Wall Street casts doubt on Warner Bros. Discovery-Paramount merge

Wall Street’s Hollywood observers got a pre-holiday surprise this year when news broke that Warner Bros. Discovery CEO David Zaslav has explored a potential deal for Paramount Global in a meeting with its CEO Bob Bakish and chair Shari Redstone, who controls the firm through family holding company National Amusements.

Shares of Warner Bros. Discovery (WBD) dropped as investors tried to unpack the news and analysts expressed their doubts about the potential deal, using such phrases as “we have a hard time seeing” a deal and equating it to catching “a falling knife” or even a “financial death sentence.”

While not quite describing the revelation of the deal talks as a nightmare before Christmas, Wells Fargo analyst Steven Cahall straight-out told investors in a report: “We prefer WBD stand-alone.” After all, “pro-forma WBD/Paramount would be a beast of a mostly linear company,” he explained. That merged company would control cable outlets ranging from HBO, TNT and TBS to Comedy Central, Nickelodeon, BET and MTV.

Cahall explored some deal scenarios in his report entitled “WBD + PARA = ?.” Scenario 1 would see WBD buying Paramount, which the analyst called a “bad idea.” His estimates include combined revenue of $72 billion and earnings before interest, taxes, depreciation and amortization (EBITDA) of $13 billion, “of which about 50 percent/90 percent would be linear.” The expert doesn’t like the idea of WBD taking on incremental debt for a takeover, noting: “WBD’s debt has been a problem since the merger, and this would only magnify melting ice cube sensitivities.”

Scenario 2, an all-stock merger, would be “more neutral” for the stock, Cahall argued. “This has the benefit of not requiring incremental debt, but Paramount’s controlling shareholders don’t cash out,” he explained. “The drawback is lack of M&A premium to the new stock.”

Deal scenario 3 would see WBD acquiring National Amusements (NAI) before a Paramount merger. “WBD could look to control Paramount through the A shares for about $2 billion,” Cahall wrote. “This gives management options, such as divestitures, prior to an all-stock merger of WBD/Paramount B (stock).” His conclusion: “We see this as the lowest risk (i.e., best) option for WBD (smaller outlay). This also gives NAI immediate cash so may be most probable.”

Cahall wrapped up with broader deal thoughts. “Paramount is in play given the preponderance of press reports,” he suggested. “We think WBD is better off as a seller than buyer given the strength and uniqueness of Warner Bros. and HBO, but management may have different ideas (or there may not be suitors). Any deals will likely require significant regulatory approvals of one to two years, and Paramount A versus B [shares] deals could engender shareholder lawsuits. Perhaps the biggest conclusion is that media’s challenges inevitably lead to rationalizations.”

TD Cowen analyst Doug Creutz sounded another bearish note on a possible WBD megadeal for Paramount. “We Have a Hard Time Seeing a Paramount Merger Happening,” he summarized in the title of his report. One of its summary’s other key takeaway was: “We don’t think M&A is the solution.”

He noted “two obstacles” to a deal agreement: “regulatory and consideration.” On the regulatory side, “we have a very hard time believing the current FTC/DOJ, which has been very aggressive in combating industry consolidation, would give this deal a pass,” Creutz argued, while others have noted that the transaction wouldn’t bring together two broadcast networks. “It would involve merging two of the five remaining major movie studios, two major television studios, and would create a very high concentration of linear network ownership (which last we checked is still a very large and EBITDA-positive business even given cord-cutting), including a significant consolidation of major sports rights.”

Even if President Joe Biden loses the 2024 election “and a GOP winner (likely to be Trump given current polling) were to bring in new regulators, however, we still think the regulatory hurdles would be high.” Why? “Trump’s head of DOJ Makan Delrahim made an unsuccessful effort to block the AT&T-Time Warner merger, and we think WBD-Paramount would be more problematic from a consolidation standpoint,” Creutz argued. “We also note that WBD’s news network CNN has been a verbal target of Trump in the past, and we would guess that he probably still holds a grudge.”

The expert sees consideration, or how to pay for it, as the second hurdle for a combination. “We think WBD is at least two years away from being able to use cash/debt to finance a major acquisition, so a Paramount deal would almost certainly have to be a stock deal,” he argued. “Shari Redstone would have to give up control of Paramount and become a minority equity holder in a merged entity; presumably she would want some sort of significant premium given the equity consideration, which we think WBD would and should be reluctant to pay (particularly given the beating WBD shares have taken since the Discovery-Warner merger was announced).”

Creutz’s takeaway from the deal talks report was negative. “Ultimately, we think such a deal would be a mistake for WBD,” he wrote. “Scale isn’t the solution to their problems, which are all about industry structure (if scale was a magic bullet, Disney’s stock wouldn’t be down more than 50 percent from its all-time high).”The analyst also argued that “Paramount would bring a lot of content ballast to the table, but much less in terms of premium, long-tail franchises, and WBD already has plenty of breadth of content.”

Creutz’s alternative deal pitch: “What might make more sense would be an agreement to bundle Max and Paramount+ together as a single product, while remaining separate companies.” Explained the analyst: “This would be a step towards reconstituting an over-the-top version of the old linear bundle (wholesaled to distributors like Amazon and Apple, as well as the multichannel video programming distributors), an outcome that we think could ultimately make media investible again.”

Meanwhile, MoffettNathanson analysts Robert Fishman and Michael Nathanson put the Paramount-WBD talks into the challenging broader media and entertainment environment. “These desperate times for media companies are leading them to explore desperate measures,” they argued.

After going through a whole list of arguments in favor of a deal, including bringing together news powerhouses CNN and CBS News, sports operations, as well as streamers Max and Paramount+, the experts also outlined the case against a merger. Among their points: “WBD would likely be paying a hefty premium for a quickly declining linear TV business, allowing it to again double down on its own pressured business,” Paramount’s debt load and the argument that “even together, the two would struggle to build a scaled streaming service that would allow the combined company to remain viable as linear cash flows fade away.” And they argued: “The IP WBD would gain would also be surprisingly limited as much of the company’s ‘crown jewels’ are owned or have significant profit participations with third parties, such as Skydance Media,” a reference to Top Gun: Maverick.

Fishman and Nathanson diagnosed an “increasing sense of desperation around media,” concluding: “As pressure mounts from growing secular linear TV advertising headwinds, cord-cutting acceleration and a weaker macro backdrop putting more burden on sustainable cash flows, and leverage moving in the
wrong direction for Paramount, we still question why any company would try to catch a falling knife?”

So the analysts see this as the wrong time for a Paramount deal, suggesting that a possible advertising recession could ensure “an even cheaper price” for any suitor. And given Paramount’s upcoming affiliate fee renewal talks with Charter Communications, “we hear April time frame … wouldn’t any buyer before underwriting any valuation need to see the negative impact on both its linear TV business and whether Paramount+ is forced to be included in a deal without wholesale payment” like Charter agreed with Disney for ESPN+ in their recent carriage deal, they asked.

The MoffettNathanson team’s alternative deal pitch includes a different sector biggie: Comcast, led by chairman and CEO Brian Roberts. “It has long been speculated that Brian Roberts has interest in getting bigger in media by leveraging ownership of NBCUniversal to better compete with Disney,” the analysts highlighted. “At the end of the day, Comcast may be the one strategic buyer with the capital structure and assets required to benefit either WBD or Paramount in a long-term viable way.”

Suggested Fishman and Nathanson: “An NBCU spin could help WBD de-lever depending on deal structure. The key issue is whether this is a path the company really wants to explore, especially over the coming months ahead of likely even more disruption in the ecosystem.”

The always-outspoken Richard Greenfield, analyst at LightShed Partners, also didn’t mince words, highlighting that “hope is not a strategy” in a Dec. 19 note before the news of the WBD-Paramount exploratory talks emerged.

“Many investors believe consolidation is the answer to legacy media’s streaming woes. We disagree,” he emphasized. “Legacy media companies are simply too late and not equipped talent-wise or strategy-wise to build scaled global streaming services on top of the growing headwinds facing their linear TV assets.”

Continued Greenfield: “Investors point to a combination of Warner Bros. Discovery and NBCUniversal or Warner Bros. and Paramount as potential solutions. Yet, layering on even more linear TV assets to any of these legacy media companies feels like a financial death sentence.”

The expert also called regulatory approval “challenging” right now. “We doubt anyone is going to attempt a major transaction in 2024 in the midst of a presidential election and with the current administration hostile toward consolidation,” he explained. “If legacy media M&A is even possible in the next administration, your are looking at announcing a deal in 2025 that would not close until 2026.”

Concluded Greenfield: “Legacy media companies simply do not have time to wait and hope for M&A as a strategy. They must take action to alter their streaming strategies immediately or their stocks will continue to suffer.” The Hollywood Reporter