Artur/iStock Editorial via Getty Images
The chart below requires very little explanation: when interest rates on long-term Treasuries (TLTs) rise, Treasuries lose, as do highly leveraged corporations like Warner Bros. Discovery (NASDAQ: WBD) and Paramount (PARA).
Long-term Treasury bond industry in conjunction with Paramount and Warner Bros. Discovery. (Looking for Alpha)
This is justified because debt regularly has to be refinanced faster or later, and interest rates will be higher, reducing profits. And if the company is rarely highly developed or in the middle of an investment cycle with dubious results (like the two media companies listed), the arrangement established through the market turns out to be correct.
The more expensive coins become, the more uncertain the outlook for expansion (or certain contraction), the more uncertain it is, and the more stock market multiples shrink. While more of the coins earned through those corporations want to be transferred to bondholders, there is less left for regular shareholders.
– Easy, isn’t it?
Add to that a sometimes sluggish market, a widely expected recession, inflation-burdened consumers, low advertising budgets, and the tug-of-war to identify streaming platforms through players who are considered laggards in the game, and you have the picture.
However, if I look at the chart above, I wonder if the activities of those two corporations are so similar as to justify their strained agreement with long-term Treasury costs.
Markets like simple narratives. Once established, they tend to work surprisingly well. Price movements become seemingly predictable in a simple way: Just by looking at one chart, you know how the other one will move – and it really works!
– At least for a while.
However, corporations are not so predictable. Companies are reacting to case conversion, and in some cases, they can take advantage of a crisis. And sometimes even getting close to bankruptcy can be a positive catalyst, as John Malone noted yesterday:
There is an exemption from antitrust legislation for bankrupt companies. In a moment of anguish, it is true, and then faced with certain restrictions, they look the other way.
The media mogul in particular referred to a possible merger between Paramount and Warner Bros. Discovery, which face antitrust opposition in general circumstances, but which could be allowed due to the imminent bankruptcy of one or any of the parties involved.
Malone singled out Paramount’s negative free cash flow, which under almost all circumstances represents a liability, but could actually bring about a transformative deal.
Therefore, paradoxically, in my opinion, Warner Bros. Discovery and Paramount may even gain advantage from the burden of higher interest rates.
That said, Warner Bros. Discovery’s situation is very different from Paramount’s. As I explained in my recent article, Paramount’s dividend cut generates great value simply because it will allow the company to pay off $1. 6 billion in debt that would otherwise move to prohibitive variable interest in 2027.
Warner Bros. Discovery has no such problems. Their debt is almost entirely constant and they have an average adult age of 15. And thanks to interest rate fixing, along with recent interest rate increases, its bonds are trading with a sharp average drawdown of about 20% in their notional values.
Therefore, we can simply argue that instead of $43 billion of net debt at the end of the third quarter, the actual amount the company has to pay is about $35 billion (if the debt is paid off before maturity). Come on, less you will have to pay back!
Obviously, the company doesn’t have the money to buy back all of its debt. Nor would it need to, as it could simply constitute a long-term competitive advantage: many media corporations went into debt during the ZIRP years and now face dire prospects. If interest rates don’t go down, they will go bankrupt or be bought out.
By hoarding cash, Warner Bros. Discovery would possibly be the one to benefit from this general angst.
Unlike Paramount, Warner Bros. Discovery generates real money of about $5 billion per year, which is expected to grow at a healthy rate in the coming years.
You’ll have to pay roughly a portion of this to have liquidity for debt repayment, as over the next five years, your average annual maturities are only about $3 billion.
It is imperative to differentiate between the two media companies. The fact that the stock market treats them as one thing doesn’t seem right in light of the above and is probably a sign of market inefficiency.
A few days ago, Warner Bros. Discovery was treated as a financially distressed business by the stock market just because its management guided to a potentially somewhat higher leverage ratio at the end of 2024 (compared to the originally targeted 2.5-3x gross), if the ad market remains sluggish.
But does any of this change the trajectory of the business? Does it create real distress? Will it impair any competitive advantage? – I don’t think so. Ad markets will come back. Whether they come back within one or three quarters doesn’t really matter over the long term.
Although the market almost necessarily applies abstract judgments, the applicable main points are missed.
Even in a sluggish ad market, Warner Bros. Discovery will have especially reduced its debt through the end of 2024 and will be on track to achieve more in the coming years, given its increased flow of loose cash.
The company trades at just over four times its TTM FCF, which is expected to grow, a valuation that would only make sense in situations of excessive monetary distress. But it is genuine money.
Most importantly, the higher interest rates go and the longer they stay high, the more debt the company might be able to retire on the cheap. This reduces financing costs and increases free cash flow.
And if you don’t and continue to raise money, the expansion of money will most likely be further thanks to opportunistic mergers and acquisitions of distressed assets, which would reduce your leverage ratio by expanding the denominator anyway.
So I think the stock market wants to be smarter and unbundle Warner Bros. Treasury Tandem Trade Discovery.
This article written by
Analyst Disclosure: I hold/hold an advantageous long position in WBD, PARA stocks, whether through stocks, securities, or other derivatives. I wrote this article myself and express my own opinions. I don’t get any refunds for this (other than from Looking for Alpha). I have no relationship with any company whose actions are discussed in this article.
Looking for Alpha Disclosure: The above functionality does not guarantee long-term results. No recommendation or recommendation is given as to whether an investment is suitable for a specific investor. The perspectives or reviews expressed above may not reflect those of Buscando Alfa as a whole. Seeking Alpha is not an inventory dealer, investment advisor, or authorized investment bank in the United States. Our analysts are third-party authors who collaborate with professional investors and individual investors who are licensed or qualified through any institute or regulatory body.