{"id":61475,"date":"2023-09-15T14:37:53","date_gmt":"2023-09-15T18:37:53","guid":{"rendered":"https:\/\/ifintechworld.com\/news\/warner-bros-discovery-the-market-is-misunderstanding-the-favorable-debt-structure\/"},"modified":"2023-09-15T14:37:57","modified_gmt":"2023-09-15T18:37:57","slug":"warner-bros-discovery-the-market-is-misunderstanding-the-favorable-debt-structure","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=61475","title":{"rendered":"Warner Bros. Discovery: The Market is Misunderstanding The Favorable Debt Structure"},"content":{"rendered":"
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Investment Thesis<\/strong><\/h2>\n

Warner Bros. Discovery, Inc. ((NASDAQ:WBD<\/span>) or the \u201cCompany\u201d) has received much attention from financial and media analysts as it has gone through its in the spotlight transformation since the closing of its merger on April 8, 2022. Despite the general macroeconomic and media market\/industry headwinds experienced, WBD has made significant progress in integrating, rationalizing and improving its businesses for the future.<\/span><\/p>\n

Notwithstanding WBD\u2019s successes to date and its continued strong prospects for success, WBD trades at a significantly discounted equity valuation relative to its media peers. In my opinion, a major reason for WBD\u2019s equity valuation discount is that the company’s capital structure is generally misunderstood and often misrepresented by many media reporters and analysts. The focus of this article is to present a \u201cdeep dive\u201d on WBD\u2019s debt capital structure, and how its debt structure has very beneficial implications for WBD’s valuation.<\/p>\n

Summary Overview of WBD’s Debt<\/strong><\/h2>\n

WBD\u2019s debt is often incorrectly referred to as a mountain or pile of debt that is looming over WBD as if the debt was short-term floating-rate debt with imminent significant refinancing needs that would cause the Company to take drastic actions to make its payments.<\/p>\n

In fact, WBD has a very favorable low cost fixed-rate (4.6% average rate, with 97% of the debt being fix-rate), long-term (14+ years average life), and staggered maturity debt capital structure (extending out to 2062). As a result, the Company is insulated from future increases in interest rates and doesn\u2019t have any refinancing risks. Furthermore, there are minimal near-term maturities \u2013 with only $42 million due before the end of this year (after payment on September 15th of $178 million) and $1.8 billion during 2024. The Company is clearly not under pressure to sell assets (e.g., CNN) to repay \u201clooming\u201d maturing debt.<\/p>\n

From the inception of the merger, WBD\u2019s management planned to rapidly pay down debt in the initial few years after closing of the transaction. The Company has delivered and has shown that its debt is very manageable given its strong and increasing Adjusted EBITDA and free cash flows.<\/p>\n

Since the merger closed last April, WBD\u2019s outstanding debt has already been reduced to approximately $45.4 billion, and its net debt to approximately $42.4 billion \u2013 representing an approximate $10.9 billion debt reduction (including payoffs and purchases of debts). Significantly, this debt reduction represents (1) approximately 20% of the Company\u2019s original post-merger debt level and (2) is equivalent to about $4.50 per equity share ($10.9 billion divided by 2.44 billion shares).<\/p>\n

With the Company\u2019s generation of significant free cash flows during the remainder of this year and expectations for next year, the Company is well on its way to achieve its targeted gross leverage level by the end of 2024 of 2.5 to 3.0 times 2024 EBITDA. This implies gross debt of approximately $36.5 billion by the end of 2024, and net debt of approximately $34 billion. To reach this debt level would represent an additional debt reduction of $9 billion \u2013 which is likely to include some debt purchases at discounts.<\/p>\n

Due to the significant increases in interest rates since when the merger closed (when rates were approximately 200 basis points below current levels), the fair value of WBD\u2019s fixed-rate debt is estimated to currently be approximately $6.9 billion less than its book value. The discounts on the Company\u2019s longer dated debt tranches are as much as 30% to 40% – creating a huge opportunity for the Company to purchase some of its debt at significant discounts.<\/p>\n

As WBD moves towards meeting its gross leverage target for 2024, its financial flexibility will continue to grow. The Company\u2019s remaining debt has very favorable fixed rates and has very long-term maturities – providing the Company tremendous flexibility to use its significant free cash flow (\u201cFCF\u201d) for additional purposes, including additional investing in its existing and new businesses, stock repurchases, additional repayment of its debt obligations (at discounts to par) and acquisitions.<\/p>\n

Given WBD\u2019s strengths as a diverse global media and entertainment company which has already gone through a significant transformation, WBD\u2019s enterprise valuation, equity market capitalization, share price and EV\/EBITDA ratio are extremely low relative to its media peer group.<\/p>\n

I believe that WBD\u2019s enterprise valuation ratio and its share price have tremendous upside as the Company continues to achieve successes in its transformation, including its improving financial performance metrics (including Adjusted EBITDA, free cash flows and debt reductions), and perhaps most significantly, the growth and profitability of its global DTC business.<\/p>\n

Review of WBD\u2019s Debt Structure<\/strong><\/h3>\n

WBD\u2019s debt structure was carefully planned and executed before the transaction closed in April 2022. When the merger closed on April 8, 2022, WBD had approximately $56 billion of debt, including $41.5 billion of debt assumed in connection with the transaction. There is no disputing that it\u2019s a lot of debt, but it\u2019s also important to recognize that WBD has significant amounts of goodwill and intangible assets – over $76.5 billion as of June 30, 2023. Having low-cost long-term fixed rate debt as a significant part of its permanent capital structure to finance a portion of these long-term intangible assets provides for an efficient and low-cost capital structure.<\/p>\n

The below summary slide from the Company\u2019s 2nd<\/sup> quarter 2023 earnings presentation highlights the summary characteristics of WBD\u2019s debt (as of June 30, 2023).<\/p>\n

\"Summary<\/span>
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WBD Summary of Debt as of June 30, 2023 (Warner Bros. Discovery)<\/span><\/p>\n<\/figcaption><\/figure>\n

Highlights<\/strong><\/h4>\n