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Banking
NYCB closes on a $1.05B rescue deal

Source: UBS, Visual Capitalist

New York Community Bancorp (NYSE: NYCB) closed on a ~$1.05B rescue plan from former Treasury Secretary Steven Mnuchin's Liberty Strategic Capital, Hudson Bay Capital Management, and Reverence Capital Partners.

Although NYCB was a winner among regional bank stocks last year, the stock declined nearly 70% this year after the bank disclosed it has identified “material weaknesses” in its loan portfolio thanks to bad risk tracking measures.

NYCB has the highest concentration of commercial real estate loans relative to other banks, with CRE loans making up 52% of total assets.

The rescue package will be funded with 525 million shares priced at $2, with new investors owning ~40% of the company. Another 315 million shares can be exercised with warrants down the road.

The 3 other largest banks listed with CRE loans of more than 25% of total loans are M&T Bank with 40%, Huntington Bankcorp with 33%, and Zions Bank with 29%.

Consumer Credit
CFPB caps late fees as delinquencies rise

The Consumer Financial Protection Bureau finalized a rule that would cap the late fees that banks charge customers after finding that cardholders paid a record $130 billion in interest and fees, as of their latest tally.

As of October 2023, the average credit card utilization was 35%, up from 33% a year earlier, and the share of borrowers with a 30-day past-due missed payment against their credit accounts was 18%.

To help the more than 45 million people charged a late fee on their credit card payments every month, the new rule would cap late fees at $8.

Since interest rates went up in 2022, per capita consumer credit card debt has increased by 10% to a record $6,360. And, according to a new report by FICO, the average credit score across the country has fallen to 717.

Average nationwide credit scores bottomed out at 686 during the housing crisis more than a decade ago, when there was a sharp increase in foreclosures. According to TransUnion’s research, “serious delinquencies,” or those 90 days or more past due, reached the highest level since 2009.

Tech
Amazon goes nuclear

Amazon Web Services is going nuclear. In an effort to find more sustainable and consistent power, Amazon will build a number of facilities next to a nuclear power plant in Pennsylvania.

The first facility will cost approximablte $650 million. Amazon has already paid $350 million upfront to Talen Energy Corporation for the site. Last year, Microsoft also committed to a power purchase deal from reactor startup Helion, which will provide the company power for its datacenters in approximately five years.

"To supplement our wind and solar energy projects, which depend on weather conditions to generate energy, we're also exploring new innovations and technologies, and investing in other sources of clean, carbon-free energy. This agreement with Talen Energy for carbon-free energy is one project in that effort," an Amazon spokesperson said in a statement.

Tech
Apple fined in Europe, China sales decline 24%

According to independent research firm Counterpoint, sales for the iPhone dropped dramatically (by 24%) over the first six weeks of 2024. At the same time, the broader Chinese mobile market itself shrank by 7% during this period.

Apple did make an effort to encourage sales by offering rare discounts on its online store in January. Some online resellers even have been cutting iPhone prices by as much as $180. Regardless, Apple’s market share still ended up falling below 16%, down from 19%.

To make matters worse, the European Union fined Apple about $2 billion, saying it set unfair rules for developers of music-streaming apps.

“Apple’s conduct, which lasted for almost 10 years, may have led many iOS users to pay significantly higher prices for music streaming subscriptions,” the commission said Monday.

The Commission’s probe into Apple stemmed from a complaint filed by Spotify, which competes with Apple’s music-streaming service, Apple Music.

Spotify said Apple’s rules prevented it from communicating with users directly in the Spotify app about how to upgrade, the price of subscriptions and its promotions.

The EU’s guidance for calculating an antitrust fine allows it to increase the baseline calculation for what the fine should be to deter a company from its behavior.

StockGeek News (news.buythegeek.com) reflects the opinions of only the authors who are associated persons of StockGeek and affiliated companies and do not reflect the views of StockGeek or any of its subsidiaries or affiliates. They are for informational purposes only, and are not a recommendation of an investment strategy or to buy or sell any security, digital asset (cryptocurrency, etc) in any account. They are also not research reports and are not intended to serve as the basis for any investment decision. Any third-party information provided therein does not reflect the views of StockGeek or any of their subsidiaries or affiliates. All investments involve risk including the loss of principal and past performance does not guarantee future results.

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Markets
Junk companies issue junk stock

Amer Sports signage on the New York Stock Exchange prior to IPO

For years, CFOs primarily turned to debt markets to raise capital, but rising interest rates have prompted a shift towards equity issuance, observed among companies like Campari or Aston Martin. Thanks to rising interest rates and all-time-high stock prices, selling stock has become a no-brainer for poorly rated companies.

• Last month, Davide Campari-Milano NV sold €650 million of shares and convertible bonds to fund its purchase of the Courvoisier cognac brand from Beam Suntory. The company’s net profit declined and net debt increased last year.

• Aston Martin Lagonda, owned by Formula 1 team boss Lawrence Stroll, used the £216 million ($270 million) it raised in July to push into electrification and pay down some of its debt, which carried a 15% interest rate and incurred a “significant interest cost.”

• The parent company of Arc’teryx outdoor apparel, Amer Sports Inc., raised $1.4 billion on the New York Stock Exchange in February to pay down its loans, some of which had interest rates of nearly 8%. S&P rated the company BB, right on the line of speculative-grade junk.

• For companies moving from private to public, IPOs and secondary sales have raised roughly $50 billion this year, up about 8% from last year’s pace, when issuance hit a more-than-decade low. But, there’s no rush for fast-growing startups to look for public capital just yet.

The bottom line:  

Although more existing public companies are issuing stock, the ones that do have speculative credit ratings and would be unable to finance or sell bonds at the required interest rate. And for fast growing startups, a $4 trillion private-equity warchest means going public to raise money could be pushed off for several more years.

Retail
Macy’s wants to ride the luxury wave

Macy’s (NYSE: M) revealed Tuesday that it plans to shut down one third of its 450 stores in order to shift focus to luxury retail through its Bloomingdales and Bluemercury brands. The news the recent appointment of new CEO Tony Spring, who wants to radically change the company.

• In 2020, Macy’s announced a strategic alignment plan called Polaris, which was meant to stabilize profitability and included a plan to close 125 stores.

• The company did not disclose how many employees would be affected, but did project $50 million of employee termination costs for the fiscal year. Many of the closing stores are near other Macy’s locations, which could allow some workers to transfer.

• The strategic shift could also come from increasing activist pressure to turn around after a series of earnings misses. Activist investor Arkhouse Management made a $5.8 billion buyout bid last December.

“The shopper is still under pressure,” said Spring, who had a four-decade career at Bloomingdale’s before taking the helm of its parent company. “Inflation is still up even if it’s not as high as it was. We’re going to have to fight for our fair share and fundamentally reposition the business for growth.”

The bottom line: 

Macy’s, like other mall-based retailers, has struggled with a long-term shift in consumer behavior that favors online and off-mall shopping. Much of the company’s value is tied up in real estate.

It currently operates 481 Macy’s stores, 33 Bloomingdale’s locations and 159 Bluemercury stores across the US. By closing a further 150 Macy’s stores, the company will be able to prioritize investment in the remaining locations and continue to expand small-format, off-mall locations

Tech
The iCar is dead

After almost a decade of speculation, Apple has officially canned its EV project, codenamed Titan. Since it began taking shape in 2014, the project has seen several bosses come and go. The new decision marks a significant shift in strategy, with Apple redirecting resources towards its artificial intelligence (AI) division.

• Just three weeks ago, Apple pushed the release of its EV out to 2028 after more technoloy setbacks that significantly limited its autonomous driving capabilities.

• Ending the project will affect some 2,000 jobs. The Apple car team employs several hundred hardware engineers and vehicle designers, a potential boon to Tesla. There will be layoffs, but it’s unclear how many.

• Cracking self-driving technology was a major challenge. Apple had road-tested its system since 2017 using a Lexus SUV exterior. The company also tested more secretive components on a track in Phoenix that was once owned by Chrysler. They just couldn’t do it.

• Despite the setback, investors seemed relieved. Apple stock climbed 1% in after-hours trading Tuesday, indicating potential support for the new commitment to AI.

Apple continues to invest heavily in other areas. The company spent $113 billion on total research and development over the past five years, with an average annual growth rate of about 16%.

The bottom line:  

Electric Vehicle sales growth is slowing in the US and around the world. While sales of plug in hybrids and full electric vehicles grew by 62% in 2022, that shrunk to 21% in 2023. Rivian Automotive (NASDAQ: RIVN) has laid off hundreds of workers after missing several sales targets. Amazon has lost nearly $6 billion on that investment.

As for Apple, there are clearly better things for the tech giant to spend its money on than a softening EV market with high barriers to entry.

StockGeek News (news.buythegeek.com) reflects the opinions of only the authors who are associated persons of StockGeek and affiliated companies and do not reflect the views of StockGeek or any of its subsidiaries or affiliates. They are for informational purposes only, and are not a recommendation of an investment strategy or to buy or sell any security, digital asset (cryptocurrency, etc) in any account. They are also not research reports and are not intended to serve as the basis for any investment decision. Any third-party information provided therein does not reflect the views of StockGeek or any of their subsidiaries or affiliates. All investments involve risk including the loss of principal and past performance does not guarantee future results.

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Top Line

• We rate AstraZeneca a Strong Buy based on their long term pipeline and breakthrough cancer treatments,

• AstraZeneca is the most prepared to take advantage of a 10% CAGR in the global cancer treatment market,

• We project double digit sales growth of 14-15% for the next two years,

• Cancer segment sales to grow 20% per year thanks to long term pipeline,

• 20% R&D/Sales ensures faster success than competitors.

Breakthrough Cancer Treatments

Cancer treatments have not changed much in the last few decades – chemotherapy and targeted radiation treatments are the still norm for a devastating disease that is responsible for 1 in 6 deaths worldwide. But ADC’s are quickly changing that.

During the last four years regulators in China, the European Union, Japan, and the United States have approved AstraZeneca’s Enhertu, Imfinzi, and Lynparza for the treatment of prostate, pancreatic, lung, liver, biliary tract, and breast cancers. AstraZeneca’s breakthrough treatments are Antibody Drug Conjugates, or ADC’s, which attack cancer cells with targeted antibodies, without the need for radiation or surgery.

Recently, the Food and Drug Administration (FDA) granted approval for AstraZeneca’s Imfinzi plus Imjudo and platinum-based chemotherapy for the treatment of non-small cell lung cancers and inoperable liver cancer.

The regulatory approvals were milestones for a company in an industry that has spent and lost billions developing novel cancer treatments. Pfizer's leukemia ADC fizzled out in the early 2000s. AbbVie's $5.8B purchase of Stemcentrx and Gilead Sciences' $21B acquisition of Immunomedics have yet to yield any profitable results. 

AstraZeneca faced challenges in 2023, experiencing a 0.7% decline to $67.35. While part of this performance can be attributed to industry headwinds, such as the modest gains in the SPDR S&P Pharmaceuticals ETF, the company's own issues, including slowing sales of its Covid-19 vaccine and disappointing trial data for a lung cancer treatment in October, contributed significantly. AstraZeneca's stock underperformed during the November market rally.

However, a more favorable outlook is anticipated for 2024. Consensus estimates project double-digit earnings growth for the company, approximately 14% and 15% in 2024 and 2025, respectively.

Each year I sit down and think about some of the major themes that investors will focus on as the year progresses. After a year of tech dominance and economic uncertainty, I believe the entire medical industry will see growth and margin expansion this year that can finally be expressed in share prices.

COVID bolstered balance sheets for big companies, and now the test is to see how they continue to deploy their excess capital to treat a rapidly aging population with solid demand for medical procedures, devices, and equipment.

Technology will still play a vital role in the market, though. Companies with robust margin expansion should continue to benefit from increased chip demand and CHIPS Act funds still in distribution.

And with energy demand increasing around the world and growth in newly-freed South American markets, developing markets are a high-risk, high-reward opportunity. Domestic Big Oil is ripe with promising opportunities too, reflected by low acquisition premiums and hightened consolidation in 2023.

Set over a sprawling 1200 acres, Spirit Aerosystems Wichita, Kansas airframe manufacturing facility is the heart of the Boeing 737 production line. Without Spirit, Boeing wouldn’t have airframes for its bestselling midsize commercial plane, but it also may not have the problems that keep coming with it. 

Boeing and Spirit AeroSystems have a long and intertwined history, dating back to the establishment of Boeing in the 1920s. Spirit AeroSystems (SA), initially part of Boeing, became an independent company in 2005 when management spun out Boeing’s facilities in Wichita, Kansas and Tulsa and McAlester, Oklahoma. The complete line of thought on the divestiture has never been clear. 

In a way, Spirit AeroSystems is Boeing’s “nepo baby,” a child (or in this case, a company) which has succeeded almost entirely thanks to its parents' success. 

The relationship between Boeing and SA has evolved into a strategic alliance. SA has played a key role in manufacturing components for the 787 Dreamliner, airframes for the entire 737 lineup, and collaborated on defense contracts and military programs. 

Late last year, Boeing and Spirit renegotiated a long term deal for 737 and 787 airframes, revising terms on the work the supplier is doing that is slated to net Spirit about $190 million in additional sales through 2033.

SA has historically benefited from the credibility and reputation associated with being a key supplier to Boeing, attracting lucrative defense contracts for navy helicopters, drones, B-52 bomber engine retrofits, and the B-2 Spirit Bomber. 

While Spirit has worked on Boeing programs like the KC-46 tanker and the P-8 antisubmarine aircraft, those projects involved building the forward fuselages on the commercial 767 and 737-800 that serve as the platform aircraft for those programs. 

The B-52 work, which Spirit openly pursued for several years, also came as the company pushed on a goal of boosting defense to 40% of its overall business. 

And in the case of the B-52H, all of which were made in Wichita, it comes with the added bonus of bringing the vaunted bomber back home to give it new life through at least 2050. 

“We’re going to come full circle and really help this aircraft finish its lifecycle,” Hein says.

But while Spirit has done a great job fulfilling their new military contracts, they haven’t done a good job keeping up with Boeing’s backlog of 4,420 737 MAX orders, which includes 962 orders for the yet-to-be-FAA-certified 737-10.

Airframe problems

Last weekend, every air traveler's worst nightmare happened, (I have a frequent recurring dream of sitting alone in an airplane when the floor blows out from under me) when part of the cabin of an Alaska Airlines 737-Max blew off at 16,000 feet, depressurising the cabin and sending phones, laptops, and t-shirt flying. 

Over 1,200 Alaska Airlines and United Airlines flights have been canceled in the U.S. following an incident with a Renton-made 737 Max 9 jet that lost a piece of its fuselage mid-flight. The Federal Aviation Administration (FAA) has grounded approximately 170 Max 9 aircraft with similar door plugs, initiating inspections to verify their airworthiness.

Although the cause of the recent failure is still unclear, some aviation experts say the allegations against Spirit are emblematic of how brand-name manufacturers’ practice of outsourcing aerospace construction and eschewing vertical integration has led to worrisome safety issues.

The faulty emergency exit door panels, known as plugs, are fully installed in two steps, in two factories. First by SA in Kansas, and later by Boeing in Washington State.

Boeing has not yet specified whether the problem originated in its own assembly, fuselage supplier Spirit AeroSystems, or elsewhere in its supply chain.

The latest incident raised questions about the quality-control processes across Boeing and its suppliers particularly as a wave of retirements has left them with more inexperienced workers, Bank of America analyst Ronald Epstein wrote in a note to investors. The company extended its required retirement age of 65 to 70 to allow Mr Calhoun, who is now 66, to stay in the top job.

A federal securities lawsuit filed a month before the accident accused Spirit AeroSystems of deliberately covering-up systematic quality-control problems, encouraging workers to undercount defects, and retaliating against those raising safety concerns. 

The lawsuit also includes statements from a former employee at Spirit AeroSystems who allegedly warned company officials about safety problems and expressed concerns about an "excessive amount of defects," suggesting that a major defect could escape to a customer. 

An amended version of the complaint, filed on December 19, provides more expansive charges against the company, citing detailed accounts by former employees alleging extensive quality-control problems at Spirit.

Company executives “concealed from investors that Spirit suffered from widespread and sustained quality failures,” the complaint alleges. “These failures included defects such as the routine presence of foreign object debris (‘FOD’) in Spirit products, missing fasteners, peeling paint, and poor skin quality. Such constant quality failures resulted in part from Spirit’s culture which prioritized production numbers and short-term financial outcomes over product quality, and Spirit’s related failure to hire sufficient personnel to deliver quality products at the rates demanded by Spirit and its customers including Boeing.”

Other analysts have argued that the Federal Aviation Administration (FAA) has failed to properly regulate companies like Spirit, which was given a $75 million public subsidy from Pete Buttigieg’s Transportation Department in 2021, reported more than $5 billion in revenues in 2022, and bills itself as “one of the world’s largest manufacturers of aerostructures for commercial airplanes.”

“The FAA’s chronic, systemic, and longtime funding gap is a key problem in having the staffing, resources, and travel budgets to provide proper oversight,” said William McGee, a senior fellow for aviation and travel at the American Economic Liberties Project, who has served on a panel advising the US Transportation Department. “Ultimately, the FAA has failed to provide adequate policing of outsourced work, both at aircraft manufacturing facilities and at airline maintenance facilities.”

McDonnell Douglas

But blaming the FAA doesn’t cut it. A widely held belief that Boeing’s approach to quality and engineering changed for the worse after the 1997 merger with rival McDonnell Douglas, which was passed down to Spirit, may be a better explanation. “McDonnell Douglas bought Boeing with Boeing’s money,” went the joke around Seattle. 

The merger resulted in internal conflicts, including a major strike, and had lasting impacts on the company's culture.

Boeing's identity as an "association of engineers" during the early decades of the jet age contributed to the company's success. The focus on engineering excellence and innovation, regardless of expenses, and the company's philosophy prioritized design and quality. Engineers had a significant influence on decision-making.

Boeing's white-collar engineering union protested the merger with a 40-day strike in 2000, with union members expressing concerns about the future competitiveness of the company and the need to preserve Boeing's engineering-centric identity.  “A passion for affordability” became one of the company’s new, unloved slogans, as did “Less family, more team.”

During the 1960s and 1970s, Boeing and the U.S. aviation industry benefited from what was considered a "golden age." However, the 1980s brought about changes in the airline industry with deregulation under Presidents Jimmy Carter and Ronald Reagan. Increased competition forced airlines to become more cost-conscious, putting pressure on aircraft manufacturers like Boeing to adapt. 

Boeing, led by CEO Phil Condit, had already initiated a program of cost-cutting, outsourcing, and digitalization. Acquiring McDonnell Douglas offered several advantages to Boeing. Firstly, it allowed Boeing to assert dominance over its oldest rival, marking a victory for the company. Secondly, the acquisition provided an opportunity to gain McDonnell Douglas' valuable military expertise, enabling Boeing to diversify its offerings beyond the volatile commercial aircraft market. The military sector was seen as a more stable source of revenue.

By the 2000’s, the FAA’s regulation of Boeing lapsed as both were under pressure to cut costs. At Boeing, pressure from Wall Street eroded the corporate culture that had defined the company for about 80 years. 

Investigative reporter Peter Robison highlighted the impact of the merger on Boeing's leadership and operational decisions. The company's culture shifted to prioritize schedule, cost, and shareholder value, with a focus on cost containment. The leadership, influenced by executives from McDonnell Douglas, emphasized reducing costs, leading to a culture where ideas were evaluated in terms of dollars, and employees faced performance and time requirements tied to cost reduction. 

Later on, the outsourcing of software-development tasks, including those related to navigation and autopilot, to recent college grads earning low wages raised concerns among experienced Boeing engineers. The engineers earned as little as $9 an hour, and were employed by an Indian subcontractor set up across from Seattle’s Boeing Field.

Stuck culture

The merger gave just enough time for the toxic culture from McDonnell Douglas to seep into the divisions that would later become Spirit Aerosystems. Today, Spirit’s top managers, quality control directors, and executives came either directly from Boeing, or reported directly to those McDonnell Douglas executives before 2005.

Terry George, Senior Vice President Wichita and Tulsa Operations, was a senior manager at Boeing for 22 years before joining the newly spun-out Spirit AeroSystems in 2005, and previously served as Boeing’s manager on the 737 program. Jose Sanchez, Executive Director of Operations, was a Composite Manufacturing Manager at Boeing for seven years before joining Spirit in 2006. 

CFO Mark J. Suchinski also joined Spirit in 2006 as an Aerostructures Controller, and later became the Vice President and General Manager of the disastrous 787 program. His Director of Quality for the 787 program, Brad Davies, joined Spirit in 2007. And Richard Cassube, Director of Quality for the 737 program, joined Spirit in 2006. You get the idea. 

The 737 MAX would become a dark mark on Boeing’s history after it was grounded worldwide between March 2019 and December 2020 following two crashes that resulted in 346 fatalities due to a malfunctioning computer system and poor engine layout. The extended grounding incurred substantial financial losses, estimated at $20 billion in fines, compensation, legal fees, and over $60 billion in indirect losses from canceled orders. 

The plane's original design, meant for a time before machine-aided cargo loading, positioned the aircraft low to the ground to facilitate ground crews hauling baggage. However, as the planes grew larger, their engines also increased in size. Unlike earlier models where engines were hung under the wing, the 737 Max had engines moved forward and upward. The repositioning of the engines caused the fatal crashes of 2018 and 2019.

To address this issue, Boeing implemented the Maneuvering Characteristics Augmentation System (MCAS), a software fix for the underlying hardware problem. However, this software solution was flawed. 

Internal exchanges revealed instances where Boeing's vice president, Mike Sinnett, misunderstood the term "single-point failure" in the context of the MCAS software system implicated in the 737 Max crashes. The assertion that pilots themselves constituted a second point of backup showed a departure from Boeing's traditional practice of having multiple backups for every flight system.

According to pilot and software developer Gregory Travis, the MCAS relied on the wrong systems and sensors, lacking cross-checks with easily accessible information from the plane's sensors. Travis emphasizes that such a flawed system should not have passed scrutiny, stating that none of these issues should have received approval from even the most junior engineering staff. 

The 2023 third quarter included the revelation and fallout of mistakes made in assembling bulkheads on the narrowbody. It followed the second quarter's quality control issue on the tail fin assembly. There also was a week-long strike in early July by Wichita workers who eventually negotiated a guaranteed annual wage increase up to 34% combined over four years.

Spirit still does not know what the ultimate cost of the tail fin issue will be. The company estimates that it will cost $31 million to perform the work on 737s yet to be delivered to Boeing, at roughly $100-150,000 per airplane.

The 787 program seemed to face a new problem every year too. While the first 787 was originally scheduled to be delivered back in 2008, a string of delays and cost overruns meant that deliveries didn’t start until 2011. Fuel leaks, smoking cabins, and fires damaged the plane's early reputation.

Then Suchinski led the 787 program between 2017 and 2019, when improperly manufactured outsourced components led to the aircrafts worst quality control issues. By August of 2020 the FAA had launched an investigation into the aircraft and grounded dozens of airplanes.  

"Boeing has identified two distinct manufacturing issues in the join of certain 787 fuselage sections, which, in combination, result in a condition that does not meet our design standards," a Boeing spokesperson said in a statement.

One problem is that the shims used for filling empty spaces installed on some aircraft weren't of a correct size while a separate issue involved "skin flatness specifications" not being met in certain parts of assembled aircraft.

The plane was grounded again a year later when another outsourced component from Leonardo SpA in Italy was manufactured improperly but installed anyway. Boeing was able to resume deliveries of the 787s after a five-month hiatus - only to halt them again after the FAA raised concerns about its proposed inspection method. 

If Boeing, why not Airbus?

Spirit AeroSystems is also a leading supplier of airframes for the Airbus A350, a direct competitor to Boeing’s 747. And for all Boeing’s faults with the 737 and 787 programs, one would think Airbus would have the same problems. But that is far from reality.

While Spirit AeroSystems did spin out of the Boeing Wichita plant, they also manufacture airframes for Airbus out of the former BAE Systems aerostructures factories in Scotland and France which were major suppliers to Airbus and Boeing, with 80% and 15% of output respectively.

And while Boeing has faced grounded airplanes and countless problems with suppliers, the only major problem with the Airbus A350 was a paint issue found by Qatar Airways and Lufthansa in 2021. Although the “surface degradation” was a major flaw for the A350 program, it was nowhere near as disastrous as the 737 MAX program with its hundreds of fatalities. Importantly, Spirit AeroSystems does not paint fuselages.

Boeing's CEO wants to make changes,

Boeing's CEO David Calhoun has taken steps to shift the company's practices back toward a product-focused approach. Weekly reports from the engineering team and the establishment of a safety committee on the board reflect an effort to prioritize safety and engineering concerns.

The list of to-do tasks for the surprising new chief executive of leading aerostructures supplier Spirit AeroSystems is clear and daunting: stabilize and increase ship sets for Boeing 737 MAXs, fix other commercial programs, repair investor relations, and figure how to make a major debt repayment looming in 2025.

Calhoun has made changes such as merging the 50,000-strong engineering department into a single, integrated global organization—previously, engineers reported to managers inside individual business units—while stressing transparency. The changes have yielded results, which included the disclosure of a quality problem Boeing found and disclosed, in August: incorrectly drilled holes in 737 aft bulkheads made by supplier Spirit AeroSystems.

That change isn’t happening quickly enough for some observers, who would like to do more and do it faster. AeroDynamic Advisory managing director Richard Aboulafia says he isn’t “seeing the progress on culture,” and believes adding more engineers in senior leadership roles would be a beneficial change.

And Spirit’s does too

Despite bad management and a broken culture, Spirit’s new CEO and Boeing veteran Patrick Shanahan wants to change the company dramatically. 

Shanahan was a Trump administration Pentagon official who previously worked at Boeing for more than thirty years, serving as the company’s vice president of various programs, including supply chain and operations, all while the company reported lobbying federal officials on airline safety issues. 

“We are uncertain on the ability of the interim CEO to change the near-term execution challenges facing Spirit, but we do believe [former CEO Tom] Gentile had lost substantial credibility with investors and even within the company and industry,” RBC Capital Markets analyst Ken Herbert said in a note. “The focus for Spirit will remain production execution, potential customer contract renegotiations, and then debt refinance.”

Tom Gentile, former CEO and president of Spirit AeroSystems, faced significant challenges during his tenure, including the Boeing 737 MAX crisis, the impact of the coronavirus pandemic, and ongoing manufacturing issues. Despite efforts to raise Spirit's investment profile and diversify revenue, the company struggled amid industry challenges. 

By last summer, analysts characterized Spirit AeroSystems as the "sick man of industry" and noted its challenges in relation to original equipment manufacturers (OEMs). 

Beyond MAX production issues, the company’s work on Airbus A220 and A350 are in forward loss positions. Corporate debt reached almost $4 billion, including $1.2 billion due in 2025 in what is still a high or rising interest rate environment.

“The path forward is focused on executing on rate ramps, dealing with forward loss contracts, and cleaning up the balance sheet,” Jefferies analysts said.

According to analysts, Shanahan has indicated his key priorities include: 1) boosting Spirit’s production rates; 2) improving supply chain execution; and 3) meeting its customer commitments. “But we assume reaching agreement with Boeing regarding price relief also is a key objective,” Cowen analysts added.

Shanahan “is well regarded and very well-qualified for the job,” the Cowen analysts further said, echoing other analysts. In the Trump administration, Shanahan served as deputy defense secretary, along with a six-month stint as acting defense secretary during Cabinet turnover in the first half of 2019. 

Analysts have said that OEMs, and namely Boeing, cannot allow Spirit to fail as a business. “So, Boeing is apt to be there for additional advances, if needed,” the Cowen analysts said. “But we don’t see Boeing wanting to buy Spirit. Doing so could put upward pressure on wage rates in Wichita, which are lower than in Seattle; and as a large Spirit customer, Airbus could object to a Boeing takeover bid.”

Would Boeing buy Spirit back?

“We’re a public company,” former Spirit CEO and President Tom Gentile said. “People can make offers for public companies, and we would respond to those things. I have no idea what Boeing’s plans are related to something like that.”

Gentile answered the question posed by a Bank of America analyst during the company's first-quarter 2023 earnings call. The question came after Spirit reported disappointing results for the first three months of the year. 

While seemingly farfetched, executives and investors previously had thought Spirit would be rising above the aftermath of Boeing’s MAX crisis and the pandemic’s commercial downturn by now. Instead, the company admittedly is facing another bad year, says Aviation Week.

“While the OEMs are never going to let Spirit fail, it is now in a form of indentured servitude that will severely impact its future cash flow,” analysts at Vertical Research Partners said. “For many investors, Spirit continues to be seen as a geared way of playing a potential recovery at Boeing Commercial Aircraft, and for us that is a risky call.”

Spirit managers acknowledged the difficulty. “Looking ahead, the rework and disruption from the vertical fin attach fitting issue, as well as the risk of lower 737 deliveries, will have a negative impact on free cash flow this year,” Gentile said. “The forward losses taken during the quarter will also result in additional pressure in our cash flows.”

Spirit previously had guided that its free cash flow should be “better than break even” in 2023, but now it is forecasting a $100-150 million cash burn in total by end of year.

But Spirit leaders acknowledged Boeing could seek compensation for its own rework on MAXs already delivered to airline and lessor customers, and Boeing’s rework will be more expensive because more is involved with reworking a finished aircraft.

A host of operating issues

While Spirit acknowledges additional costs, it is relying on increased 737 production to mitigate debt and cash burn. The company aims to raise monthly fuselage production to 38 in August and 42 in October. Despite the challenges, Spirit plans to deliver 390-420 fuselages in 2023. The potential financial impact of Boeing seeking compensation remains uncertain at this time.

On its November earnings call, and prior to the latest incident, the company reported unprecedented demand in the aerospace sector and strong delivery and revenue growth. This demand surge is particularly notable in Spirit AeroSystems' core segment, where they currently have a substantial $42 billion backlog.

The company tightened its relationship with Boeing with a memorandum of agreement ("MOA"), bringing an immediate higher price on the 787 program, resulting in a $350-370 million reversal of forward loss and material right obligations.

The MOA also includes a release of claims and liabilities, funding for tooling and capital, and extended repayment dates on customer financing. It also benefited from higher deliveries, as revenues in 3Q23 were $1.4 billion, up 13%, driven by higher production on various programs.

“We think investors had expected a poor quarter from Spirit given the well-known 737 fin issue, but the expected cost of fixing that has been dwarfed by yet more charges on existing OEM programs, most notably $81 million on the Airbus A220 program,” Vertical analysts noted. “With charges on the 787 and A350 also being called out, Spirit is clearly struggling with a host of operating issues at the moment.”

CEO Patrick Shanahan wisely declined to provide guidance for 2024. 

Although it’s hard to speculate what will happen to Boeing’s existing aircraft, Spirit’s fuselages aren’t going anywhere. But if Spirit AeroSystems and Boeing can’t address their mutual challenges, the 737 may stay grounded far longer than anticipated.

Once the largest company on the planet, U.S. Steel (X) was established in 1901 when the steel companies of J.P. Morgan and Andrew Carnegie merged. The company played a vital role during the 20th century, enduring the Great Depression and contributing to manufacturing efforts during World War I and II.

However, the oil and trade crises of the 1970’s and the Asian currency crisis and trade agreements of the 90’s diminished the company's influence and forced it to restructure.

“That company peaked out in 1916,” longtime steel industry analyst Charles Bradford told CNN in August when the bidding started for U.S. Steel. “It’s been downhill ever since. Peak output was in the 1970s. It’s done nothing for decades.”

The company’s peak employment of 340,000 came in 1943, during World War II, when it played a critical role in the Allied forces’ war efforts.

Steel output peaked in 1953, when the company produced 35.8 million tons of steel while steelmakers in Europe and Japan were still struggling to recover from the war. Last year, U.S. Steel shipped only 11.2 million tons of steel from its US operations and had just under 15,000 US employees.

In 1959, U.S. Steel was challenged when half a million steelworkers began one of the longest and most damaging strikes in U.S. history. President Dwight D. Eisenhower intervened using the Taft-Hartley Act to compel workers back to their jobs, citing concerns for national security. 

The strike marked a turning point for U.S. Steel and the steel industry. Its aftermath saw the company's slow decline and eventual removal from the S&P 500 index in 2014. Valued at $3.8 billion, a 30% drop from 1959, U.S. Steel's fall reflected broader shifts away from heavy manufacturing in the U.S. economy. 

Later trade protections under the Reagan, Clinton, and Bush administrations tried unsuccessfully to protect domestic steel production and keep U.S. Steel afloat. The failure to adapt to newer technologies and changing customer preferences, which favored competitors like Nucor, contributed to U.S. Steel's decline. 

Cleveland-Cliffs Rejected

Price increases and trade protections did little to protect the broader domestic steel industry from consolidation and foreign competition, and in 2023, U.S. Steel quietly began considering bids for the entire company. 

By August, the company had rebuffed a takeover bid from rival Cleveland-Cliffs Inc. (CLF), which sought to create one of the world's largest steelmakers. The proposed cash and share deal, valued at approximately $7.25 billion, reflected a 43% premium at the time.

Cleveland-Cliffs produced 16.8 million tons of steel in 2022, while U.S. Steel produced 11.2 million tons at its US operations and another 3.7 million tons in Europe. The deal fell apart after Cleveland Cliffs executives refused to sign a company-wide non disclosure agreement. 

Shortly after, Esmark Inc entered the contest, with an all-cash public offer of $7.8 billion, or $35 per share. Esmark, which has a number of steel interests in its portfolio, noted in its statement that the deal would be “subject to regulatory and antitrust clearances.”

Esmark majority owner and chief executive James Bouchard said in an interview that his steelmaker, which does not publicly report its earnings, has cash for its $7.8 billion bid for U.S. Steel Corp (X.N) sitting in his bank account. "I got $10 billion in cash in my bank account," Bouchard said. He did not provide more details to verify he has access to the cash.

Nippon Outbids

After a few more months of silence, Japan’s largest steelmaker Nippon Steel extended an offer of $14.1 billion or $55 per share, which U.S. Steel proudly accepted. The deal places an enterprise value of $14.9 billion for U.S. Steel. 

The proposed deal would make U.S. Steel a wholly owned subsidiary of Nippon’s North American division, and its finalization is expected in the second or third quarter of 2024, pending regulatory approval. 

“We are confident that … this combination is truly best for all,” said U.S. Steel CEO David Burritt. “Today’s announcement also benefits the United States — ensuring a competitive, domestic steel industry, while strengthening our presence globally.”

“U.S. Steel’s best days are ahead, together,” Burritt told investors at the conclusion of a conference call Monday.

According to estimates by the World Steel Association industry group, the total production capacity of the combined entity would be nearly 59 million metric tonnes, pushing it up to third place among global steel producers. 

Politicians on both sides of the aisle including Sen. John Fetterman and Sen. J.D. Vance reacted negatively to the proposal, citing national security concerns and fearing for the health of the dwindling manufacturing industry. 

But Harvard educated Nippon Steel President, Eiji Hashimoto, framed the acquisition in geopolitical terms, envisioning a dominant force in the global steel sector to compete with China.

Hashimoto emphasized the "sufficient economic rationality" of the deal and his desire to establish a comprehensive global network for the steel industry's evolving global landscape. According to a joint press release, the transaction “combines cutting-edge technologies…to advance innovation and deliver high-grade steel products…to customers around the world.”

Hashimoto has overseen Nippon Steel with an iron fist, forcing customers to pay more on their low margin orders, including its biggest customer, Toyota. 

Hashimoto would later sue Toyota, alleging that Toyota had used stolen technology for a steel material in electric motors, seeking damages equivalent to $176 million from Toyota and Toyota supplier Baoshan Iron & Steel, a subsidiary of China Baowu Steel.

Last year, Toyota said it would refrain from pushing suppliers for lower prices as the industry grappled with skyrocketing energy and materials costs. Despite initial losses when Hashimoto began his tenure in 2019, the company rebounded to generate a profit of $5.1 billion last year under his leadership.

The deal's political complexity will intensify as it faces approval from the Committee on Foreign Investment in the United States (CFIUS). 

National Security and The “Steel Crisis”

When Cleveland Cliffs made its offer in August, the United Steelworkers union vowed only to support an offer from another unionized American steel company. The union, which has 11,000 members at U.S. Steel, attacked the Nippon Steel deal.

“To say we’re disappointed in the announced deal between U.S. Steel and Nippon is an understatement, as it demonstrates the same greedy, shortsighted attitude that has guided U.S. Steel for far too long,” said USW President David McCall. 

“We remained open throughout this process to working with U.S. Steel to keep this iconic American company domestically owned and operated, but instead it chose to push aside the concerns of its dedicated workforce and sell to a foreign-owned company.”

In a letter to Treasury Secretary Janet Yellen, Republican senators urged the Committee on Foreign Investment in the United States (CFIUS) to block the sale, alleging that Nippon Steel’s allegiances lie with a foreign state. 

“[CFIUS] can and should block the acquisition of U.S. Steel by NSC, a company whose allegiances clearly lie with a foreign state and whose record in the United States is deeply flawed,” Sens. JD Vance (R-Ohio), Marco Rubio (R-Fla.) and Josh Hawley (R-Mo.) wrote.

Democrats are also critical of the acquisition, with concerns about its impact on the American steel industry and national security. 

“Today, a critical piece of America’s defense industrial base was auctioned off to foreigners for cash,” said Ohio’s Republican Senator JD Vance, in a statement. “I warned of this outcome months ago and will oppose it in the months ahead.”

The statement is ironic for Senator Vance, who wrote about the earlier acquisition of Armco by Kawasaki in his 2016 memoir “Hillbilly Elegy.” It was as though “General Tojo himself had decided to set up shop in southwest Ohio,” Mr. Vance recalled. Then the locals realized new owners could invest in their decaying community.

“The Kawasaki merger represented an inconvenient truth: Manufacturing in America was a tough business in the post-globalization world,” Mr. Vance wrote in his book. “If companies like Armco were going to survive, they would have to retool. Kawasaki gave Armco a chance, and Middletown’s flagship company probably would not have survived without it.”

Pennsylvania Democrat Sen. John Fetterman – who lives in and was previously mayor of Braddock, PA, where one of U.S. Steel’s first steel plants still operates – slammed the deal and promised to work to block the transaction.

“It’s absolutely outrageous that U.S. Steel has agreed to sell themselves to a foreign company,” Fetterman said in a statement. “Steel is always about security – both our national security and the economic security of our steel communities. I am committed to…block this foreign sale.”

Rep. Ro Khanna (D-Calif.) told The Hill in an interview that part of the corporate intention behind the deal is to boost Japanese exports of high-end steel while shifting U.S. production to lower-end steel in states where companies don’t have to pay union wage rates.

“What you’re going to allow Nippon to do is eliminate union jobs in Pennsylvania, Michigan, Ohio; send those jobs down South; move to mini-mills and get rid of blast furnaces; and have the blast furnace jobs…come from Japan.” Khanna said.

Neither party has mentioned moving or closing production facilities in the United States or laying off workers. A joint statement said “[Nippon Steel] has long admired U.S. Steel with [a] deep respect for its…talented workforce…we are committed to honoring all of U.S. Steel’s existing union contracts.”

But claims of the imminent demise of America’s domestic steel industry and threats to national security at the hands of “unfair” imports and deals are not new. In fact, they sound just like claims made by politicians and the press during the 1999 “Steel Crisis.”

Significant protectionist measures were proposed, and both President Clinton and Bush put significant tariffs in place to prevent foreign dumping on the domestic steel industry. 

However, a closer examination reveals that there was no steel crisis. In 1998, domestic steel mills shipped 102 million tons, the second-highest annual total in the preceding two decades. Moreover, 11 of the 13 largest steel mills were profitable in 1998, collectively earning over $1 billion. Steel imports continued to fall in 1999 and domestic productivity improved. 

Instead, the influx of steel imports could be attributed to the Asian economic crisis, resulting in a collapse in demand for steel in the region and a realignment of currency values that made foreign steel more price competitive in the United States. 

Global Steel Production

China and Chinese companies have become dominant players in global steel production, contributing approximately 54% of the nearly 2 billion tons produced annually worldwide, as reported by the World Steel Association. State-owned Baowu Group in Shanghai, China, alone produced nearly 120 million metric tons of steel in 2021. Baowu is still being sued by Nippon Steel.

In comparison, the combined steel production of Cleveland-Cliffs and U.S. Steel in the same year amounted to almost 33 metric tons. A combined entity would have been in the top 10 global steelmakers, albeit at the lower end of the list. The United States currently holds the fourth position in global steel production, behind China, India, and Japan.

In 2023, steel prices stabilized as countries sought alternative supplies to replace losses from the Russian and Ukrainian markets. Furthermore, China, the world's largest steel producer, lifted trade limitations associated with its previous zero-COVID policy. This change enabled China to utilize its steel production more freely on the global market, although efforts to reduce production persist.

The construction sector, which played a pivotal role in driving steel demand in 2021, is expected to experience a slowdown due to the phasing out of subsidies, increased uncertainties, rising prices of essential commodities, and a projected increase in borrowing costs. This deceleration in residential construction demand is anticipated over the forecast period.

To offset the cooling construction market, the machinery demand is projected to recover. Post pandemic, machinery demand saw growth as industrial activities picked up. Automation is becoming a significant area of investment, addressing labor shortages and mitigating risks of potential future shutdowns. Additionally, the agricultural machinery sector is expected to gain momentum amid the looming food crisis caused by Russia's invasion of Ukraine, with countries aiming to enhance productivity and yields.

The steel industry is increasingly focusing on sustainability, decarbonization, and circular economy practices. Escalating emissions permit costs, societal pressure, and government regulations are compelling carbon-intensive steel manufacturers to seek solutions for reducing their carbon footprint. 

Sustainability is poised to become a pivotal trend in the industry, with companies anticipated to invest in recycling scrap metal waste to diminish the environmental impact of their production processes. 

“We are excited that this transaction brings together two companies with world-leading technologies and manufacturing capabilities, demonstrating our mission to serve customers worldwide, as well as our commitment to building a more environmentally friendly society through the decarbonization of steel,” NSC President Eiji Hashimoto said.

Financial Performance

United States Steel (U.S. Steel) holds a strong market share, contributing to robust profit margins, Return on Invested Capital (ROIC), and Net Operating Profit After Tax (NOPAT). The firm's market share provides a competitive advantage, allowing it to achieve operational efficiency and impressive financial figures. 

U.S. Steel is expected to benefit from a favorable labor environment and a potential interest rate shift. Lower wage demands may lead to increased profit margins, and a shift in interest rates could enhance U.S. Steel's borrowing capacity, enabling aggressive expansionary capital expenditure (CapEX) cycles.

The company has consistently outperformed earnings expectations, with its third-quarter results revealing a revenue beat of $170.33 million and an earnings-per-share beat of 25 cents. U.S. Steel's business segments, including flat-rolled, tubular and U.S. Steel Europe have shown positive progress. 

Mini Mill activities, especially after the full acquisition of Big River in 2021, contribute to revenue diversification. However, the tubular business remains a strong performer, delivering EBITDA margins above 32% for the past five quarters.

U.S Steel’s Mini Mill’s are smaller mills that can be built around the country for less cost than a traditional mill, and provide state of the art finishing capabilities for U.S. Steel’s raw products. 

While U.S. Steel faces challenges with idled facilities like Granite City, Lorain, and Lone Star, these may not significantly impact the stock price due to their prolonged idle status. Looking ahead to 2024, U.S. Steel anticipates $200 million in new income from investments in the Big River Steel mill and steel products suitable for electric vehicles (EVs). The management expects the baseline net income to remain around $2 billion in 2024.

A Bad Economic Impact

Fears about an overreliance on Chinese production capacity during the pandemic has led to closer coordination among U.S. economic allies, especially in the Asia-Pacific region, notably Japan, South Korea and Taiwan.

The economic fallout from the pandemic has been catalyzing some longer-term tailwinds away from uniformly globalized production and toward increased domestic capacity, which may be another reason the U.S. Steel sale isn’t sitting well with lawmakers.

“We will unapologetically pursue our industrial strategy at home,” national security adviser Jake Sullivan said in a programmatic speech earlier this year on U.S. economic strategy.

Sullivan qualified his embrace of “industrial policy” — a doctrine of more centrally planning the economy that fell out of fashion in the mid-1970s — by saying Asian allies and international partners would be a central part of this shift in strategy.

“Through our trilateral coordination with Japan and Korea, we are coordinating on our industrial strategies to complement one another, and avert a race-to-the-bottom by all competing for the same targets,” he said.

But imposing barriers against steel imports carries a significant economic cost for the United States. While the domestic steel industry may enjoy temporary benefits, millions of American workers and tens of millions of consumers will face negative consequences. 

Consumers are likely to pay more for products made with steel, such as household appliances, trucks, and cars, by artificially propping up the domestic price of steel through trade barriers. 

According to the Cato institute, If protectionist measures raise the average price of steel mill products by $50 a ton, Americans could face the equivalent of a $6 billion “tax” on the more than 120 million tons of steel consumed annually. 

Steel protection measures also pose a considerable burden on major manufacturing sectors that heavily rely on steel as a primary input. Sectors like transportation equipment, fabricated metal products, and industrial machinery and equipment, employing a total of 3.5 million production workers, could be adversely affected. 

Production workers in manufacturing industries using steel as a major input far outnumber steelworkers, with a ratio of 20 to 1. Companies like General Motors, a major consumer of steel, have warned that anti-dumping duties or harsh policies on steel imports could negatively impact their ability to compete globally.

The construction industry, accounting for approximately 35% of domestic steel consumption, is one of the largest direct consumers of steel. Tariffs on imported steel would result in higher prices for homes and commercial office space, jeopardizing the jobs of thousands of construction workers. 

When considering non-manufacturing industries, the 8 million employees in steel-using sectors significantly outnumber the fewer than 200,000 steelworkers, with a ratio exceeding 40 to 1.

Smaller companies engaged in manufacturing metal products are especially vulnerable to rising import prices. These firms, typically purchasing on the spot market rather than long-term contracts, are the first to feel the impact of higher steel prices. 

As many of them also serve as suppliers to larger corporations, they are less capable of passing on increased steel costs in the form of higher prices for their final products.

U.S. Steel closed at $48.35 per share on December 26th, indicating the market predicts a roughly 58% chance of a merger.

Paramount Global ($PARA) is in serious trouble, and now investors and media giants alike are scrambling to split it up. 

Paramount’s financial circumstances were laid out in unquestionable terms on December 5th, after S&P downgraded the company’s debt to BBB-, one rank above non-investment grade or speculative debt. 

In addition to potential erosion in the institutional investor base, the company’s access to “commercial paper” (institutional loans at reasonable interest rates) could be compromised. Commercial debt is a crucial tool used by media businesses to finance films and TV shows, whose budgets can reach into the hundreds of millions long before their release benefits the balance sheet. 

Its rating was lowered "due to the weakening macroeconomic environment, higher peak losses in its direct-to-consumer (DTC) segment, and worsening trends for linear television," S&P Global Ratings wrote.

“Even as the company has outpaced its initial subscriber growth targets for Paramount+, its operating losses have accelerated because of increased content investments, a weaker advertising market, and costs to enter new markets,” the firm wrote. 

“The company’s losses in its DTC segment increased by more than 80 percent in 2022 to $1.8 billion and we estimate they will peak at over $2 billion in 2023 before improving to about $1.4 billion in 2024. The company has not issued guidance for when it expects its DTC segment revenue to reach break-even.”

But that’s not all. Paramount Global, which owns CBS, Paramount+, Paramount Pictures, and Nickelodeon also owes the NFL $2 billion, and it may not pay them anytime soon. 

Unsettled Debts

Despite NFL football maintaining its status as one of the most-watched events on American television, Paramount faces a significant financial hurdle. The rights to air NFL games will cost the company $2 billion next year. S&P credit analyst Naveen Sarma expressed concerns about Paramount's ability to meet this payment, citing a lack of sufficient cash on the balance sheet. 

The company is expected to have slightly over $3 billion after the sale of Simon and Schuster closes in the fourth quarter, but with streaming and production losses increasing, that amount is expected to steadily decline.

Sarma also highlighted uncertainties in Paramount's streaming business compared to industry peers. While Disney and WarnerBrothers Discovery have provided break-even guidance, Paramount's trajectory remains unclear, requiring the studio to generate free cash flow and outline a path to streaming profitability soon.

The broader media landscape, as Sarma noted, is undergoing challenges beyond Paramount. The shift from linear TV advertising, a decrease in pay-TV spending, and a decline in affiliate fee revenue pose financial difficulties for all legacy media providers. 

Golden Parachutes

There’s more than meets the eye at Paramount, which has a complicated ownership structure. 

Paramount’s most important shareholder is based out of a three-story office building, nestled between an indoor ice-skating rink and a Home Depot distribution center in Norwood, Massachusetts. 

The company is Shari Redstone’s National Amusements, Inc., a movie theater operator with 22 cinemas in the U.S. which holds an 80% voting interest in Paramount Global, while only holding a 10% financial interest.

Now like her grandfather Michael Redstone, who opened a drive-in movie theater in Massachusetts in 1948, and Sumner Redstone, who closed it 30 years later, Shari faces a big decision about her future. 

Shari has long been an ally of Paramount CEO Bob Bakish and was reluctant to sell her stake, just like her father, who founded NAI. But these are not the good old days of legacy media. 

At NAI, Shari has the final call on Paramount Global corporate decisions like choosing its CEO and board of directors. She also gets to decide which Paramount assets stay and which go. 

Although Shari has not signaled a sale of her Paramount ownership, last month Paramount Global updated its senior leadership’s golden parachutes in the case of acquisition. If Paramount gets bought and CEO Bob Bakish is ousted, he now stands to receive $50 million — plus benefits. 

And that policy may pay out soon. 

WarnerBrothers Discovery ($WBD) CEO David Zaslav recently engaged in discussions with Paramount Global in New York City, exploring the prospect of a potential merger, according to Axios.

The meeting was a dramatic turn from Zaslav’s statements at November’s New York Times DealBook Summit. "I think we have everything that we need," he said, at least for the near future. WBD, facing a declining stock since the April 2022 close of the $43 billion WarnerMedia and Discovery merger, has been reducing its substantial debt but still has much to go. 

The company could also become a target itself starting in April due to an arcane clause in the merger set to expire two years after the close. "Every public company is technically for sale," acknowledged Zaslav, noting that boards are obligated to consider shareholders' best interests. "But our perspective is, we are positioned for growth next year. To invest in more content. To position ourselves so we have options."

"What is the rush to buy Paramount now?" added LightShed Partners' Rich Greenfield in a recent blog post, acknowledging that it "undoubtedly will be sold." However, he sees this as a buyer's market, asserting, "All signs point to legacy media worsening as we move into 2024, with executives finally realizing that linear TV advertising is never getting better."

The envisioned merger between the two media giants, with a market capitalization of around $29 billion for WarnerBrothers Discovery and just over $10 billion for Paramount, could spark further consolidation within the industry. Zaslav has also involved Shari Redstone, regarding a potential deal for her controlling stake at NAI.

The meeting, held at Paramount's Times Square headquarters, extended over several hours and delved into potential synergies between the companies. One such consideration is the merging of their primary streaming services, Paramount+ and Max (formerly HBO Max), as a strategic move to compete more effectively against streaming giants like Netflix and Disney+.

The specifics of a merger remain uncertain, as it's unclear whether WBD would acquire Paramount Global or its parent company, NAI. However, sources suggest that both options are under consideration. WBD's international distribution footprint could enhance Paramount's franchises, while Paramount's children's programming assets may prove integral to WBD's long-term streaming goals in competition with Disney.

WarnerBrothers Discovery is far from alone should Shari Redstone’s stake in National Amusements or Paramount as a whole hit the market. 

David Ellison, son of Oracle founder Larry Ellison, and his fund Skydance, are working with RedBird Capital Partners to evaluate a majority stake acquisition in NAI, and subsequently NAI’s controlling stake in Paramount Global. 

Ellison, whose father is Skydance's biggest shareholder, "wants a studio," said one Hollywood dealmaker to the Hollywood Reporter. "It's no surprise that David Ellison is interested in a stake in Paramount; he always wanted to be studio boss." Paramount's main studio is valued at $7 billion. 

Despite potential regulatory challenges in an active antitrust climate, several media executives express confidence in receiving regulatory approval for the deal, per Bloomberg. Notably, WarnerBrothers Discovery's absence of a broadcast network could facilitate the regulatory process compared to potential combinations with companies like NBC owner Comcast.

Regardless, Comcast could also take an interest, although President Mike Cavanagh expressed caution about mergers and acquisitions at a recent UBS conference. Cavanagh's statements dampen expectations for an immediate deal, but the cash Disney will pay Comcast for the remainder of its Hulu stake, which is now worth $8.6 billion, is expected to match or surpass Paramount's current $10 billion market capitalization as a whole.

Sum of its Parts, Greater Than The Whole

Paramount’s future depends on the outcome of the potential sale – whether it occurs as a whole entity or whether the company, or a new controlling shareholder at National Amusements, opts to divest its assets piece by piece. 

An influential Paramount investor, Mario Gabelli, has advocated for splitting up the company's assets, which are more valuable on their own than under Paramount, which has an estimated enterprise value of $23 billion. 

Gabelli, whose fund ranks as the second-largest shareholder in Paramount's voting stock after National Amusements, suggested retaining the CBS network while spinning off owned and operated TV stations.

Paramount subsidiary BET Media Group, which includes the BET cable channel, VH1, BET Studios and streaming service BET+, has been on and off the market all year. Earlier this year, media mogul Byron Allen extended an offer of $2.7 billion for the brand, which he has now raised to $3.5 billion. 

Other potential buyers of BET Media Group include BET CEO Scott Mills, a 26-year veteran of the company, and Chinh Chu, a former executive at private-equity firm Blackstone who runs CC Capital Partners, who have discussed a price tag of under $2 billion, Bloomberg reported.

For entities like Skydance and tech giants Netflix, Apple, or Amazon, the Paramount studio stands out as the most coveted asset. Its library, including smash hit Yellowstone and intellectual property, led by showrunner Taylor Sheridan, make it a significant asset. Even Netflix has expressed interest in the Paramount lot in Los Angeles while selling much of its real estate in New York.

In the event of a breakup, WarnerBrothers Discovery might consider CBS, with its news and sports divisions potentially complementing existing assets. This move could bring the NFL and a broadcast network to WBD, addressing a current gap in its portfolio.

Counter to Gabelli, according to estimates by Wells Fargo analyst Steven Cahall, divesting the company's TV networks, including CBS, local TV stations, Showtime, MTV, Nickelodeon, Comedy Central, and Pluto TV, could result in a $13.5 billion equity value. The remaining businesses, encompassing Paramount Pictures, CBS Studios, and production operations, might be valued at $19 billion, or $23 per share. 

But what about Paramount+, which reported a loss of $238 million in the last quarter? The streaming service, a product of the merger between CBS All Access and Showtime, has reached peak losses with no clear path to profitability. In alignment with industry trends, it could adopt a more aggressive bundling strategy. 

Paramount has recently explored bundles with Apple TV+, implemented "hard bundles" internationally to boost adoption, and even formed an alliance with Delta Airlines. Amid concerns about the fate of Paramount+, the breakout success story of the free, ad-supported streamer Pluto TV has been overshadowed. 

Acquired for $340 million in 2019, Pluto now generates billions in annual ad sales while spending a fraction of what its streaming counterparts do on programming, as it has avoided entering the “originals” race.

What’s the Catch?

An NAI transaction may not be the best thing for Paramount's public shareholders. Media analyst Alan Gould of Loop Capital downgraded the company to "sell," saying he doesn't see "any upside for the public shareholders of Paramount." In other words, Shari or the Redstone family "would get a premium" for their stake, while others would not.

“It’s the worst-kept secret in Hollywood and on Wall Street that Paramount is in financial straits and consolidation is inevitable,” he added in an interview with Deadline.

Adding to the confusion, Citi's Jason Bazinet has a "buy" rating on the company. He said the downside in Ellison buying NAI instead of Paramount directly is "tax leakage."

"If Paramount was going to sell the entire company, they might do that with equity. So there would be no check back to the IRS," he says. But if Ellison buys NAI, then sells CBS for cash, for instance, "he'd have to pay capital gains tax [so] there is less value for shareholders,” he said on CNBC. 

But what happens if Ellison can't sell the linear TV assets and ends up running all of Paramount? Would he make better decisions?

Unloading the TV assets would be a complicated process, especially because they continue to generate considerable free cash flow in decline. Securing distribution, however, is a more complicated task than ever for network owners. 

Paramount faces major carriage renewal deadlines with Comcast and Charter, the two largest U.S. cable operators, over the next several months. Carriage rights are negotiated between companies to rebroadcast each other's programming on different cable networks. 

Comcast and ViacomCBS signed a renewal in 2022, but insiders have confirmed the companies are facing another renewal at the end of this month.

Charter, for its part, has drawn a clear line in the sand with programmers. It recently squared off with Disney coming to a deal after a 10-day blackout of ABC, ESPN and other networks. 

In exchange for promoting and bundling streaming services like Disney+, long-established networks like Freeform and FXX were permanently dropped by Charter, a major disruption to the traditional dual revenue stream of pay-TV, in which Disney received an affiliate fee from the cable network and a subscription fee for the premium Freeform and FXX channels.

Linear TV is in something of a limbo state after defining many of the top media companies and making billions of dollars for several decades. Disney recently reversed course after exploring a potential sale of local TV stations and linear TV networks, with CEO Bob Iger concluding that they remain valuable as promotional tools for streaming programming.

For a major cable brand like Nickelodeon, the stakes in the distribution negotiations are significant. Even in a diminished cable TV landscape, the kids powerhouse collects about $1 billion in affiliate fees annually. 

As Nickelodeon brands like PAW Patrol have shown, there is also huge merchandise potential tied to various Paramount properties. Over the summer, Teenage Mutant Ninja Turtles cleared $1 billion in global retail. 

This stemmed from the $180.5 million global gross revenue of Paramount's animated Teenage Mutant Ninja Turtles: Mutant Mayhem movie. Paramount Consumer Products' Turtles theatrical program was its most ambitious yet, counting north of 400 licensees for the film and 1,100 total for the franchise.

Layoffs

In May, the recently combined Showtime/MTV Entertainment Studios as well as Paramount Media Networks, overseen by the division’s President and CEO Chris McCarthy, reduced its headcount by 25%. 

Among the senior-level executives impacted are Jessica Zalkind, SVP, Talent and Series Development, MTV Networks, and Todd Radnitz, SVP of Original Unscripted Series at MTV Entertainment Group and Paramount+. 

Now new reports from the Wall Street Journal indicate that executives are contemplating laying off another 1,000 employees in early 2024, with a current full-time staff count of 24,500 as of the end of 2022.

The prospect of a transaction involving NAI has prompted discussions on the strategic focus of Paramount Global. Wells Fargo analyst Steven Cahall suggests that, if consummated, the best approach would be to swiftly move the distribution assets into discontinued operations, allowing a more concentrated focus on content.

In addition to these strategic considerations, layoffs have recently impacted the ad sales ranks within CBS owned-and-operated TV stations, part of a broader restructuring effort. The net number of departures, including recent hires, totals around 17 people across the markets where the 28 CBS-owned stations are based. 

Paramount Global's advertising business, including CBS stations, has faced challenges, with a 14% decline in ad revenue in the third-quarter earnings report attributed to global advertising market softness and lower political advertising. Despite these challenges, the upcoming election is expected to generate record levels of revenue and reinterest in traditional cable news networks.