2023-05-05 11:55:45 ET
Summary
- Although the move was widely expected, Paramount Global sold off because of a drastic dividend cut.
- My personal opinion is that this move was overdue and will create massive value. I present the math within the article.
- The sell-off was exacerbated by a huge short position and relatively small trading float.
Paramount Stock Metrics
Paramount Global (PARA) (PARAA) (PARAP) trades for $16.40, has 652m shares outstanding and its market cap is $10.7B. After the addition of $15.6B of debt, the EV is $26.3B. After the dividend cut (and despite the price slump), the stock yields only 1.2%.
Short interest is very high and has been growing lately to ~15% of shares outstanding. Based on average trading volumes, days to cover are close to 10. This is why some investors were speculating on a short squeeze - now the opposite has happened, as a massive wave of sales has encountered very few buyers, thus exacerbating the crash.
Since 2023 earnings are expected to be negative, the P/E ratio is negative as well. As far as EBITDA is concerned, in Q1 Paramount delivered Adj. OIBDA of $548m and over the past four quarters the total Adj. OIBDA was $2.9B. Therefore the company currently trades for 9x Adj. OIBDA.
That said, all metrics are skewed by the current volatile macro environment coupled with the company's own investment initiatives. Ad markets are experiencing a massive cyclical downturn and the company is deliberately losing money in order to build its streaming subscriber base.
Q1/23 Earnings
Overall, I don't think Q1'23 earnings were that bad.
Revenues were roughly stable overall, as DTC revenue growth largely compensated reductions in the TV Media and Filmed Entertainment segments.
As far as TV Media is concerned, over half of the revenue shortfall was due to less advertising revenue. These revenues are very likely to come back in a better macro environment, and political ads will certainly do their part in 2024.
This segment was also responsible for two thirds of the YoY Adj. OIBDA reduction. The other third was halved due to the release of "Dungeons & Dragons: Honor Among Thieves" on the last day of the quarter (i.e. the results account only for the launch expenses, but for almost no revenues) and half due to higher investments into the nicely growing DTC business.
GAAP earnings were heavily impacted by a non-cash impairment charge on content assets which the company doesn't intend to use anymore. This is a non-issue for me, as these write-offs are simply part of the media business.
Why Did Paramount Cut Its Dividend?
Clearly, a dividend cut is never a popular move.
That said, it can still be a smart move.
On the conference call , Paramount simply stated that it wanted to gain more flexibility in a difficult macro environment. It explicitly said that the move was not intended to make more cash available for additional DTC investments.
However, the macro environment was expected to worsen already in late 2022, yet Paramount kept the dividend. This could mean that its cash flow outlook has worsened.
The dividend reduction will save $500m annually for debt reduction.
According to the company's quarterly report, its weighted average interest rate is 5.13%.
If Paramount pays out $1 of dividends, its shareholders receive only $0.70 after taxes. In contrast, if the same $1 is used to retire debt, it entirely moves from the debt part of the enterprise value into the equity part, and shareholders not only benefit from owning a greater part of the EV, but also from 5.13% income growth.
Moreover, Paramount has $1.6B of debt outstanding which currently pays a fixed interest rate, but will switch to floating rates in 2027. (See 2022 annual report , II-77.) Unless redeemed earlier, in 2027 interest rates will reset to LIBOR plus about 4%. These notes currently cost a bit more than 6%, but could easily go up to about 10% four years from now. The additional interest expense just from these notes would be about $60m. This means that retiring these notes before 2027 should be an absolute priority, but it will require $1.6B of free cash.
A Different Explanation For The Dividend Cut
It is widely known that Paramount is a hodgepodge of assets, many of which are available for sale. For example, on the Q1 call, management was optimistic that it could finally manage to sell Simon & Schuster before the end of 2023 and maybe even for a higher valuation that previously thought.
Clearly, when a company navigates a difficult macro environment, a recession is looming, free cash flow is negative and investment needs are high, even the potential buyers of its assets know how important a cash infusion is. By increasing its flexibility, Paramount is gaining a better bargaining position. You usually get a good deal when you are able to walk away from the negotiation table.
The same is true when it comes to content licensing deals.
This would also explain why management did not clearly state the reason for the sudden u-turn on the dividend: If several potential buyers for Simon & Schuster are knocking at Paramount's door, it would be stupid to publicly announce a weakness.
Ultimately, I believe that shareholders will benefit in many ways from the dividend cut and equity returns should follow.
Is Paramount A Buy After The Sell-Off?
If Simon & Schuster is sold for about $2.5B and the savings from the dividend cut are used to pay back debt, two years from now, Paramount will carry ~$3.5B less debt and likely be cash-flow positive (helped by ~$200m of lower interest expenses).
Further asset sales are very likely.
Its investment phase will be closer to its end. Subscribers will probably have grown nicely from here and DTC profitability will be in sight. Political ads and a better macro environment should benefit the legacy business.
Assuming little Adj. OIBDA growth to ~$3.3B, lower net debt of $12B and a stable and modest multiple of just 9x, the EV would be ~$30B, of which the equity would be ~$18B, or $27/share (+64% from here).
With a better balance sheet and reduced complexity, Paramount Global itself could become an acquisition target. Its content library would be a great add-on for other deep-pocketed players in the streaming business, and its takeover valuation would likely be 2-3x its current market cap.
Therefore, I think there is a solid margin of safety and have initiated a position around yesterday's lows.
For further details see:
Paramount: Dividend Cut Creates Massive Value