Less than a month after Skydance closed its takeover of Warner Bros. Discovery, the market is already signaling it doesn't believe the combined company's numbers.
In short, investors think Skydance overpaid. That doesn't mean the company will post big write-downs anytime soon, or possibly ever. Under accounting rules, that comes down to whether future cash flows support the asset values on its books. Nonetheless, the disconnect between the company's share price and balance sheet is striking.
Skydance's current stock-market value is about $40 billion, excluding warrants worth $1.6 billion. By comparison, Skydance's initial pro forma balance sheet showed about $58 billion of book value, or common shareholder equity. About $57 billion of that was goodwill, almost all resulting from the Warner purchase. Goodwill isn't a salable asset. It's just the ledger entry for paying a premium in an acquisition.
To believe Skydance's books, the goodwill from Warner by itself is worth more than Skydance's entire stock-market value. One of those numbers is bound to be wrong. Skydance paid about $97 billion to buy Warner, including cash and loan settlements. It allocated $55 billion to goodwill, representing the difference between the purchase price and the CNN owner's net identifiable assets.
The goodwill was more than double the $25 billion asset value that Skydance assigned to programming and other inventory, including film and TV content rights. Skydance also allocated $40 billion to other intangible assets, such as affiliate relationships, franchises and brands like HBO and TNT. That adds to a collection that already included CBS and Paramount Pictures, which came with Skydance Chief Executive David Ellison's previous takeover last year.
Financing the deal left Skydance highly leveraged, and the equity market's signals have direct implications for debtholders. Since the Warner deal closed Oct. 6, Skydance shares have fallen 19%. In market terms, the value of the equity cushion shielding bondholders from losses is shrinking.
Skydance added about $57 billion of acquisition-related debt, bringing total debt to about $87.5 billion, according to a Fitch note on Oct. 5 that downgraded the company's credit rating. With that much debt, bondholders own the cash flows, and the equity is more like a levered bet that shareholders someday will get a piece of what's left over.
Fitch, which rates Skydance two notches below investment grade, pegged leverage at 7.8 times the combined company's 2026 earnings before interest, taxes, depreciation and amortization. That implies roughly $11 billion of Ebitda. For context, analysts expect interest expense next year to be about $5.9 billion, according to Visible Alpha.
Skydance has said it expects to reduce annual operating expenses by $6 billion within three years, while targeting a net leverage ratio of 3.0 times Ebitda in 2029 and more than $10 billion of free cash flow by 2030. Fitch said it believes hitting that leverage target would require debt repayments through equity issuances or asset sales, and that free cash flow will likely remain limited initially.
In a statement, a Skydance spokesman said the company "is very comfortable with the way it is considering its assets, its operating business and their performance." It is conceivable that the equity markets overreacted to the warrant distributions on Oct. 13, with the stock falling 22% the next day. Each warrant gives the holder the option to buy one share at $12, and they are out of the money with the shares now trading below $8.
Issuing the warrants shouldn't have caused a large price drop, at least in theory. They went only to holders of Skydance shares that were in the public float before the deal closed. Those shares now represent around 9% of its shares. Yet the market reacted as if every Skydance share deserved a big price haircut.
Either way, there is still a large gulf between Skydance's market value and book equity. Ironically, Warner was in a similar predicament last year. Its stock-market value, too, was languishing at a large discount to book, and even below the value of its goodwill.
Then Netflix and Skydance got into a bidding war, and Ellison prevailed, thanks to money from his father, Oracle Chairman Larry Ellison. Just when it looked like Warner might be due for more write-downs, its shareholders got rescued.
Could Skydance have such a savior? Last week, former Warner director John Malone floated a scenario in which SpaceX becomes a strategic investor in Skydance. Soon after, news reports said SpaceX founder Elon Musk had invested $1 billion in Skydance.
Even with all that excitement, Skydance still trades for a large discount to the goodwill alone. Its first post-deal earnings report is due Nov. 9. Management must show its cost-cutting plan is credible and that the company can generate free cash to pay down debt without having to sell its crown jewels.
Meanwhile, the longer the market discount remains, the more pressure management will be under to show that its balance-sheet values can hold up. For investors, a Musk put is a lottery ticket, not a strategy.
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