(Bloomberg) — It began as a concession in private conversations to assuage wary credit analysts looking at Paramount Skydance Corp.\u2019s blockbuster takeover of Warner Bros. Discovery Inc.: a verbal pledge by the Ellison family to do whatever it takes to slash debt at the combined company.<\/p>\n
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Then Wall Street forced it into the open.<\/p>\n
Paramount is financing its Warner Bros. acquisition with a daunting roughly $50 billion of debt, leaving investors skeptical of creating a heavily leveraged entity in a turbulent media industry.<\/p>\n
To ease those concerns, Paramount Chief Executive Officer David Ellison privately promised ratings agencies including S&P Global Ratings that the family \u2014 which controls Paramount \u2014 would step in to tame leverage at the merged entity. The credit graders then pushed for that commitment to be made public and sure enough, Paramount revealed it in a regulatory filing last week.<\/p>\n
\u201cIt was a verbal comment from David Ellison,\u201d said Naveen Sarma, sector lead for US media and telecom at S&P. \u201cI think all the agencies, and certainly us, insisted on a public disclosure as well.\u201d<\/p>\n
The exchange highlights the anxiety surrounding the proposed $110 billion combination, which beyond concerns over the massive debt load, is facing widespread opposition in Hollywood and contending with the prospect of rankling Warner Bros.\u2019 existing creditors as well.<\/p>\n
Yet the public disclosure proved decisive for S&P, which viewed the wealthy family\u2019s backstop as a tacit commitment to inject additional capital if needed. While S&P has said it expects to lower the post-merger company\u2019s rating by one notch to BB, Sarma noted that without the family\u2019s backstop, the expected rating would have gone down by two notches.<\/p>\n
\u201cWhen we came up with our rating, the disclosure on the leverage commitment and the potential for them to do equity, if they need, was a very strong part of that,\u201d Sarma said. \u201cFrom our standpoint, it\u2019s a pretty powerful statement.\u201d<\/p>\n
A representative for Paramount declined to comment.<\/p>\n
Leverage Goals<\/p>\n
The pledge mirrors assurances the Ellison family and RedBird Capital Partners made earlier to Warner Bros. to guarantee their $47 billion equity investment. Ellison\u2019s father, Oracle Corp. Chairman Larry Ellison, is one of the world\u2019s richest people.<\/p>\n
In Paramount\u2019s May 19 filing \u2014 which detailed other elements of the deal\u2019s financing \u2014 the company added a section titled \u201cCommitment to Deleveraging.\u201d It disclosed that it told certain ratings agencies it was \u201cParamount\u2019s and its controlling stockholder\u2019s plan and commitment\u201d to reduce leverage at the combined company to specified targets over the coming years.<\/p>\n
Paramount expects the entity\u2019s net debt to sit at 4.3 times earnings at closing, before dropping to three times within three years via cost-cutting and other synergies. But analysts are skeptical that these measures alone can achieve such targets.<\/p>\n
\u201cBased on what we know about the industry, and using a rough calculation, we don\u2019t think their target for net debt can be reached only by improving profit margins,\u201d said Wunmi Adekanmbi, an analyst at Fitch Ratings. \u201cWe assume they are also planning to pay down some debt.\u201d<\/p>\n
Fitch expects gross debt \u2014 meaning total debt before subtracting cash on hand \u2014 to be about seven times annual cash earnings after the merger, though Adekanmbi said that number could fall after accounting for the deal\u2019s savings and efficiencies.<\/p>\n
CreditSights, meanwhile, said earlier this month that post-merger leverage could rise to about five times annual cash earnings, which its analysts deemed a \u201cfrightening level.\u201d<\/p>\n
Representatives for Fitch and Moody\u2019s declined to comment on the discussions with David Ellison.<\/p>\n
Complex Structure<\/p>\n
Warner Bros., formed through the 2022 merger of AT&T Inc.\u2019s WarnerMedia business and Discovery Inc., was at the center of a fierce bidding war earlier this year, before Paramount outmaneuvered Netflix.<\/p>\n
To fund the deal, Apollo Global Management Inc., Bank of America Corp. and Citigroup Inc. initially provided $54 billion in short-term financing which was later reduced to $49 billion and shared with a larger group of banks. Paramount said in the May 19 filing it plans to replace that temporary funding with $39.5 billion of first-lien debt and another $12.4 billion of second-lien debt.<\/p>\n
S&P also said in its note that if the acquisition closes as proposed, it plans to assign a BBB- rating to the first-lien secured debt, which is the lowest investment-grade rating.<\/p>\n
While credit markets largely expect the offering to attract sufficient demand, the complex structure and size will likely command a steeper price. Investors must absorb a rare mix of high-grade and junk paper from a volatile entertainment sector. The financing is also evoking uneasy memories of the leverage that burdened bondholders after the 2022 WarnerMedia-Discovery merger.<\/p>\n
\u201cThe structure introduces complications that investors might be a little wary to deal with,\u201d said Jim Fitzpatrick, head of US investment grade research at Allspring Global Investments. \u201cThey\u2019re going to have to make this quite attractive to build a book that\u2019s going to be able to handle the size they want to get done.\u201d<\/p>\n
Planned Buyers<\/p>\n
Ryan O\u2019Malley, a portfolio manager at Ducenta Squared Asset Management, is among those planning to buy the newly issued debt across both the investment-grade and high-yield tranches. He remains undeterred despite expecting the company\u2019s post-closing debt burden to be about 4.5 times annual cash earnings.<\/p>\n
\u201cThey will manage to de-lever through cost cutting and by selling assets they don\u2019t need,\u201d he said.<\/p>\n
The financing could launch within weeks, an accelerated timeline that suggests Paramount is seeking to lock in institutional demand before a shifting macroeconomic backdrop pushes borrowing costs higher.<\/p>\n
Bank of America and Citigroup are preparing to syndicate the debt, which will include investment-grade bonds sold in multiple tranches, dollar- and euro-denominated loans, as well as high-yield bonds also split across the two currencies, Bloomberg reported.<\/p>\n
On Wednesday, Warner Bros. said it won an agreement from bondholders to change the terms of some existing debt, a step that allows Paramount to exchange or repurchase Warner Bros. debt as part of its acquisition.<\/p>\n
Even in the junk debt market, surging yields have buoyed demand, cushioning the blow from a recent global bond selloff<\/p>\n
\u201cIt\u2019s a large, complicated deal but it\u2019s coming into a fairly tight credit market and if they price it attractively it has the potential to do very well,\u201d said Campe Goodman, a fixed income portfolio manager at Wellington Management Company.<\/p>\n
(Updates with context on Ellison family in tenth paragraph, details on Warner Bros. latest debt steps)<\/p>\n
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