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Netflix buying Warner Bros. Discovery? Cue Stefan from SNL, “this deal has it all: spin-offs, collars, monopoly risks, and more!” We’re breaking it all down for you in this week’s edition…

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Will our favorite HBO Max show Industry…be on Netflix soon!?!

Netflix and Warner Bros. Discovery have entered into a definitive agreement under which Netflix will acquire WBD’s content and streaming/studio business, specifically: HBO, HBO Max, Warner Bros. film & TV studios, and their extensive film and TV library. The deal is priced at $27.75 per share, valuing this part of the business at $72bn in equity (or an enterprise value of $82.7bn, including debt).

Remember our M&A terminology: Netflix’s offer to pay $72bn for the equity is our “offer value”, whereas when we add in net debt, the term changes to “transaction value”.

But, a key point: before the acquisition is to close, Warner Bros. Discovery will spin off its legacy cable and global-networks division (so, assets like CNN, TNT, the Discovery Channel, sports, etc.) into a new, publicly-traded company.

What this means is that Netflix is only buying the streaming + studio + content/IP side of the business, not the cable/networks side. The spin-off happens first, and WBD shareholders receive $23.25 in cash + $4.50 in Netflix stock per share. The stock portion will be subject to a “collar”, which we’ll explain below.

First, what its a spin-off?

A spin-off is when a company separates part of its business into a new, independently-traded public company.

Pretend WBD only owns two assets: HBO and CNN.

Before the spin-off, if you are a shareholder, you own a share worth $10 for a company that has both HBO and CNN.

After the spin-off, you’d get one share of HBO valued at, say, $8…and one share of CNN valued at $2. You still own $10 total of value, comprised of shares in two different public companies. Netflix in this example would only be buying the HBO portion for $8.

Of course, this is a gross oversimplification, since Warner Bros. Discovery has way more assets than just HBO and CNN. Its Global Networks division (cable, news, sports, etc) will now be spun into a new company called “Discovery Global”. This leaves behind the remaining portion of WBD that Netflix is buying, which houses HBO, the studios, and the IP.

What’s the Premium?

Netflix is offering $27.75 per share, a roughly 13-15% premium to where Warner Bros. Discovery stock was trading prior to the announcement (around $24.50).

That’s relatively low by M&A standards. Strategic deals often come with more like a 25-40% premium. What gives?

1. Much of the deal was already priced in. WBD announced the spin-off months ago, and had reportedly already begun a sale process. By the time Netflix formalized its offer, the market had already priced in a potential acquisition.

2. Netflix isn’t buying the whole company. The offer only applies to the slimmed-down, post-spin version of WBD. Fewer assets will be acquired, which compresses the premium paid.

What’s a Collar? How does it work, and why does it matter?

This deal is being done as a combination of cash and stock. The stock portion of the deal ($4.50 in Netflix shares for every 1 WBD share) is subject to what’s called a collar. That means:

• If Netflix’s 15-day volume-weighted average price (VWAP) is between $97.91 and $119.67, WBD shareholders receive a fixed $4.50 in Netflix shares per 1 WBD share.

• If Netflix’s stock falls below $97.91, they receive 0.0460 shares per 1 WBD share.

• If Netflix’s stock rises above $119.67, they receive 0.0376 shares per 1 WBD share.

In short:

• Sellers (WBD shareholders) care about the total dollar value they receive.

• Buyers (Netflix) care about the number of shares they issue (i.e., they don’t want to be diluted).

The collar, structured typically through a combination of puts and calls, helps balance both sides. For the seller, it fixes the cash value paid to sellers within a pre-defined band if valuations stay relatively stable. If prices move outside that band, the collar protects Netflix from overpaying if its stock surges, and from over-diluting its shareholder base if the stock collapses.

So, is it a good deal?

Hold your horses. This deal is by no means done. There will likely be significant concerns from a monopoly standpoint, and it will be interesting to see whether or not this deal passes the proverbial anti-trust sniff test.

But if you were thinking, “man, that offer price looks light,” now you know the full picture. Netflix is not acquiring ALL of Warner Bros. Discovery, just a post-spin version focused on IP, streaming, and studio content. And the market had largely priced in an acquisition, so the remaining upside potential on price was limited.

If it goes through, this is a major move that could reshape the streaming landscape, giving Netflix the legacy media moat and franchise IP it has longed for. I, for one, just hope the quality of our favorite HBO shows is preserved!

See you next week, when we’ll be back to recording our Industry season 3 recaps to get all caught up for Season 4 in Jan!