Netflix Debt Gets a Thumbs Down. The Warner Deal Math Is Worrying the Market.

Netflix shares have fallen since the company announced its offer for Warner Bros. Discovery. ( PATRICK T. FALLON/AFP via Getty Images)

Key Points

• The bond-research company Gimme Credit lowered its recommendation on Netflix’s debt to Underperform.
• Buying Warner Bros. Discovery increase Netflix’s debt-to-Ebitda ratio to over four times from 1.1 times, exceeding the three times typically sought for investment-grade ratings.
• Analysts suggest the acquisition’s immediate impact is negative.

Netflix is stretching itself with its planned acquisition of Warner Bros. Discovery , analysts at Gimme Credit say. The independent corporate-bond research firm lowered its recommendation on the streaming platform’s debt to Underperform on Tuesday.

Netflix has agreed to pay $27.75 a share in cash and stock for Warner Bros, or roughly $72 billion. However, it will also assume nearly $11 billion in debt and intends to take on around $50 billion of new debt to fund the cash portion of the acquisition.

“Considering that the company should produce free cash flow of $9 billion per year or better, debt could be reduced rather quickly,” wrote Gimme Credit analyst Dave Novosel in a research note. “But management noted that while it will prioritize de-leveraging, it will still pursue share repurchases.”

With a potential bidding war against Paramount Skydance poised to drive the price even higher and the continued need to invest in content, Netflix could face a few strained years before planned cost savings kick in.

Under the current deal terms, Netflix’s debt would rise to more than four times its earnings before interest, taxes, depreciation, and amortization from around 1.1 times currently. Companies seeking to maintain investment-grade debt ratings typically try to keep debt to three times Ebitda, or less.

On a conference call early Friday, Netflix Chief Financial Officer Spencer Neumann said that the company is committed to a “healthy balance sheet and our solid investment-grade credit ratings.”

Netflix debt now has single-A credit ratings—roughly the middle of the investment-grade spectrum—from Moody’s and S&P Global, the two leading credit-rating firms. Barron’s has previously noted the planned acquisition could drop those ratings to triple-B, the lowest investment-grade mark.

“The history of media mergers is littered with failed marriages,” Novosel wrote. “We believe there is a good possibility that either the Netflix transaction does not get approved or that Paramount ultimately prevails, given its hefty backing by Ellison family money. If Netflix wins the battle the immediate impact is decidedly negative.”

Netflix shares were down 0.1% in morning trading, while Warners Bros Discovery was up 1.4%.

Write to Adam Clark at adam.clark@barrons.com