Fitch Affirms Warner Bros. Discovery's 'BBB-' IDR; Outlook Stable

Fitch Ratings has affirmed the 'BBB-' Long-Term Issuer Default Ratings (LT IDRs) of Warner Bros. Discovery, Inc. (WBD), Discovery Communications, LLC (Discovery), and Warner Media, LLC (WM), and Discovery's Short-Term (ST) IDR of 'F3'.

Fitch has also affirmed the 'BBB-' LT IDR of WarnerMedia Holdings, Inc. (WMH). Magallanes, Inc., the original issuer of debt undertaken to fund Discovery's merger with AT&T's WarnerMedia assets, changed its name to WMH after the merger's completion.

Fitch has also affirmed the 'BBB-' senior unsecured ratings for instruments at Discovery and WMH, the 'BB+' senior unsecured ratings for instruments at Warner Media and the 'F3' commerical paper rating at Discovery.

Fitch has also assigned a LT IDR of 'BBB-', ST IDR of 'F3' and a commerical paper rating of 'F3' to Discovery Communications Benelux B.V. (DCB), WBD's European issuer of commercial paper, and a 'BBB-' rating to WMH's issuance of senior unsecured notes due 2026. Finally, Fitch has affirmed and withdrawn the 'F3' ST IDR and commercial paper ratings of Magallanes.

The ST IDR and CP ratings of Magallanes, Inc. are being withdrawn due to incorrect information.

Key Rating Drivers

Merger Synergy Benefits: WBD increased its expected merger-related expense synergies to $4 billion on its 4Q22 conference call, up from its initial $3 billion estimate when the merger was announced. The synergies are driven primarily by operating efficiency improvements and corporate function and technology benefits. Fitch believes the cost synergies are largely attainable, and its rating case assumes a blend of expense realization success for each category, generating an aggregate realization of $3.6 billion by 2025. Neither Fitch nor the company included any revenue synergies in their calculations.

Strong Brands: WBD offers a wide array of brands across multiple distribution platforms including Discovery, Food Channel, HGTV, TLC, Animal Planet, HBO, HBO Max and discovery+ (DTC offerings), CNN, TNT, TBS, Cartoon Network, and Warner Brothers Studios, substantial IP including DC Comics, Harry Potter, Game of Thrones, Lord of the Rings and Friends, and a broad offering of news and sports content. The company also has a library of more than 200,000 content hours.

Market Position: WBD is the world's largest pay-TV company, second largest global media company, and second largest U.S. television company in terms of aggregate share and reach across linear and digital platforms. Its suite of U.S. networks delivers almost 30% of all ad-supported linear U.S. aggregate television and nearly 25% of female viewers, with the top four female-skewing U.S. cable networks.

DTC Offerings: DTC offerings will be critical components of content creators' and aggregators' long-term viability as MVPDs continue shedding subscribers. Areas of focus for DTC providers include growing subscribers fast enough to offset near-term costs content increases, elevated competitive threats, and ongoing linear subscriber declines. While most industry participants are expecting DTC-related losses to peak in 2023, they are experiencing increased pressure to accelerate towards profitability as a faster pace.

WBD has shown an ability to drive its DTC offering toward profitability faster than the industry due to its focus on maximizing revenue and not just subscriber growth while simultaneously managing content costs. For 4Q 2022, yoy DTC losses declined more than $500 million to $217 million. Management expects its U.S. offerings to break even by 2024 and its global offerings to generate approximately $1 billion of EBITDA by 2025. WBD's leadership position across several affinity groups and scripted and unscripted content strength should continue to provide substantial benefits.

Advertising Market: Fitch expects the current U.S. advertising recession will continue into 2023, leading to low-single-digit revenue declines, followed by a recovery into 2024 in line with historical trends. While Fitch expects WBD to navigate the current environment, it does remain concerned about linear media's long-term growth prospects.

FCF Generation: Fitch anticipates FCF will improve over the rating horizon as significant near-term content spend growth should be offset by WBD's global linear and digital distribution platforms, increased scale and resultant expense synergies, and relatively low capital intensity. WBD's lower cost non-scripted content provides an offset to higher cost scripted content. Declining near-term DTC losses will also improve FCF generation.

Capital Allocation: WBD's internal investments will continue to focus on the production and acquisition of content for distribution over multiple platforms. Although near-term DTC internal investments will continue to be heightened by infrastructure costs and content buildout requirements, the company has made significant progress toward profitability.

Management restated their commitment to maintaining their investment-grade rating and Fitch expects the company to use FCF to prepay debt until the company reaches its 2.5x to 3x target leverage range. Fitch expects WBD's Fitch-calculated pro forma leverage will decline below its 4.0x negative rating trigger during 2024 due to debt repayment and EBITDA improvement. Fitch-calculated pro forma leverage declined to 4.5x at Dec. 31, 2022, down from 4.9x at the merger's April 2022 closing due to approximately $7 billion of debt repayments which more than offset a decline in EBITDA.

Parent-Subsidiary Relationship: Fitch links and equalizes the IDRs of WBD, Discovery and WMH based on a strong subsidiary/weak parent approach and the IDRs of WMH and WM based on a strong parent/weak subsidiary approach.

Warner Media, LLC's Structural Subordination: WM is an indirect, wholly-owned subsidiary of WBD. It's approximately $1.5 billion of legacy debt is notched down from the IDR as it is structurally subordinated to all WMH and Discovery debt and is not guaranteed by WBD or any of its subsidiaries.

Derivation Summary

WBD is well-positioned within its rating category with leading positions in scripted, reality-based, news, sports and documentary programming. Its content distribution is diversified across multiple linear and digital platforms and geographically. Despite being the second largest global media company, WBD still lacks the size and diversification of The Walt Disney Company (A-/Stable) and NBC Universal Media LLC (A-/Stable). Although WBD is larger than ViacomCBS Inc. (BBB/Stable), leverage is slightly higher.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Issuer

For FY2023, Fitch expects low single digit aggregate revenue growth. The studios segment is expected to grow mid-single digits due to theatrical release schedule at the studios. The network's decline of low single digits is due primarily to the advertising recession, as the expected improvement in 2H 2023 is unable to offset the high single digit declines in 1H 2023. DTC sees mid-single digit growth due to continued subscriber and advertising growth;

Thereafter, aggregate revenues grow in the mid-single digits annually driven primarily by overall advertising improvement and continued steady DTC subscriber growth as the company expands into new international markets;

Margins benefit from WBD's increased scale, top line improvement, Fitch's expectations of $3.6 billion of cost synergies (with most of the upfront cost incurred in 2022), and slowing DTC infrastructure investment;

Capex remains flat in 2023 as the company finishes its global digital platform buildout and the capex intensity declines to the low 2% thereafter;

Fitch-calculated annual FCF increases to approximately $8 billion by 2025.

No M&A or share buybacks over the near term, in line with Discovery's behavior after the Scripps Network Interactive, Inc. acquisition. Fitch expects share buybacks to resume in 2025 once the company reaches its 2.5x to 3.0x leverage target;

Cash balances and near-term FCF geared toward debt repayment, driving leverage below Fitch's negative sensitivities of 4.0x in 2024.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Fitch-calculated EBITDA Leverage sustained below 3.0x;

A Fitch-calculated cash flow ratio (cash from operations minus capex/total debt with equity credit) sustained above 20%;

Material viewership on platforms that will drive increased advertising and affiliate/subscription fees and enhance revenue diversity.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Weaker operating performance or discretionary management actions causing Fitch-calculated EBITDA Leverage to exceed 4.0x in the absence of a strong commitment to reduce leverage;

A Fitch-calculated cash flow ratio sustained below 12.5%;

Meaningful customer defections to alternative viewing platforms;

FCF pressure from higher programming costs.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: As of Dec. 31, 2022, WBD had cash of $3.7 billion and full availability under its $6 billion unsecured revolver that matures in June 2026, with two 364-day extensions. Discovery and WarnerMedia are co-borrowers. Fitch excludes the $1.5 billion CP program (full availability) given the overlap with revolver availability and the 'F3' Short-Term IDR. Discovery and WarnerMedia are co-issuers under the CP facility.

WBD has redeemable equity balances with put rights of $318 million, including $112 million that has been put to the company. The company is currently in the process of determining a fair market value and expects to finalize the transaction later in 2023.

Fitch estimates WBD's pro forma closing total debt with equity credit to operating EBITDA was around 4.9x. However, WBD reiterated its desire to remain investment-grade after the merger and announced it was tightening its leverage target to 2.5x to 3.0x from its prior 3.0x to 3.5x. To insure adequate liquidity to fund near-term debt repayments, WBD temporarily paused share buybacks in line with its efforts to quickly delever after acquiring Scripps Network Interactive, Inc. in 2018. To facilitate its delevering efforts, the merger's financing was structured to include 25% prepayable debt and $2.8 billion due in 2024. Aggregate near-term maturities are $363 million remaining in 2023, $4.3 billion in 2024 and $3.1 billion in 2025.

Issuer Profile

WBD, formed with the April 2022 merger of WarnerMedia and Discovery, Inc., is the second largest global media company offering significant scale of scripted and unscripted content across a broad range of internal and external distribution platforms.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.