2023-12-02 06:59:59 ET
Summary
- PARA acquisition chatter is heating up after the company announced modifications to its executive severance pay, as well as talks to bundle streaming with AAPL.
- I believe Paramount is worth multiples of its current valuation in an acquisition scenario, using sum of parts analysis.
- PARA's propensity to bundle services with other companies could be a catalyst for competitive bidding of the company, if an acquirer is perceived to be hostile to PARA's business partners.
Introduction
I have been transparently bullish on Paramount (PARA, PARAA) for a while now, particularly after the market decided to throw the company out the window to around $15 a share for cutting its dividend. The price decline didn’t stop there though, and the shares traded hands almost as low as $10/share. This happened alongside well publicized sell side downgrades , negative Malone comments and a credit downgrade . Despite all this, I have continued to buy. The asset-based margin of safety has given me quite a bit of conviction.
More recently, the adjusting of executive change in control pay and the report of talks to bundle streaming services with Apple has reignited the market’s excitement for Paramount as an acquisition target. Though I think the company could perform just fine on its own, I long have thought the most shareholder accretive scenario would be Paramount proving it can operate profitably over the next year or more, and then packaging itself up to the highest bidder. Consolidation would be good for the industry, and good for Paramount shareholders. Paramount, with its well-rounded media offering would serve as a kingmaker asset to a lucky acquirer.
Margin of Safety
I’ll just put this here to start, so people can see where I am initially coming from on a takeout asset valuation standpoint. I will be valuing each component of the business roughly and individually.
Linear Segment
This segment so far has generated $3.6 billion in adjusted OIBDA this fiscal year. If we assume conservatively that the segment will earn $4 billion this FY, and Byron Allen's 8x EBITDA bid for ABC can be used as a proxy here, this values the segment at approximately $32 billion .
Streaming Segment
How much is a top streaming competitor worth on the open market? The easiest comparison to make is with Hulu , which recently has been in the news for its $27.5 billion floor valuation. Hulu actually has less subscribers than Paramount Plus, with 48 million and 63 million subscribers respectively. Hulu, appears to have higher ARPU though, at around $12 reportedly , whereas I calculated roughly $8.5 per month for Paramount based on trailing 9-month revenues and subscribers. Disney does not provide profitability data on Hulu, but to be conservative, let's assume that Paramount Plus should be discounted significantly. $20 Billion seems like a fair valuation.
Film Segment
This is much more difficult to value, there is the $70 billion 21st Century Fox Acquisition but that included more assets than the movie studio, such as 1/3 of Hulu and certain linear channels like FX. Perhaps Amazon's purchase of MGM Studios provides an appropriate floor valuation of $8.5 billion. This was almost 6x revenue. Perhaps we could assume Paramount Pictures is worth 3x 2022 revenue of $3.7 billion, or around $10 billion. Of note though, this segment has generally not added significantly to total company OIBDA, so benefit to an acquirer would be mostly strategic in nature.
Putting It Together
Adding it all up we get a total of $62 billion estimated takeout value for the enterprise. Currently, the EV is around $26 billion, with a $10.5 billion equity valuation as of Friday's close. Zeroing out debt, the estimated takeout value to shareholders is a market cap of $46.5 billion, or around $70 a share.
Where I Disagree With Wall Street
Analysts have been focusing on full company earnings, and the smaller scale of the company making it unable to compete. Both of these are misguided in my opinion. On the first count, growing out a new business segment (streaming) is expensive, but will hopefully pay dividends in the long term. Analysts have suggested instead licensing away all content to Netflix and becoming an “ arms dealer .” While of course this would make near term profits better, it actually isn’t a new idea. Everyone licensing their content is what allowed Netflix to become the behemoth it is today, and become a major production titan, after initially only participating in distribution.
So it’s adapt or let Netflix dominate. Clearly, Paramount and most of the rest of the industry has chosen the former. Paramount + is subscale but growing quickly with 38% y/y revenue growth as of the MRQ and cash burn is slowing. Pointing to full company earnings is not a very fair way to look at valuation at this at this time and I think sum of parts is much better, as I valued above. Why? They’re creating something that will likely have steady cash flows for many years into the future, but of course takes time to build out initially.
How could someone build out a similar business to Paramount Plus from scratch, and how much would that cost them? 10s of billions? More? It seems like an impossible task. Apple ( AAPL ) is perhaps discovering that it is an impossible task even with their deep pockets. That’s one way to look at where Paramount + gets its value from, replacement value, despite total amount of future cash flows being largely uncertain.
Is Paramount too Small to Compete?
TV media has historically been a very good business for all market participants. It’s packaged and subscription based and you pay for all the services, even those you don’t want. Could we get there with streaming? Probably, and more bundles are starting to come about, most recently with the Paramount / Apple negotiations. I could see a scenario where there is a bundle of almost every major streaming competitor for a reduced price, just like in the legacy business. Size therefore shouldn’t be an issue in the future.
Interestingly, when comparing total revenue to its peers, the difference in total business does not seem so much different although of course Warner Brothers Discovery ( WBD ) and Netflix ( NFLX ) are generating significantly more free cash flow.
Initial Asset Selling Chatter
There has been a lot of chatter about what is going to happen to Paramount’s assets, and I think the majority has been either the competition, or those partial to Paramount’s competitors. The main competitors want their assets, but most of them could only take a small portion. Warner Brothers Discovery ((WBD)) might enjoy having the number one broadcast network, Netflix ((NFLX)) might enjoy a proven movie studio and Comcast ( CMCSA ) might like Showtime to round out their streaming offering. The sale of core assets one by one seems highly unlikely, as this would be a horrendously tax inefficient way to return money to shareholders.
The most shareholder accretive thing of course would be if a company decides to purchase Paramount in its entirety. If parts get spun off, tax considerations may delay the company’s ability to complete a merger. Instead, the acquisition could occur and if there are regulatory issues, parts can be offered to be sold or spun off as a condition of the merger. This, in my understanding would be tax efficient to Paramount shareholders.
Bundling, Partnerships and Acquisitions?
Bundling is great, but is there ever too much of a good thing? Possibly, and perhaps this could be a catalyst for the purchase of Paramount in its entirety. Building on this idea, the two likely acquirers of Paramount are Walmart ( WMT ) and Apple ((AAPL)). Why? Bundling with Paramount has been beneficial for Walmart + and will probably be very beneficial for Apple TV+. Paramount though playing nice with both, does not have to be loyal to any one partner. There are diminishing returns for the partners if more partners exist.
If consumers are getting Paramount + through Walmart, this is going to negatively impact the uptake of Apple TV+ with Paramount. Simply, it might just make more sense to acquire Paramount and kick Walmart out of the equation. Walmart might feel the same way about Apple. Could this lead to a rush to acquire? Maybe. We will have to see what happens. I would think if Paramount ultimately sees itself as an acquisition target, they are being very careful with the negotiations currently occurring with Apple. They can’t give too much, otherwise they could reduce the chance of an acquisition taking place.
Risks
Low Profitability
Since my last article, Paramount has actually had a free cash flow positive quarter and publicly stated peak streaming losses already occurred in 2022. It is yet to be seen if free cash flow positivity can continue even when the industry strikes are no longer active.
High Interest Rates
Also since I last covered the company, Paramount sold Simon & Schuster and should have its near to mid-term maturities taken care of. This should reduce risks in this higher interest rate environment, and hopefully if they ever do need to refinance there will be lower rates. Additionally, if cash flow can remain in the near future, they have the flexibility to pay down longer-term debt at a discount in the current environment.
No Acquisition Could Occur
Buying a company as an acquisition target is speculative in nature, and there is no guarantee this will happen, or if it will pass regulatory approval. Offers for Paramount as a whole could also be much lower than what I estimated via my sum of parts analysis. Additionally, Shari Redstone has a controlling interest in the company and may not necessarily act in best interest of all shareholders, though I believe her to be shareholder aligned.
Conclusion
Despite being very volatile, Paramount has what appears to me to be a fantastic asset-based margin of safety, with a potential $70/share takeout value for its underlying assets even when zeroing out debt. Of course, Paramount may not be looking to be acquired in the near future and could instead have to prove itself via organic free cash flow growth which would take a lot longer to show it deserves a higher valuation. But with the recent news on changes in severance pay and talks of streaming partnerships with Apple, I think it is appropriate to be speculating a little more about a forthcoming acquisition. Partnering with Paramount is well and good, but there's a risk an acquirer could come knocking on the door. This acquirer may or may not be friendly towards the old business partners. Because of this dynamic, I think bidding for Paramount could go from nothing to a whole lot, relatively quickly. As Warren Buffett would say, we'll see what happens.
For further details see:
Paramount: Is Apple Ready To Buy This Streaming Kingmaker?