Welcome back to Dry Powder. I’m Bill Cohan.

Before we get going here today with my latest pitcher of cold water on a deal for National Amusements Inc., the Redstone family holding company, Axios’ Sara Fischer has broken the news that WBD C.E.O. David Zaslav met with Paramount Global C.E.O. Bob Bakish on Tuesday in New York to talk about a possible merger between WBD and Paramount. Zaz has long expressed interest in owning CBS and Paramount, and now that he runs WBD, the combination of CNN and CBS, and Paramount and Warner Bros., makes strategic sense. But let’s not get too carried away by this potential combination just yet. (The market did not react positively to the news of the Zaz/Bakish meeting; the Paramount stock was down 2 percent on the day, in an overall down market.)

First of all, as I have been reporting for months, Zaz can’t do a deal with WBD until April, at the earliest, or else he risks blowing up the tax-free status of the Reverse Morris Trust transaction that created WBD in April 2022. Yes, these deals take time to put together, often many months, and considering Fischer’s scoop, alongside my partner Matt Belloni’s reporting, it’s now clear that Shari is making a serious play to sell either NAI or Paramount. So if people are starting to kick the tires, I’m not the least bit surprised to see Zaz getting his nose under the hood, too.

But as I lay out below, Zaz could also have a problem similar to the one that Gerry Cardinale and David Ellison are staring down. After all, the last time I checked, WBD has $43 billion of net debt and is itself sitting on the BBB cliff. Adding Paramount’s $14 billion of net debt to WBD’s could push Zaz’s whole enterprise right over the edge. More on this potential problem below…

Unfortunately for Shari, given all the power she has over the company’s fortunes, she also has to take the blame for its troubles. Since her father’s death, in August 2020, when there was no longer any question that Shari was running things at the company, the stock is down 41 percent. (She was probably running things long before his death, but we’ll give her the benefit of the doubt on this one.) Meanwhile, over the same time span, the S&P 500 is up 45 percent. Disney and Warner Bros. Discovery are down too, of course, but when it comes to long-term value destruction, Paramount is truly in a league of its own.

The Ellison/Cardinale idea is presumably an attempt to get control of Paramount Global—and enjoy all those rights and powers at their disposal to, perhaps, shed assets and refocus the company—by buying NAI for far less than it would cost to buy Paramount Global the old-fashioned way. The numbers make clear that the Ellison/Cardinale theory is sound. Shari’s 10 percent economic stake in Paramount is worth about $1 billion these days. As I’ve noted before, a likely bid price would be at least $3.125 billion when you account for a hefty takeover premium (let's say 100 percent, for the sake of round numbers, allowing the Redstones to walk away with $2 billion), plus NAI’s $1 billion in debt and the $125 million preferred that BDT & MSD Partners invested in NAI earlier this year.

That’s a relative bargain compared to the potential purchase price of Paramount, itself. The equity of all of Paramount Global now is around $10 billion, plus there’s $14 billion of net debt—$15 billion of debt, less the $1 billion of cash Paramount has on its balance sheet. You can see why Ellison/Cardinale are focused on getting control of NAI versus buying all of Paramount Global. That’s $3.125 billion versus $24 billion.

That’s clever, I suppose. But if you dig into Paramount Global’s senior notes, a number of much headier risks become clear. And smart guys like Ellison and Cardinale, and certainly their lawyers, would be aware of the cascade of financial obligations that would ensue. Perhaps that’s one reason why Axios reported today that Warner Bros. Discover C.E.O. David Zaslav met with Paramount C.E.O. Bob Bakish earlier this week. Paramount seems to be trying to gin up some competition for itself—and fast.

And then there is the genuine migraine for any buyer of NAI—and especially a financial buyer—lurking in plain sight in the indentures of Paramount Global’s senior notes, filed publicly with the Securities and Exchange Commission. These debt indentures have what are known as “change of control” provisions that apply directly to who owns NAI and what happens when the Redstone family no longer owns, directly or indirectly, more than 50 percent of the voting shares of Paramount Global. In other words, if Shari sells NAI, along with it the voting control of Paramount, the “change of control” provisions in $11.2 billion of Paramount’s $15 billion in debt become applicable.

The Paramount senior notes also have “double-trigger” provisions, meaning that for the $11.2 billion to be immediately redeemable, at 101 percent of face value, upon a change of control, two things have to happen: The voting control of Paramount Global would have to leave the Redstone family, which of course would happen if Shari sells NAI. The second trigger is a bit more of a judgment call: All three credit rating agencies would have to downgrade Paramount Global’s debt ratings to “below investment grade.”

In a change-of-control situation, like the potential sale of NAI, the credit rating agencies would either affirm Paramount’s current credit ratings or change them, either up or down, depending on the buyer. Financial buyers are most vulnerable to ratings agency downgrades because they tend to make acquisitions through empty shell companies, using a minimal amount of equity, whereas a strategic buyer tends to use its company to buy another company. And, until the ratings agencies have opined, this is where reasonable people can disagree. I’m sure Shari’s camp would take the optimistic view: There’s no reason to believe the sale of NAI to a financial buyer would result in a debt downgrade, especially since NAI does not guarantee any of Paramount’s debt; all that’s happening is a new buyer is replacing Shari in the Paramount pilot seat. But others on Wall Street take issue with that thinking.

Skydance may technically be a studio, but many of my Wall Street sources don’t view this potential transaction through the prism of one media company acquiring another. Instead, the potential acquiring entity is essentially a combination of a financial buyer and a production company. My smart private equity sources assure me that, by definition, nearly every time a financial buyer acquires a company, there is a credit-rating downgrade. And the Ellison/Cardinale combination is not different from any other financial buyer just because Ellison runs Skydance. (If Larry, net worth around $125 billion, were buying NAI, instead of his son, the calculus might be different.)

When the ratings agencies downgrade existing corporate debt as part of a change-of-control transaction, they are alerting investors to a higher risk of default under the new owner than the old one. And that’s what the senior note holders in Paramount wanted to guard against by having the change-of-control provisions in their debt indentures. In other words, Shari can’t sell NAI to just anyone she wants, consequence free. She has to sell to someone who won’t cause the rating agencies to downgrade the Paramount debt, or else a whole bunch of it becomes due and payable immediately. That could add a layer of pain that most financial buyers would resist.

In fact, I’m told, this is the inevitable result if the ratings agencies downgrade most, if not all, of Paramount’s $15 billion of debt: The “double-trigger” provision would be met, since the company’s debt is already just one notch away from “below investment grade.” Et voila: an instant poison pill that requires Paramount Global to repay or to refinance $11.2 billion of debt at 101 percent, or a total purchase price of $11.31 billion.

In this case, the putative Ellison/Cardinale thesis of gaining control of Paramount for perhaps something like $3 billion becomes much more complicated. They’ll potentially take on the risk of also having to repay or refinance an additional $11.3 billion of Paramount Global debt. Cardinale and Ellison would probably argue to the ratings agencies that nothing has changed and the debt should not be downgraded. I’m sure Paramount’s senior debt holders would argue precisely the opposite and demand their 101 percent. So all would hinge on the ratings agencies’ decision.

Yes, Ellison and Cardinale could—and would—discuss their plans with the credit ratings agencies in advance of actually doing the deal to get a “sense” of what they would decide. But until the deal is announced, the agencies won’t issue a ruling. Could you imagine being in a position of thinking the credit rating agencies wouldn’t downgrade the debt, and then they decide to do just that? Then you’re suddenly stuck in an $11.3 billion nightmare.

I reached out to Paramount Global for its view on whether a change of control at NAI would trigger the change-of-control provisions in its senior notes, but Paramount declined to answer. I also reached out to Cardinale, figuring the ex-Goldman partner would have had his plethora of lawyers pore over the provisions in the Paramount senior notes indentures—a little light reading—and would have some crisp thoughts. But he did not respond, either. I was directed to a spokesman for Ellison/Cardinale, who also declined to comment.

I admire Cardinale’s chutzpah. He’s an ex-banker who likes to take chances. But I just don’t see how any financial buyer, or someone that reads like a financial buyer, could risk triggering the change-of-control provisions in $11.2 billion of debt—and certainly not in this credit environment. On the other hand, if Shari could somehow interest Apple, or Amazon, or Microsoft, or Google, or Walmart (or Larry) in buying NAI, I would definitely agree with Shari that the chances of a credit downgrade would become more remote. But I don’t see any of those companies emerging anytime soon as the potential buyer of NAI. If Cardinale and Ellison really want Paramount, they may have to pay for it, fair and square.