Paramount (PSKY.US) $110 Billion M&A Financing Arrives Late: Bond Issuance Delayed by Three Months, May Require an Extra $500 Million in Annual Interest Payments

Paramount (PSKY.US) has spent months pitching investors on the financing bonds for its acquisition of Warner Bros. Discovery (WBD.US), but as negotiations dragged on, the cost of funding has climbed. The $110 billion acquisition is finally moving forward after overcoming litigation hurdles. But with growing concerns about global inflation pushing up borrowing rates, issuing bonds this week rather than three months ago will cost the company hundreds of millions of dollars in additional annual interest. Various estimates put the extra annual interest burden at between $250 million and more than $500 million. For a company that will ultimately carry a massive debt load, this is a thorny problem. According to CreditSights data, Paramount will issue about $42 billion in bonds and $9.5 billion in loans to finance the acquisition. After the deal closes, the company will have more than $87 billion in investment-grade and high-yield debt, ranking it among the largest borrowers in Bloomberg's high-yield bond universe. To keep debt in check, the combined company will need to generate enough earnings, find enough cost savings, and perhaps sell assets to pay down debt. CEO David Ellison plans to cut $6 billion in costs annually, a target Paramount hopes to achieve within three years. But the company's heavy reliance on traditional TV network businesses means significantly boosting revenue could prove quite difficult. "If overall debt expenses rise, that could weigh on cash flow," said Stephen Flynn, an industry research analyst. "That's a problem, and there are other issues that could complicate the planned deleveraging." A Paramount representative declined to comment. Bank of America Corp and Apollo Global Management Inc also declined to comment, while a Citigroup representative did not immediately respond to a request for comment. The three firms are the lead arrangers of the debt deal. Not all investors are convinced Paramount can hit its targets. According to people familiar with the matter, some investors pulled out of the debt deal due to execution risk. Warner's 2022 acquisition of Discovery followed a similar playbook, only to see its credit rating cut to junk last year while also considering a business split which hardly helps the situation. Bleak M&A track record "The history of media mega-mergers is abysmal," wrote CreditSights analysts Hunter Martin and Brian McKenna. The two analysts believe the merger makes strategic sense, "but we are concerned about the overall debt burden and execution risk," especially Paramount's "very aggressive" targets for cost cuts and synergies. On Tuesday, Paramount launched its investment-grade bond offering, a class of debt that has first claim on company assets in the event of distress. The company aims to issue about $30 billion of such bonds. It is also issuing about $12 billion of second-lien junk bonds and $9.5 billion in loans. According to people familiar with the matter, the final cost of financing depends on the outcome of the offering, and the company's annual interest expense could increase by as much as $500 million compared with expectations when the financing plan was about to be finalized in May. They estimate the premium at about 0.5 to 1 percentage point above the rate Paramount would have paid had it issued bonds mid-year. Flynn said the extra interest cost on the bond issuance could be even higher possibly 100 to 150 basis points above what Paramount would have originally paid, or about $450 million to more than $600 million annually. If the financing had been finalized earlier, interest costs could have been lower, but the original plan was disrupted by legal and union challenges to the deal. Those disputes have now been resolved. Meanwhile, the 10-year U.S. Treasury yield has surged over the past three months to its highest level since 2007. Credit spreads the extra yield investors demand to buy corporate bonds relative to Treasuries have also widened, especially for junk-rated securities. Moody's Corporation expects Paramount's bond issuance to fall within that rating range, including the new first-lien notes. The latter, however, received investment-grade ratings from Fitch Ratings and S&P Global, Inc. Against this backdrop, Paramount's Ellison hosted a call with investors on Monday. People familiar with the situation said management received a flood of questions about the cost synergy plan. Some investors said they were skeptical the targets could be achieved and decided not to participate in the bond offering, but the pricing under discussion was attractive enough for some of them to offset those concerns, according to people familiar with the matter. Moody's Corporation on Monday rated the new first-lien and second-lien notes as speculative grade. Moody's rating rationale is based on Paramount delivering on cost synergies, paying down debt, and asset sales, which it believes could significantly deleverage the company in the first few years, citing "the Ellison family's substantial financial resources and its public commitment to reducing leverage" as supporting factors. "High leverage, highly concentrated equity ownership, a plan to weaken the recovery prospects of existing senior unsecured bondholders, and management's mixed track record of achieving financial targets reflect significant governance risk," Moody's Corporation said.