed, you knew the heads were going to roll. The company is reportedly looking to cut 30% of its global advertising sales team or nearly 1,000 jobs. To accelerate the process, it is offering voluntary buyouts.
Earlier this year, Warner Bros. Discovery’s CFO, Gunnar Wiedenfels, said it was looking to cut $3 billion from its operating expenses. According to the company’s most recent proxy, the median employee compensation was just under $83,000. Double that amount to get an estimate of the average salesperson’s compensation and you’re talking about 16.6 million in annual savings.
Over the past three years, Zaslav made $330 million in total compensation. You know he’s not going to take a pay cut, so the sales staff will take a hit for the team.
David Zaslav took over as Discovery CEO in January 2007. Shareholders have received very little in return for Zaslav most likely becoming a billionaire. According to Morningstar.com, Discovery, and now WBD, has generated a 15-year annualized total return of 6.6%, 186 basis points less than the entire U.S. market and 183 basis points less than his entertainment industry peers.
Part 2: Is WBD a Buy?
Shareholder advisory firm ISS has consistently rallied against the company’s CEO compensation arrangement. Flat out, it’s egregious. What’s really scary is that Zaslav’s 2021 compensation of $246.8 million was only good for the sixth position in Equilar’s 2022 edition analyzing CEO pay.
As I said earlier, the company is trying to cut $3 billion in annual operating expenses from the income statement so that it can accelerate its debt repayment. Currently, its debt is $55 billion, 1.7x its market cap.
In June, Variety reported that JPMorgan (JPM) analysts cut their rating on WBD to neutral. It has concerns about the company’s plans regarding HBO Max and Discovery+.
“We [are] confident WBD will achieve the announced synergy target of $3b within 24 months of [the WarnerMedia] deal close, but we are wary of its growth profile beyond that due to exposure to the linear video ecosystem and questionable direct-to-consumer strength.”
While there is no question the merged entity has some excellent media properties, the move by Zaslav to scale Discovery seems like an ego trip that will end badly for shareholders while the CEO heads to retirement a very wealthy person.
Personally, I would not consider buying WBD stock until its debt was reduced to 1x market cap or less. As for the options, it will cost you a lot less to be wrong.
Buy away.
More Options News from Barchart
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