Salesforce and Micron Tech among market cap stock movers on Friday

Andrew Bary

Netflix is calling its purchase of Warner Bros. Discovery a transformation deal that will accelerate its growth, but the streaming leader is paying a stiff price for the Warner assets — and taking on substantial debt to do so.

Wall Street isn't thrilled with the transaction. The deal will complicate and change the Netflix investment story from a focused streaming company to a more complex and diversified entertainment business.

Netflix is paying $82.7 billion including assumed debt (roughly $72 billion of equity value) for the film and TV studio assets of Warner Bros., plus HBO Max and HBO. Warner Bros. Discovery will spin off its cable networks business to shareholders before the transaction closes.

That $83 billion price tag works out to about 25 times the $3.3 billion in Ebitda (earnings before interest, taxes, depreciation, and amortization) that Netflix expects the Warner assets to produce in 2026.

In comparison, shares of the leading media and content company, Walt Disney, trades for just 10 times next year's Ebitda. Netflix is choosing to emphasize a post-synergy Ebitda of $5.5 billion annually, and an acquisition multiple based on that of 14.3 times. But it will take the newly combined company three years to achieve those synergies, which could involve lower costs for entertainment programming.

Netflix already trades at a premium to its media peers, at about 30 times next year's projected earnings and 25 times Ebitda, due to its higher growth.

Netflix stock is down 3% at $100 Friday after trading under $98 early in the session. The shares are off 7% this week and down from a high of $124 in October. Netflix's market value is around $425 billion.

Warner Bros. stock is up 3.7% at $25.45 Friday, trading below the deal value of $27.75. That value understates the total value to Warner Bros. shareholders since they will also receive the networks business, which would push the deal's estimated total value above $30 a share.

Investors will be wrestling with the strategic and financial implications of the acquisition, and those issues could create a cloud over Netflix stock, which trades under the ticker NFLX.

"NFLX stock transitions from pure, organic growth elegance to something more complicated. NFLX must now price in regulatory uncertainty, execution and business model uncertainty," wrote Wolfe Research analyst Peter Supino in a client note Friday.

"Investors will continue to wonder about the mix of offense and defense that motivated Netflix to pay an extremely full enterprise value of $82.7B for Warner," Supino continued. He added that with "sound execution," the deal could add value for Netflix shareholders.

In a client note Friday, Oppenheimer analyst Jason Heffstein estimated that Netflix's pro forma debt would rise to $76 billion from the third-quarter level of $16 billion. He's assuming a roughly $9 billion cash balance at closing, unchanged from the third quarter.

The deal is expected to close in 12 to 18 months, Netflix said.

To fund the mostly cash offer, Netflix secured a bridge lending facility to borrow $59 billion from a consortium of banks. That facility roughly equals the cash portion of Netflix's bid for Warner.

The willingness to take on so much debt marks a big change for Netflix, which has been run with low leverage — more like a technology company. Netflix could have issued more equity in the transaction, but presumably wanted to limit the equity dilution to Netflix equity holders.

By Heffner's math, the Netflix pro forma net debt level would be around four times trailing 12-month Ebitda for the combined companies. That's high but manageable for Netflix. Companies seeking to maintain investment-grade debt ratings typically try to keep their debt-to-Ebitda levels to three times or less.

On a conference call early Friday, Netflix Chief Financial Officer Spencer Neumann said that the company is committed to a "healthy balance sheet and our solid investment-grade credit ratings."

Netflix debt now has single-A credit ratings — roughly the middle of the investment-grade spectrum — from Moody's and S&P Global, the two leading credit credit-rating firms. Given all the new debt, its ratings could drop to triple-B, the lowest investment-grade mark.

Neumann said that Netflix will prioritize "deleveraging" after the deal closes but also continue share buybacks.

Netflix co-CEO Ted Sarandos said on the conference call earlier Friday that Netflix is "beyond excited" about the deal, but investors are less convinced about its merits.

Write to Andrew Bary at andrew.bary@barrons.com

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