The Long and Short

Magallanes makes it through a volatile market

| March 11, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Magallanes, the financing subsidiary of the to-be-formed Warner Brothers Discovery, tapped the market in the last week with the largest bond deal since 2019.  The company took advantage of the first real positive tone in the market since the Russia-Ukraine war started to issue $30 billion of debt across 11 tranches. Even though the deal tightened in secondary, it still has room to go tighter.

Exhibit 1. MGLLNS vs. Media Peer Curves

Source: Bloomberg TRACE; APS

The books for the deal ended up roughly 4x oversubscribed.  Even on the break, the debt tightened as the deal represented .04 spread duration of the index.  With the deal expected to close early in the second quarter this year and the financing to fund the cash payment to AT&T Inc. (T) completed, there should be further upside in the MGLLN bonds.  In the intermediate part of the curve, the deal priced roughly 40 bp behind Discovery, Inc. (DISCA) 3.625% 2030 bonds and approximately 25 bp behind DISCA 4.65% 2050 bonds.  Given the attractive pricing, the deal should continue to grind closer to DISCA secondary levels as the new bonds will rank pari passu with existing DISCA debt represented by the blue line in Exhibit 1.  As the company delevers post-merger, MGLLNS bonds should collapse closer, if not through PARA (ViacomCBS – now named Paramount Global), given its larger size and stronger credit profile.

Exhibit 2. MGLLNS Multi-Tranche Deal

Source: Company Press Release; Bloomberg; APS

New Deal Guarantees

Given that the bond deal was priced ahead of the closing of the WarnerMedia merger with DISCA, the MGLLNS bonds contain a conditional guarantee by T and will remain a subsidiary of T until the deal closes. This guarantee will fall away once MGLLNS is spun from T along with the WarnerMedia assets. Within 30 days of the closing of the merger, the bonds will be fully guaranteed by the new Warner Brothers Discovery, Inc., as cross guarantees will be put in place.  MGLLNS will be the core financing subsidiary of Warner Brothers Discovery Inc. upon completion of the merger.

Commitment to Leverage Reduction and Investment Grade Ratings

Warner Brothers Discovery Inc. has noted that they are committed to reducing leverage to the 2.5x-3.0x range within two years post close, down from roughly 5.0x expected when the deal is completed.  Management had originally targeted a leverage range of 3.0x-3.5x, but recently revised the range lower which is a positive for the ratings.  Until the leverage target is achieved, management will refrain from pursuing additional M&A transactions as well as share repurchases.  Management is targeting significant cost synergies of $3 billion+ on a run-rate basis by 2024, which is expected to fuel EBITDA growth, a large part of the company’s leverage reduction plans.  We note that free cash flow conversion is anticipated to be in the 60% range, which translates to free cash flow of over $8.0 billion in 2023, assuming management’s forecast of $14 billion of EBITDA for the year.  For the two-year period post close, Warner Brothers Discovery Inc. has the ability to generate between $14 billion-$15 billion in free cash flow.  Given that DISCA does not pay a dividend, that provides management with some flexibility to also reinvest in the business/content if needed.  Management remains committed to Investment Grade ratings and could see ratings improve a notch if they hit their leverage target range.  We note that higher rated peers such as FOXA (Baa2/BBB) and PARA (Baa2/BBB/BBB) have gross leverage of 2.7x and 4.0x, respectively.

Exhibit 3. Warner Brothers Discovery Inc. Guidance

Source: Company Presentation; APS

Warner Brothers Discovery to Become the Premier Pay TV Company

The merger dramatically improves DISCA’s scale and creates the largest TV studio in terms of revenue and volume as well as the largest content library with over 200k hours of video.  DISCA’s six core brands (Discovery, Food Channel, HGTV, TLC, Animal Planet and Investigation Discovery and Travel) will now be benefit from the addition of the WarnerMedia assets which include HBO, HBOMax, CNN, TNT, TBS, Cartoon Network and Warner Brother Studios.  The marriage of these assets helps to address linear bundle concerns surrounding cord cutting.  Additionally, the portfolio will be better positioned to be a stronger partner to both advertising and distribution counterparts, which bodes well for the top line.  We also believe the improved cash generation will enable the new company to focus on expanding its direct-to-consumer offerings (after debt reduction), a large growth driver given the proliferation of media streaming.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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