The Long and Short
Value in Warner Brothers on recent widening
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Warner Brothers Discovery (WBD) spreads have widened more than its peer group after the company reduced full-year EBITDA guidance for 2023 due to the ongoing WGA and SAG-AFTRA strikes. The revised guidance anticipates that the strikes will last through the year, a change from previous guidance that assumed the strikes would end in September. WBD spreads widened roughly 10 to 20 bp across the curve, which seems to be a bit an overreaction, especially given that management raised full-year free cash flow guidance and reaffirmed leverage targets.
WBD remains in debt reduction mode and the increase in free cash flow will provide for additional debt reduction to help offset the decline in EBITDA. That said, management still believes that it will end the year with net leverage below 4.0x and gross leverage will be in the 2.5x-3.0x by year-end 2024. Ratings should remain intact as they are largely predicated on management’s ability to hit its leverage targets. The spread widening in the credit provides for an attractive opportunity to add or enter the credit, particularly in tenors of 7 years and out (Exhibit 1). WBD is unlikely to issue new debt in the near term as it focuses on debt reduction, which bodes well for spreads as new issuance typically comes with a concession to secondaries.
Exhibit 1. WBD Spread Curve vs. Peer Group (Week over Week Comparison)
Source: Bloomberg TRACE; Santander US Capital Markets
Updated Guidance
WBD lowered its full year adjusted EBITDA range to $10.5 billion – $11.0 billion which reflects a $300 million -$500 million decline from previous guidance provided on the last earnings call, predominately reflecting the impact of the strikes. Free cash flow for the year is now expected to be at least $5.0 billion, up from the prior guidance range of $4.5 billion – $5.0 billion. While free cash flow benefits from the ongoing strikes, it is also benefitting from the strong box office performance of the Barbie movie. Additionally, management expects third quarter 2023 free cash flow to exceed $1.7 billion. WBD had previously guided that free cash flow for the quarter would be approximately $1.7 billion, similar to that of the second quarter.
Given the increase in free cash flow guidance, WBD reiterated its leverage targets. Management maintains that net leverage will be below 4.0x by the end of 2023. Furthermore, gross leverage is expected to be in the 2.5x-3.0x range by year-end 2024. Subsequent to quarter end, WBD launched a tender offer for up to $2.7 billion of bonds and was successful in retiring over $1.9 billion. The tender comes on the heels of over $1.6 billion of debt reduction during the second quarter. WBD has further levers to pull to reduce debt to hit its leverage target. The company has a $3.0 billion term loan maturing on 10/11/23 as well as nearly $1.8 billion of debt maturing through 2024. Management is also likely to pursue further tender offers to address its maturity wall in 2025, which includes $2.66 billion of bonds and a $7.0 billion term loan (Exhibit 2).
Exhibit 2. WBD Debt Maturity Schedule
Source: Bloomberg; Santander US Capital Markets
Ratings Hinge on Leverage Targets
WBD’s leverage remains high for the current ratings, so the maintenance of leverage targets and management’s focus on debt reduction is important to the current Investment Grade ratings. WBD is likely to achieve Investment Grade leverage metrics some time in 2024. Additionally, management remains focused on capturing synergies, with a total synergy estimate of more than $5.0 billion for its combination with Discovery Communications. As of the end of the second quarter of 2023, WBD had delivered more than $2.0 billion in incremental cost synergies. The acceleration of synergy capture has management confident in achieving $4.0 billion in total synergies sooner than previously anticipated. Management has a track record of overachieving on cost synergies and delivering on leverage targets ahead of schedule. WBD reduced leverage by over a turn and a half within a year of closing on its acquisition of Scripps Networks Interactive Inc.
While the strikes have impacted adjusted EBITDA, the increase in free cash flow should help to deliver on increased debt reduction to achieve leverage targets. All rating agencies maintain a stable outlook on the current ratings given their confidence that the majority of free cash flow generated will be used to reduce total debt levels. S&P recently noted that they are forecasting leverage (using their adjustments) to decline to the 3.3x area by 2025. The agency’s downgrade threshold for the current ratings remains at 3.5x.
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