Warner Bros tender paves way for break-up
Warner Bros Discovery’s tender for up to US$14.6bn of bonds as part of a planned spinoff of its streaming business has tipped it into junk territory and left debtholders assessing how best to play the storied media giant.
The proposed break-up, announced on the same day as the liability management plan, would spin out the streaming and studio operations from the network television business. It sparked investor speculation about the eventual capital structure of the two resulting entities.
“You have to take a probability weighted approach. How much debt are they going to have? How much secured debt are they going to have versus unsecured debt? What's the leverage going to be? What's the ultimate leverage target? We don't have a lot of that [information] yet,” John Lloyd, lead for multi-sector credit strategies at Janus Henderson Investors, said on Wednesday.
Though it remains unclear what the exact split of Warner’s onerous debt load will look like, the cashflow-generating legacy business will take on the brunt of the leverage, according to an investor call on Monday. But the proportion of that split will involve fraught discussions between Warner and market participants.
“There’s going to be a dance that goes on over the next few months between the company and the rating agencies, because Warner will be very keen on trying to get the best rating per turn of leverage,” said a portfolio manager.
Questions about the final balance sheet of the two businesses will come on top of concerns that the separation will hurt the company’s overall credit, even though the tender will reduce leverage because many of Warner’s bonds trade at deep discounts.
That fear led the major rating agencies to downgrade Warner’s bonds to junk, which would make it the fourth-biggest fallen angel, according to JP Morgan analysts, who noted that around US$31.5bn of index-eligible debt will fall into high-yield benchmarks.
S&P lowered the rating of the company’s unsecured debt to BB from BB+ on Monday, in addition to last month’s single-notch downgrade, and put the company’s overall rating of BB+ on CreditWatch.
Moody’s followed suit on Tuesday with a downgrade of the bonds and the company to Ba1 from Baa3, putting the credit fully into junk territory.
Already, high-yield investors are trying to game out whether to buy ahead of index rebalancing. But some argue it could prove prudent to wait amid a lack of clarity on the pro forma capital structures of the separated companies and questions about whether the tender will affect investors' ability to buy and sell Warner's debt.
“It is kind of a challenging one. Because of the tender, a lot of the bonds in the market will be locked up when this enters the index. We don’t know exactly how large a name it will be,” said a second portfolio manager.
Doubling up
To prepare for the spinoff, Warner is using the tender to clean up its balance sheet. It is financing the bond buyback with a US$17.5bn secured bridge loan from JP Morgan, which the company expects to refinance with secured debt at both entities.
Dividing Warner’s capital structure in this way will follow how telecoms company Charter Communications organised its highly leveraged balance sheet, having unsecured debt and secured debt to lower its overall cost of funding.
“You can take advantage of the fact that you can get the investment-grade buyer base and the high-yield buyer base,” said the first portfolio manager.
Prime target
The tender offer, which ends on July 9, is split into six pools. Warner is offering to repurchase its bonds at premiums to secondary levels but mostly at prices below par, cutting Warner’s leverage.
Investors are also incentivised to participate in what some describe as a coercive offer, because those who do not will be primed by the new bridge loan.
"Better to tender than be orphaned," said a third portfolio manager.
Even if a tender is not accepted, participating investors will still receive a cash payment or could exchange into a junior lien note that would sit above the company’s unsecured debt and rank alongside the bridge loan, according to the presentation. Tender participants are prohibited from organising a boycott of the new debt from the eventual bridge refinancing.
That anti-boycott language has taken some investors aback who say such actions are the province of private equity-owned companies and not a listed blue-chip business.
“As a high-yield investor you’re used to seeing that from some of the aggressive sponsors. You’re not really used to seeing that in the investment-grade market,” said Lloyd.
The announcement of the spinoff – set for completion by mid-2026 – comes three years after Discovery purchased WarnerMedia from telecoms company AT&T, a deal that was funded with US$30bn of US high-grade bonds.
But since the merger, Warner has struggled with its leverage as it tried to shift away from its profitable but shrinking cable television business into media streaming, an expensive and uncertain undertaking.