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No one can say Warner Bros Discovery lacks a flair for the dramatic.
Indeed, it’s fitting that a Game of Thrones spin-off photo sits atop its financial news page. As it splits (or . . . spins off) its studio and streaming business, the company’s creditors were caught in a bond-contract version of the Red Wedding. A red divorce, perhaps.
The central issue is that Warner Bros Discovery, or WBD, already had roughly $35bn of unsecured debt outstanding. And it wants to raise $17.5bn of debt — secured debt — to finance the deal. Because the new debt is secured, new creditors will be able to push in line ahead of current bondholders if WBD’s legacy business files for bankruptcy. Existing lenders were obviously unhappy:
Jamie Newton, head of global fixed income research at Allspring Global Investments, which owns some of the company’s debt, said it was “understandable” WBD tried to push the deal through quickly. “But as a bondholder, that doesn’t mean you have to love it,” he said.
The deal was approved a few weeks ago, but that’s just the start of it. WBD’s plan for all of its existing bonds is so complex that ICE Data — a big provider of bond market benchmarks, especially for high-yield bonds — is excluding the credit from all of ICE’s bond indices for the month of July.
Bloomberg will include WBD in its high-yield indices, but this matters less than ICE’s decision to punt it until things become clearer. About 35 per cent of the high-yield industry’s publicly-reported assets under management follow ICE’s indices as a benchmark. For ETFs — vehicles that often have less discretion over their investments than other types of fund managers — it’s 45 per cent.
The index provider’s decision, announced Thursday, creates some funny side effects.
For one, it’s going to have an effect on the broader high-yield bond market, which includes everything from future rising stars to companies nearing default, plus a smattering of “fallen angels” like WBD.
Many in the market had probably girded themselves for the index addition of $14bn of debt from a large, formerly BBB-rated company. This would constitute about 1.1 per cent of the main high yield benchmark, according to BofA. Now people will just have to wait even longer for the splash.
However, the market will also eventually benefit from the addition of a widely-known and relatively solid company (well, solid relative to the median high-yield market borrower), BofA’s analysts pointed out. Investors will now have to wait longer that too.
ICE’s decision will obviously have an effect on the WBD bonds themselves — and this will probably be negative. WBD bonds had underperformed because of uncertainty about the deal, so when it was announced, spreads over Treasuries tightened (ie they outperformed US debt). But their exclusion means the bonds will probably undo some of that, BofA analysts argue — at least until their inclusion.
This isn’t the first time a company has engaged in this type of bare-knuckled negotiation with creditors, but it is unusual for a non-distressed company — at the time of its spin-off announcement, WBD had an investment-grade rating! That didn’t last long, of course, but still meant the liability-management exercise was an unpleasant surprise for less vigilant lenders.
From CreditSights at the time of the proposal:
We previously viewed . . . a spin-off as highly likely, so this announcement did not come as a surprise. However, we expected WBD to rebalance its capital structure via a more simplified framework (raise new debt at [streaming & studio], upstream to WBD via dividend and/or debt exchange, reduce outstanding bonds via tender with front-end focus). We also thought the amount of debt raised would be notably smaller . . . The path WBD elected . . . is more aggressive and normally seen in stressed, [high yield] situations rather than in [investment-grade] companies.
Now, readers will need to forgive us for not diving neck-deep into the specifics of a six-part consent tender and exchange, where each group was provided a different set of incentives. If it puzzled ICE Indices this much, we probably won’t be able to do it justice. But we do want to highlight a few parts of the offer that analysts found most interesting.
As initially proposed, the consents “strip[ped] most of the restrictive covenants and events of default”, CreditSights pointed out the week of the deal. This matters because the deal almost certainly wouldn’t be allowed under the prior bond documents.
But what really made ICE Indices’ provision tricky was the company’s offer of a “junior lien” to lenders who weren’t able to sell their bonds back to the company, but also weren’t holdouts.
A junior lien bondholder would rank behind the secured debt, and ahead of anyone who declined the deal. At the time of WBD’s original offer, CreditSights said it was “very important” for longer-dated bondholders to get at least some lien on the company, because of the pressures on WBD’s legacy business.
There were also thresholds for participation — if a certain proportion of bondholders didn’t consent to a deal, they wouldn’t be able to tender their bonds, get the consent fee, and be rid of the whole situation altogether.
Beyond that, the documents contained an “anti-boycott” provision, which the company said was to prevent any bondholders from sinking the bridge refinancing. But at the time, this was flagged by analysts as a risk that bondholders wouldn’t be able to take additional action. It will be interesting to see if that is true!
In defence of bondholders who got wrongfooted by the deal, the timeline was very short. It was announced on June 9. and the deadline was — in cinematic fashion — Friday the 13th.