As studios spend billions on content and Endeavor scraps its IPO, long-term obligations may weigh down strategic bets.
A ripple of anxiety ran through Wall Street on Sept. 9 when Jay Clayton, chairman of the SEC, warned that corporate debt now stands at $11 trillion, half the annual gross domestic product of the United States. “Should we be cognizant of the growth in corporate debt, who holds that debt and the potential ramifications for our markets and our economy?” Clayton asked. “Of course we should.”
His warning was timely for Hollywood, coming just a couple of weeks before Endeavor Group Holdings CEO Ari Emanuel pulled the plug Sept. 26 on an initial public offering that investors had regarded warily because of his company’s staggering debt of $4.6 billion.
Clayton’s comment also came within hours of activist investor Elliott Management’s disclosure that it had upped its stake in AT&T — initiated with the goal of reversing an acquisitions strategy that has led the telecom giant to borrow massively in order to purchase assets such as DirecTV, which it obtained for $67.1 billion (including debt) in 2015; and WarnerMedia, which it bought for $85 billion in 2018.
These moves may signal a watershed for the media and entertainment business. Debt, which has fueled much of the industry’s growth for the past decade, is being less widely encouraged by shareholders, who are concerned about the amount of money needed to service it. While none of the bankers and analysts interviewed by THR for this article expressed alarm, many said they were concerned about the path ahead.
“It was getting out of control there for a while,” says one top investment banker, who declined to be named. “The entertainment bank market is very competitive and banks have been very aggressive in relaxing certain covenants and lending against certain assets or cash flows where they would not have lent a few years ago.”
Already some banks have paid the price for their over-eagerness, at least when it comes to smaller, production-oriented film companies that have borrowed to cover the cost of prints and advertising (P&A) rather than the “negative.”
In September 2018, Open Road Films declared bankruptcy with $140 million in debt; and in August, Annapurna Pictures agreed to pay its lenders 82 cents on the dollar to resolve $200 million in debt. With a string of flops — including Midnight Sun and Show Dogs from Open Road and Detroit, Phantom Thread and Vice from Annapurna — neither company generated enough revenue to cover its loans.
“When you allow a P&A credit, your only collateral is how a film performs,” says the investment banker. Still, the sums involved with these firms are minor compared to the amounts that have gone to such behemoths as Netflix, Comcast and AT&T. As of June 30, Netflix carried debt of $12.5 billion, Comcast of $108 billion and AT&T of $170 billion, per SEC filings.
Is that too much? No, say most analysts — at least for now. “The cash flow of the major media companies is entirely sufficient to service any debt,” says veteran analyst Hal Vogel. “It’s a different story with these big corporations than production and film companies.”
Wall Street has an established methodology for evaluating whether a company’s debt is out of hand, generally using a calculation that weighs debt against revenue. “It’s best to summarize the leverage [indebtedness] of each of these firms with their net debt/EBITDA ratios,” says Scott Abrams, a professor at USC’s Marshall School of Business, referring to earnings before interest, taxes, depreciation and amortization. The communication services sector, which includes media and entertainment, averages a ratio of 1.9 — that is, its total debt (minus cash on hand) divided by its annual earnings. The higher the ratio, the more worrying. “Generally speaking,” says Abrams, “when the ratio gets to [a multiple of] four or five, that may be cause for concern.”