Paramount goes hostile

Paramount Global made a hostile all-cash bid of $30 a share for Warner Bros Discovery on 19 December, an open attempt to wreck the all-stock merger Netflix had already agreed. The fight for the media industry's leftover assets is now in the open.

A rejected suitor returns

Paramount is not a new arrival in this contest. Since David Ellison's Skydance completed its takeover of the company in August, Paramount has made a series of approaches to Warner's board, each rejected, before the board opened an auction and chose Netflix. Going hostile means taking the offer straight to shareholders, bypassing directors who have already signed with someone else. Paramount has also argued that its bid would have an easier ride with regulators than a combination of the two largest streaming libraries.

The mechanics give Warner's board a defined role even so. Under American securities rules, directors must tell shareholders within ten business days of a tender offer whether they recommend accepting it, rejecting it or neither. The board can argue that the Netflix agreement is worth more over time, but it must weigh that against an offer of certain cash. Any break fee owed to Netflix if Warner walks away becomes part of the price Paramount must cover.

Cash now or Netflix paper

Warner Bros Discovery shareholders now have a plain choice. They can take a premium cash exit, paid for by a group of Wall Street private credit funds and sovereign wealth backers, or they can tie their fortunes to Netflix's volatile share price. For WBD's management, Paramount's money would deal with the debt immediately, but the combined company would be carrying more than $50 billion of borrowings.

The appeal of cash is easy to understand. A shareholder who accepts $30 a share knows what the deal is worth on the day it closes, while one who takes Netflix stock carries the risk that the buyer's shares fall during a long antitrust review. Netflix's own investors have reacted coolly to the idea of issuing large amounts of new stock, which has not helped the value of its offer. For arbitrage funds, which buy target shares to capture the gap between market price and deal value, a cash bid is simpler to price and hedge.

The cost falls elsewhere. Private credit funds and sovereign investors expect a return on the money they provide, and the combined company would have to service that debt out of cash flows from studios, streaming and cable networks whose audiences are shrinking. Paramount would be paying for its bid by borrowing against the future earnings of the business it is buying, a structure that looks efficient in a strong market and fragile in a weak one.

Bond investors flinch

Bondholders did not like the look of it. Spreads on media company bonds widened sharply, and the rating agencies warned that a debt-financed takeover by Paramount would likely push the credit well down into junk.

The mechanism is familiar to credit investors. Warner's existing bonds were issued on the assumption of a certain level of leverage and a plan to reduce it; a takeover financed with fresh debt adds claims on the same cash flows, and new lenders often insist on security or seniority that pushes older unsecured bonds further back in the queue. Ratings fall because the ratio of debt to earnings rises, and the price of existing bonds falls with the ratings as some holders are forced to sell once the bonds lose investment-grade status.

Some bondholders have a partial defence. Many investment-grade bonds carry change-of-control clauses that let holders sell their bonds back to the issuer at slightly above face value if a takeover is followed by a downgrade to junk. The protection depends on the exact wording of each indenture, and older bonds or those issued under looser terms may lack it, so the pain would be uneven across Warner's debt stack.

The RJR lesson

The precedent that credit markets still remember is RJR Nabisco. The 1988 leveraged buyout of the tobacco and food group by Kohlberg Kravis Roberts loaded the company with debt and sent the prices of its existing high-grade bonds sharply lower, and bond investors learned that a solid credit rating could vanish overnight in a takeover. The change-of-control protections now common in bond documents were a direct response. The Warner fight tests how well those protections work when a bidder is determined to win.

The case for the cash bid

Paramount's defenders make a reasonable argument. The combined company would own two major studios, a large catalogue of films and television, CBS and a set of cable networks that still produce substantial cash, and the savings from combining overlapping operations could be large. On that view, the debt can be paid down over several years, as other leveraged media deals have managed, and bondholders would recover much of their losses as leverage falls.

The weakness in that argument is the cable business. Cable networks generate cash today, but the number of households paying for traditional television keeps falling, and each year of decline removes some of the income that is meant to repay the debt. A plan that depends on steady cash flows from a shrinking business leaves little margin for a recession, a failed film slate or a costly sports rights renewal.

The financing brings its own reviews. Sovereign funds putting money into a company that owns CBS and its broadcast licences could draw scrutiny from the Committee on Foreign Investment in the United States and from the Federal Communications Commission, which limits foreign ownership of broadcast licensees. Those reviews would run alongside the antitrust process and add time, and every month of delay is a month in which Warner's bonds trade on uncertainty.

What decides the contest

The next steps are the Warner board's formal response to the tender offer, the share of stock tendered as the offer period runs, and whether Netflix raises its bid or adds a cash component. Rating agencies' formal actions, rather than their warnings, will set the price of Warner's bonds, and the detailed financing commitments behind Paramount's offer will show how much of the debt is secured.

Paramount is borrowing heavily to avoid being left behind by the streamers. If it wins, WBD's bondholders will probably pay first, with downgrades to deep junk soon after the deal closes. Shareholders who tender would keep a cash premium, while unsecured lenders without change-of-control protection would absorb the losses in the months after completion.