Hello!

Welcome to this special edition of The Crossover where I will be sharing some of my thoughts on Paramount’s Q1 earnings.

This is quite the lengthy writeup as it is approaching 4,000 words (with zero help from ChatGPT/AI. 100% Alan!). Don’t want to read all of it?

Well here is the TL;DR

I think that either Paramount will be successful in streaming or will sell the company for 2-3x the current share price. However, the pain could easily, and likely will, get worse in the short run.

Also, I have been pretty busy at the day job so please bear with me if there are some grammatical errors or that not every section is as thought out as I would like!

The Crossover is for entertainment and education purposes solely, and is not investment advice. Additionally, I am long shares of Paramount. 

Showtime!

Introduction

I love FinTwit for several reasons.

Whether it is the fact that it gives me a place to talk about stocks with other passionate investors (which my friends most definitely appreciate) or how it has helped me along my professional career, I am very grateful.

However, being active on FinTwit most definitely has its drawbacks (outside of being addicted to Twitter of course). On FinTwit, there is a lot of noise. Whether it is people celebrating their most successful investments (which seems like they have only been holding for a couple weeks) or tough criticism directed at you when your stock does not do well, it can be tough treading.

It would only be human to find yourself being influenced by the noise and worried about the thoughts of others. Hence, as people like to say, it is important to go touch some grass every once in a while and especially get some space from the bird app before making big investment moves.

I think it was Ron Barron who said on CNBC a few months back how some of his best investments did nothing for years, before delivering outsized returns. Long story short, for you to have the Barron perspective, you need to be very patient and FinTwit can make it difficult.

I think this is my third or fourth attempt at putting together a piece on Paramount's Q1 ‘23 earnings. I needed to restart multiple times as I felt myself too influenced by the perspectives of others and not sharing my thoughts. And look – people have made some phenomenal points about the issues with Paramount which I still re-evaluate often.

However, many of the criticisms in my mind are short term focused and sitting here after a 30% decline last week, I still feel good about the trajectory of the company. In some ways, these tough times could be making the company leaner and meaner for when the tides do turn whenever that is.

I feel that one of my best characteristics is my ability to say I am wrong when I am wrong (although my girlfriend probably would not agree). If I felt I was wrong with Paramount, I absolutely would say it, bite the bullet, and move on. However, I do not think I am wrong and feel good about the long term prospects to see a 2-3x return from the current levels over the coming 3-5 years.

Below, I am happy to be sharing some of my thoughts from the first quarter earnings. As always, I look forward to your feedback, especially the bearish perspectives, as I think a good conversation makes us all smarter!

The Analysis

Dividend Disappointment

First, let’s start with a negative – the dividend cut. This was easily one of the most disappointing parts of the earnings call. Well, not the fact that they cut the dividend – this likely should have been done a couple of quarters ago. Rather, the disappointing part was the communication and way Paramount handled making this decision.

At the end of last year, Paramount had $15.8B in Debt with $2.8B in Cash representing ~5.6x leverage. However, with “peak spending” coming in 2023 and over $800M in FCF burnt in the latter half of ‘22, the leverage figure would continue to get worse. By burning more than $550 in cash this quarter, Paramount finds themselves with $2.1B in cash and therefore nearly 8x levered.

Thankfully, help to the balance sheet is on the way with the sales of Simon and Schuster and BET (which I will touch on in a little bit), but clearly, this was not a company that should have been shelling out $150M+ each of the past couple of quarters.

Specifically, the comments that CEO Bob Bakish and CFO Naveen Chopra made regarding the dividend on the Q4 call and then the Morgan Stanley Conference in March respectively, did not signal a dividend cut was imminent. If anything, just the opposite, which was puzzling to analysts, who did a great job asking questions about it, and investors alike.

Here were their comments:

• Chopra on Q4 call: “And then I think the last part of your question related to the dividend and what I’d say there is that our capital allocation strategy is well aligned with our operating plan. Yes, cash flow will be negative in 2023. That’s sort of the nature of some of the context we’re operating in, including the fact that we’re going to be at peak losses for D2C in 2023, and there are some ad headwinds. But both of those things are short-term in nature. We’re going to start to grow D2C earnings next year, and we do expect the ad market to recover starting in the back half of 2023, which means that we’re going to see significant improvement in OIBDA and free cash flow in 2024. And in the interim, we’ve got a very strong balance sheet that includes over $3 billion of cash on the balance sheet. That’s prior to incorporating any future asset sales. We finished last year with net leverage around 4 times. We don’t have any near-term debt maturities, and we have a $3.5 billion revolver that remains undrawn. So we feel good about that plan both from a growth perspective and from a financial perspective.”

• Bakish at MS: “Yes. Our capital allocation strategy hasn't changed. First is to invest organically in the company. And that's essentially streaming. We're not really negative cash flowing in other parts of the company. We're running those more on the legacy side, kind of leaner and meaner than ever. Then it's delever.And so yes, there's no real change in that. And again, we have the balance sheet to manage through - oh, and then it's the dividend, sorry. And we have the leverage to pull to manage through the negative free cash flow of '23 year.”

These comments do not sound like a management team looking to make a drastic dividend cut in the near future. The quick pivot on this matter signaled panic to Wall St. and was in part as to why the stock lost 30% of its value last week.

While Paramount management has done a great job building Paramount+ into a serious player in the Streaming Wars, they really mishandled the dividend from start to finish.

Simon & Schuster and BET

Paramount is looking to shore up their balance sheet with the sale of some non core assets like Simon & Schuster and BET. It sounds as if Paramount will be able to garner at least the $2.2B that they were planning on receiving from Penguin Random House before the FTC blocked the transaction as the company did $248M in operating income in 2022, representing 16% growth. Management shared that depending on who the acquirer ultimately is, the deal could close by end of year.

Also, when looking at the sale of BET many are projecting that the sale price should be around ~$1.5B. I was actually hoping that we could see this number creep closer to $2B due to the significant interest from deep pocketed acquirers like Byron Allen, Tyler Perry, and most recently Shaq and 50 Cent.

On Monday, however, Puck News broke that bankers are saying that the consortium of assets could demand up to $3.5B citing the significant interest in the asset (over 50 bids). The assets for sale include BET/BET+, BET Studios and VH1. The report also shared that there are financial opportunities that BET could pursue due to being a black owned and operated brand – something that it is not under Paramount – and therefore demand a 20% premium.

$3.5B would be incredible. I would be happy with $2.5B. Let’s say that Paramount is able to sell 80% of it for $2.5B, that means there could be another $2B in cash coming in. Assuming Paramount burns another $1.2B this year, this could mean that by mid ‘24, they could have over $5B in cash on their balance sheet with $15.8B in debt as a FCF+ entity.

Not bad at all. There are quite a few assumptions built into the prior paragraph, so we will obviously see. At the same time, it is important for bulls to recognize that the balance sheet will continue to look worse and worse over the coming year – something that bears will most definitely discuss – until the asset sales go through.

I also think that it is important for Paramount to hold onto a minority stake in BET. Over the coming 10-15 years, there is no reason that a star studded group can’t build a profitable streamer in BET+, give new life to an iconic brand, and create an entity worth 2-3x the size of the one they are buying today.

Paramount+

Easily, the biggest risk factor with this investment as well as the greatest unknown is if Paramount+ can get near profitability by/in 2024. If the ad market does not return or there is higher churn from price increases, we are in trouble.

In the quarter, Paramount had ~$1.5B in D2C revenue and an adjusted OIBDA loss of $511M. It is important to recognize that Showtime, Noggin, BET+, and PlutoTV are included in these figures so it is difficult to know how much of the loss is from Paramount+ specifically. However, it is likely at least $500M.

Looking at the Paramount+ statistics specifically, Paramount+ had 60M subscribers in Q1 ‘23 and $965M in revenue, which breaks down to an ARPU of $5.36. This compares to Q1 ‘22 stats of 39.6M subscribers (20M+ subs YoY) subscribers, $585M (65% YoY growth), and an ARPU of $4.92 (+$0.44) .

Clearly, Paramount+ has strong momentum, and it is encouraging to see ARPU growth, but there is serious work to do.

The Paramount+ Essential Tier will move from $4.99 to $5.99 a month later this year and the Premium Tier which will now include Showtime will go from $9.99 to $11.99. However, let’s say Paramount can grow to 70M subs and increase ARPU by $1.50, which is obviously not a given, this would generate $315M in additional revenue – still leaving $200M in losses that need to be made up.

The Showtime cost cuts which are estimated to be ~$700M annually and a return of the ad market/better monetization of PlutoTV is really needed to make up this gap.

I continue to be a big believer in the offering of Paramount+ and consumers' demand for the product. The CBS hits, Sheridan Universe, Paramount Picture Films, live sports, kids content, is a real offering. Adding in Showtime should also really help with decreasing churn and give more eyeballs to great shows like YellowJackets.

Yellowstone coming to an end I also feel will be a bigger tailwind than people realize. I think the transition to the McConaughey sequel will be seamless and give fresh energy to the show. Additionally, the rights to the show will be on Paramount+, and the clock will start ticking for the Yellowstone original to return from Peacock.

Legacy Revenue

In Q1 ‘23, Paramount’s legacy revenue dropped to ~$5.19B compared to ~$5.64B in Q1 ‘22 representing an ~8% decrease year over year. Affiliate and subscription revenue was relatively even YoY and Advertising and Licensing dropped by 10% and 15% respectively.

The drop in revenue was undoubtedly impacted by the continued exodus of subscribers from the pay TV ecosystem which specifically saw 5.8M subscribers leave the bundle compared to 4.7M in 2021.

Additionally, the difficult ad market had a significant impact on the revenue and bottom line too. By how much? I do not know, but everything points to it being meaningful.

Interestingly, if you look at the difference in adj OIBDA for Q1 ‘22 and Q1 ‘23, the decrease is $238M compared to the decrease in revenue of $452M in revenue. It is nice to see that management is keeping their promise of making that line of business as lean and mean as possible. If the ad market comes back, I think there is a chance that we can even see an adj. OIBDA increase YoY in Q1 ‘24.

The adj. OIBDA from this segment should also benefit from the 25% of staff layoffs at Paramount Media Networks (cable) that the company announced yesterday.

Warner Bros. and Netflix

Speaking of streaming profitability, Warner Bros. had a surprise announcement that they actually achieved EBITDA streaming profitability in Q1 of $50M, compared to a loss of $654M in Q1 ‘22. Some of the other key stats include that they had 97.6M subscribers and global ARPU of $7.48.

I attached the rest of the trending schedules below to check out as there is a lot of good stuff in there:

However, from a Paramount perspective, there are a couple of takeaways.

One, costs can be cut in streaming rapidly. Two, you need around 100M subscribers and an ARPU of $7.50 to achieve profitability – at least if your content/overhead spend is at the same level as $WBD. Problem: Paramount is about 40M subscribers short and $2 of ARPU short.

The ARPU side of the equation should get closer to $7.00, up from $5.32 assuming with the $1 and $2 price increases to the two plans. However, it is clear that the subscriber side of the equation is well short. Cost cutting as well as the likely need to run PlutoTV at profitability in 2024 should also help close that gap.

Side note – if this was my day job, I would totally do a deep dive on $WBD as well and what Zaslav is up to!

I also just wanted to put one more chart from Alex Morris of The Science of Hitting on your radar:

Netflix lost almost $11B in streaming as they built their juggernaut. Paramount will get to streaming profitability while burning less than this. Investing in streaming is expensive, however, if (and the key word is if) you can get to global scale, the profits can be serious too.

Netflix is doing a lot of the dirty work in streaming and creating a playbook for everyone else to learn from. Whether it is pricing strategies in certain countries, password sharing crackdowns, analyzing churn after pricing increases, Netflix is creating a playbook.

Additionally, getting consumers accustomed to paying serious prices for streaming is a big benefit for other streamers as well.

In many ways, I feel that Netflix’s playbook is a reason that Paramount has been able to scale so fast and (trigger warning) efficiently. Paramount has seen what works in which countries, what works in others from their predecessors and have sprinkled their own magic like distribution partnerships with Walmart, Delta, etc.

For intellectual honesty purposes, it is also important to recognize that Netflix was at 158M paid subscribers and $20B in revenue at the end of 2019, however I still think there is a point to be made. Also, taking the other side, Paramount does have several other ways of amortizing the content with their theatrical and legacy businesses.

Paramount has work to do, however, if they can survive the next couple of years from a cash flow/balance sheet perspective, I think they can reap nice profits from streaming over the following years and into perpetuity (or buyout which is more likely).

Putting the Global in Paramount Global

Over the past week, Mario Gabelli has been very vocal about his support for Paramount Global even saying that he thinks we have a $75 stock on our hand in three years. I would settle for half of that.

One point that Mario discusses is how Paramount Global is focused on achieving global scale, and I think often in the US we can forget how there is a world outside of the US.

Interestingly, in the US we often discuss how Peacock and Paramount+ are grouped together as competitors. However, with a global view, you would recognize that these services are very different. Peacock is just a US service while Paramount+ is global. Peacock has 22 million subscribers, Paramount+ 60M. Also, Last year, Peacock lost $2.5B as well and is expected to burn $3B this year. When looking at the amount that Paramount has burnt in their streaming unit ($171M in 2020, $992M in 2021, $1.8B in 2022, and $2B+ likely in 2023), it is interesting to note how Peacock has burnt more in their streaming endeavors just to become a domestic service. If people are skeptical of the push into streaming, a domestic only service is likely even more questionable.

I also wanted to touch on PlutoTV and its fierce competitor Tubi. It looks as if Tubi might have caught PlutoTV when it comes to FAST services, supported by the Nielsen Ratings reports.

From a consumer perspective, this makes sense. Tubi has built a great brand, done phenomenal advertising like their Super Bowl ad, and are investing in original, exclusive programs for the platform. CEO of Paramount Streaming and PlutoTV Founder Tom Ryan has stated that he does not see how originals can be profitable on FAST services. However, since FOX does not have an SVOD service, spending a little extra on making their service a little stronger makes sense.

Yes, PlutoTV might be a close second domestically to Tubi, PlutoTV is global while Tubi is just US.

Pluto is in 25 countries, growing fast (pun not originally intended), and is the first serious FAST player to market in these countries like BlueAnt in Canada or NENT group in the Nordics. Additionally, Pluto is not just resting on their laurels, but have launched with domestic partners in these foreign countries in order to incorporate local offerings and become the leader.

The ad market is a whole lot less lucrative overseas than domestically for FAST services, but we are in the first inning and Pluto’s few runs in the top of the first give them a real lead.

Warren Buffett

“We will see what happens.”

This has been Warren Buffett’s go to line when asked by Becky Quick what he sees in Paramount and why he has scooped up 90M shares of the company. Interestingly, almost every statement Buffett has made regarding Paramount has been negative like calling streaming a bad business.

So then why did he pick up 90M shares? Was this a Ted or Todd pick? Does he think there is an acquisition in play? Do we think he sold his stake in the company this past quarter?

Who knows. What I can tell you for sure is that I am done trying to over analyze his statements. We will see what Buffett decided to do when the 13F drops in just a few days.

Interestingly, even if the 13F still shows Paramount as a big holding by Buffett, this does not necessarily mean that Berkshire still owns the company as they easily could have sold since the Q1 earnings date (after nasty FCF and dividend cut) and therefore after the date that will be reported in the 13F.

Buffett’s lack of enthusiasm does likely imply that he sees an acquisition being made, and he is not too excited about the prospects of a stand a lone Paramount. If I had to guess, he sees that some of the greatest companies in the world like his beloved Apple making content a top priority.

Paramount due to its size and including the fact that they have incredible, beloved content, makes a fold in acquisition to a tech giant almost a no brainer. Apple just announced another buyback, this time of $90B, which is multiple Paramount’s.

If I did have to guess, I would say that Buffett still owns Paramount which will not only be revealed in the 13F, but still being held into Q2. Obviously, I have no idea.

When Buffett was asked about Paramount on Saturday, he laughed and said “and how would you would like to manage my money for nothing. We are not in the business of giving stock advice to people and people can make a lot of money doing that and we don’t think it is something we should give away.”

His statements make it sound like that he has something up his sleeve with Paramount, and it is not something he just wants to give away for free.

He went on to say that people “love to use their eyeballs being entertained on a screen in front of them… but, there are a lot of companies doing it and you need fewer companies or higher prices…”

Buffett also emphasized, it is never good when a company cuts their dividend and that streaming is a bad business. Confusing. And with that, I am officially retiring from over analyzing Buffett’s statements.

Even if he backs out, which I would totally understand because this company is bleeding cash, we still have Gabelli on our side which is serious.

One final note, also, reading the Unscripted book on the Redstone family drama, Buffett was mentioned on multiple occasions displaying interest in Viacom. Very very interesting.

In the words of the Oracle, we will see what happens!

Conclusion

A couple nights ago, as I was watching my favorite athlete, Lebron James defeat the Golden State Warriors, I decided to put the TV on mute and turn on Aryeh Bourkoff’s (LionTree) interview with Jessica Toonkel at “The Future is Everything” Conference by WSJ.

I am always intrigued to hear what Bourkoff has to say as he is one of the most connected power brokers not only in the media space, but the entire world of business. Additionally, he is a close confident of Shari Redstone. While Bourkoff had a plethora of interesting nuggets and tidbits that stuck out to me, there is one quote that I wanted to point out about how companies should be viewing this macro environment:

“Matching long term oriented CEOs with long term oriented capital is what we are supposed to (be) doing and (ultimately) sets up for a different cycle which will come eventually.”

Simply put – I believe that Paramount has a long term oriented executive team and the balance sheet to survive these next few quarters. In the mean time, they are becoming a leaner and meaner company which will benefit them when the cycle turns.

Hopefully, this ultimately will allow them to pull off something that no one thought was possible: Paramount once again becoming a giant in the media space.

Talk soon,

Alan

Disclaimer: The Crossover is not a professional financial service. All materials released from The Crossover are for educational and entertainment purposes. The Crossover is not a replacement for a professional's opinion. Contributors to the Crossover might have positions in the equities in the The Crossover Portfolio or mentioned in the newsletter.