What is going on at Paramount?

Paramount Global ($PARA) is in serious trouble, and now investors and media giants alike are scrambling to split it up. 

Paramount’s financial circumstances were laid out in unquestionable terms on December 5th, after S&P downgraded the company’s debt to BBB-, one rank above non-investment grade or speculative debt. 

In addition to potential erosion in the institutional investor base, the company’s access to “commercial paper” (institutional loans at reasonable interest rates) could be compromised. Commercial debt is a crucial tool used by media businesses to finance films and TV shows, whose budgets can reach into the hundreds of millions long before their release benefits the balance sheet. 

Its rating was lowered "due to the weakening macroeconomic environment, higher peak losses in its direct-to-consumer (DTC) segment, and worsening trends for linear television," S&P Global Ratings wrote.

“Even as the company has outpaced its initial subscriber growth targets for Paramount+, its operating losses have accelerated because of increased content investments, a weaker advertising market, and costs to enter new markets,” the firm wrote. 

“The company’s losses in its DTC segment increased by more than 80 percent in 2022 to $1.8 billion and we estimate they will peak at over $2 billion in 2023 before improving to about $1.4 billion in 2024. The company has not issued guidance for when it expects its DTC segment revenue to reach break-even.”

But that’s not all. Paramount Global, which owns CBS, Paramount+, Paramount Pictures, and Nickelodeon also owes the NFL $2 billion, and it may not pay them anytime soon. 

Unsettled Debts

Despite NFL football maintaining its status as one of the most-watched events on American television, Paramount faces a significant financial hurdle. The rights to air NFL games will cost the company $2 billion next year. S&P credit analyst Naveen Sarma expressed concerns about Paramount's ability to meet this payment, citing a lack of sufficient cash on the balance sheet. 

The company is expected to have slightly over $3 billion after the sale of Simon and Schuster closes in the fourth quarter, but with streaming and production losses increasing, that amount is expected to steadily decline.

Sarma also highlighted uncertainties in Paramount's streaming business compared to industry peers. While Disney and WarnerBrothers Discovery have provided break-even guidance, Paramount's trajectory remains unclear, requiring the studio to generate free cash flow and outline a path to streaming profitability soon.

The broader media landscape, as Sarma noted, is undergoing challenges beyond Paramount. The shift from linear TV advertising, a decrease in pay-TV spending, and a decline in affiliate fee revenue pose financial difficulties for all legacy media providers. 

Golden Parachutes

There’s more than meets the eye at Paramount, which has a complicated ownership structure. 

Paramount’s most important shareholder is based out of a three-story office building, nestled between an indoor ice-skating rink and a Home Depot distribution center in Norwood, Massachusetts. 

The company is Shari Redstone’s National Amusements, Inc., a movie theater operator with 22 cinemas in the U.S. which holds an 80% voting interest in Paramount Global, while only holding a 10% financial interest.

Now like her grandfather Michael Redstone, who opened a drive-in movie theater in Massachusetts in 1948, and Sumner Redstone, who closed it 30 years later, Shari faces a big decision about her future. 

Shari has long been an ally of Paramount CEO Bob Bakish and was reluctant to sell her stake, just like her father, who founded NAI. But these are not the good old days of legacy media. 

At NAI, Shari has the final call on Paramount Global corporate decisions like choosing its CEO and board of directors. She also gets to decide which Paramount assets stay and which go. 

Although Shari has not signaled a sale of her Paramount ownership, last month Paramount Global updated its senior leadership’s golden parachutes in the case of acquisition. If Paramount gets bought and CEO Bob Bakish is ousted, he now stands to receive $50 million — plus benefits. 

And that policy may pay out soon. 

WarnerBrothers Discovery ($WBD) CEO David Zaslav recently engaged in discussions with Paramount Global in New York City, exploring the prospect of a potential merger, according to Axios.

The meeting was a dramatic turn from Zaslav’s statements at November’s New York Times DealBook Summit. "I think we have everything that we need," he said, at least for the near future. WBD, facing a declining stock since the April 2022 close of the $43 billion WarnerMedia and Discovery merger, has been reducing its substantial debt but still has much to go. 

The company could also become a target itself starting in April due to an arcane clause in the merger set to expire two years after the close. "Every public company is technically for sale," acknowledged Zaslav, noting that boards are obligated to consider shareholders' best interests. "But our perspective is, we are positioned for growth next year. To invest in more content. To position ourselves so we have options."

"What is the rush to buy Paramount now?" added LightShed Partners' Rich Greenfield in a recent blog post, acknowledging that it "undoubtedly will be sold." However, he sees this as a buyer's market, asserting, "All signs point to legacy media worsening as we move into 2024, with executives finally realizing that linear TV advertising is never getting better."

The envisioned merger between the two media giants, with a market capitalization of around $29 billion for WarnerBrothers Discovery and just over $10 billion for Paramount, could spark further consolidation within the industry. Zaslav has also involved Shari Redstone, regarding a potential deal for her controlling stake at NAI.

The meeting, held at Paramount's Times Square headquarters, extended over several hours and delved into potential synergies between the companies. One such consideration is the merging of their primary streaming services, Paramount+ and Max (formerly HBO Max), as a strategic move to compete more effectively against streaming giants like Netflix and Disney+.

The specifics of a merger remain uncertain, as it's unclear whether WBD would acquire Paramount Global or its parent company, NAI. However, sources suggest that both options are under consideration. WBD's international distribution footprint could enhance Paramount's franchises, while Paramount's children's programming assets may prove integral to WBD's long-term streaming goals in competition with Disney.

WarnerBrothers Discovery is far from alone should Shari Redstone’s stake in National Amusements or Paramount as a whole hit the market. 

David Ellison, son of Oracle founder Larry Ellison, and his fund Skydance, are working with RedBird Capital Partners to evaluate a majority stake acquisition in NAI, and subsequently NAI’s controlling stake in Paramount Global. 

Ellison, whose father is Skydance's biggest shareholder, "wants a studio," said one Hollywood dealmaker to the Hollywood Reporter. "It's no surprise that David Ellison is interested in a stake in Paramount; he always wanted to be studio boss." Paramount's main studio is valued at $7 billion. 

Despite potential regulatory challenges in an active antitrust climate, several media executives express confidence in receiving regulatory approval for the deal, per Bloomberg. Notably, WarnerBrothers Discovery's absence of a broadcast network could facilitate the regulatory process compared to potential combinations with companies like NBC owner Comcast.

Regardless, Comcast could also take an interest, although President Mike Cavanagh expressed caution about mergers and acquisitions at a recent UBS conference. Cavanagh's statements dampen expectations for an immediate deal, but the cash Disney will pay Comcast for the remainder of its Hulu stake, which is now worth $8.6 billion, is expected to match or surpass Paramount's current $10 billion market capitalization as a whole.

Sum of its Parts, Greater Than The Whole

Paramount’s future depends on the outcome of the potential sale – whether it occurs as a whole entity or whether the company, or a new controlling shareholder at National Amusements, opts to divest its assets piece by piece. 

An influential Paramount investor, Mario Gabelli, has advocated for splitting up the company's assets, which are more valuable on their own than under Paramount, which has an estimated enterprise value of $23 billion. 

Gabelli, whose fund ranks as the second-largest shareholder in Paramount's voting stock after National Amusements, suggested retaining the CBS network while spinning off owned and operated TV stations.

Paramount subsidiary BET Media Group, which includes the BET cable channel, VH1, BET Studios and streaming service BET+, has been on and off the market all year. Earlier this year, media mogul Byron Allen extended an offer of $2.7 billion for the brand, which he has now raised to $3.5 billion. 

Other potential buyers of BET Media Group include BET CEO Scott Mills, a 26-year veteran of the company, and Chinh Chu, a former executive at private-equity firm Blackstone who runs CC Capital Partners, who have discussed a price tag of under $2 billion, Bloomberg reported.

For entities like Skydance and tech giants Netflix, Apple, or Amazon, the Paramount studio stands out as the most coveted asset. Its library, including smash hit Yellowstone and intellectual property, led by showrunner Taylor Sheridan, make it a significant asset. Even Netflix has expressed interest in the Paramount lot in Los Angeles while selling much of its real estate in New York.

In the event of a breakup, WarnerBrothers Discovery might consider CBS, with its news and sports divisions potentially complementing existing assets. This move could bring the NFL and a broadcast network to WBD, addressing a current gap in its portfolio.

Counter to Gabelli, according to estimates by Wells Fargo analyst Steven Cahall, divesting the company's TV networks, including CBS, local TV stations, Showtime, MTV, Nickelodeon, Comedy Central, and Pluto TV, could result in a $13.5 billion equity value. The remaining businesses, encompassing Paramount Pictures, CBS Studios, and production operations, might be valued at $19 billion, or $23 per share. 

But what about Paramount+, which reported a loss of $238 million in the last quarter? The streaming service, a product of the merger between CBS All Access and Showtime, has reached peak losses with no clear path to profitability. In alignment with industry trends, it could adopt a more aggressive bundling strategy. 

Paramount has recently explored bundles with Apple TV+, implemented "hard bundles" internationally to boost adoption, and even formed an alliance with Delta Airlines. Amid concerns about the fate of Paramount+, the breakout success story of the free, ad-supported streamer Pluto TV has been overshadowed. 

Acquired for $340 million in 2019, Pluto now generates billions in annual ad sales while spending a fraction of what its streaming counterparts do on programming, as it has avoided entering the “originals” race.

What’s the Catch?

An NAI transaction may not be the best thing for Paramount's public shareholders. Media analyst Alan Gould of Loop Capital downgraded the company to "sell," saying he doesn't see "any upside for the public shareholders of Paramount." In other words, Shari or the Redstone family "would get a premium" for their stake, while others would not.

“It’s the worst-kept secret in Hollywood and on Wall Street that Paramount is in financial straits and consolidation is inevitable,” he added in an interview with Deadline.

Adding to the confusion, Citi's Jason Bazinet has a "buy" rating on the company. He said the downside in Ellison buying NAI instead of Paramount directly is "tax leakage."

"If Paramount was going to sell the entire company, they might do that with equity. So there would be no check back to the IRS," he says. But if Ellison buys NAI, then sells CBS for cash, for instance, "he'd have to pay capital gains tax [so] there is less value for shareholders,” he said on CNBC. 

But what happens if Ellison can't sell the linear TV assets and ends up running all of Paramount? Would he make better decisions?

Unloading the TV assets would be a complicated process, especially because they continue to generate considerable free cash flow in decline. Securing distribution, however, is a more complicated task than ever for network owners. 

Paramount faces major carriage renewal deadlines with Comcast and Charter, the two largest U.S. cable operators, over the next several months. Carriage rights are negotiated between companies to rebroadcast each other's programming on different cable networks. 

Comcast and ViacomCBS signed a renewal in 2022, but insiders have confirmed the companies are facing another renewal at the end of this month.

Charter, for its part, has drawn a clear line in the sand with programmers. It recently squared off with Disney coming to a deal after a 10-day blackout of ABC, ESPN and other networks. 

In exchange for promoting and bundling streaming services like Disney+, long-established networks like Freeform and FXX were permanently dropped by Charter, a major disruption to the traditional dual revenue stream of pay-TV, in which Disney received an affiliate fee from the cable network and a subscription fee for the premium Freeform and FXX channels.

Linear TV is in something of a limbo state after defining many of the top media companies and making billions of dollars for several decades. Disney recently reversed course after exploring a potential sale of local TV stations and linear TV networks, with CEO Bob Iger concluding that they remain valuable as promotional tools for streaming programming.

For a major cable brand like Nickelodeon, the stakes in the distribution negotiations are significant. Even in a diminished cable TV landscape, the kids powerhouse collects about $1 billion in affiliate fees annually. 

As Nickelodeon brands like PAW Patrol have shown, there is also huge merchandise potential tied to various Paramount properties. Over the summer, Teenage Mutant Ninja Turtles cleared $1 billion in global retail. 

This stemmed from the $180.5 million global gross revenue of Paramount's animated Teenage Mutant Ninja Turtles: Mutant Mayhem movie. Paramount Consumer Products' Turtles theatrical program was its most ambitious yet, counting north of 400 licensees for the film and 1,100 total for the franchise.

Layoffs

In May, the recently combined Showtime/MTV Entertainment Studios as well as Paramount Media Networks, overseen by the division’s President and CEO Chris McCarthy, reduced its headcount by 25%. 

Among the senior-level executives impacted are Jessica Zalkind, SVP, Talent and Series Development, MTV Networks, and Todd Radnitz, SVP of Original Unscripted Series at MTV Entertainment Group and Paramount+. 

Now new reports from the Wall Street Journal indicate that executives are contemplating laying off another 1,000 employees in early 2024, with a current full-time staff count of 24,500 as of the end of 2022.

The prospect of a transaction involving NAI has prompted discussions on the strategic focus of Paramount Global. Wells Fargo analyst Steven Cahall suggests that, if consummated, the best approach would be to swiftly move the distribution assets into discontinued operations, allowing a more concentrated focus on content.

In addition to these strategic considerations, layoffs have recently impacted the ad sales ranks within CBS owned-and-operated TV stations, part of a broader restructuring effort. The net number of departures, including recent hires, totals around 17 people across the markets where the 28 CBS-owned stations are based. 

Paramount Global's advertising business, including CBS stations, has faced challenges, with a 14% decline in ad revenue in the third-quarter earnings report attributed to global advertising market softness and lower political advertising. Despite these challenges, the upcoming election is expected to generate record levels of revenue and reinterest in traditional cable news networks.