Behind the Mountain
Several readers have asked us what Paramount's acquisition of Warner Bros Discovery means for MEP. The deal cleared its last major hurdle this week when Paramount settled with the state attorneys general. The broader industry implications have been covered extensively elsewhere and since we don't typically finance studio-backed projects, our exposure comes from second-order effects.
Through the lens of library financing, the combined company is one fewer licensee of third-party content. How much that matters depends on how a library earns its money. Some libraries rely on active licensing: multi-year deals with subscription streamers and networks, negotiated title by title with a handful of buyers. Those deals produce lumpy cash flows with renewal cliffs, and the price at renewal depends on how many bidders are at the table. Other libraries earn most of their cash flow passively. Their titles sit non-exclusively across many ad-supported and transactional platforms, get paid per view or per ad impression, and keep earning without anyone renegotiating. Passive income has no contractual floor and moves with ad rates and platform concentration, as we noted in May with Fox's acquisition of Roku. But it doesn't depend on winning a renewal from a shrinking pool of buyers. The merger reinforces our preference for passive platform-driven cash flows and in our underwriting we haircut income that depends on renewals.
The settlement also requires Paramount to keep Pluto TV running as a free service. This is positive as Pluto is one of the larger outlets for independent libraries. Separately, we are already seeing non-core assets being sold by Paramount in our pipeline.
An important component of the settlement is contingent on the enactment of the federal film tax credit, which we think is a much more significant industry development than the Paramount/Warner merger. By the California Attorney General's account, only about 5% of the combined studio's film production currently takes place in the U.S. The settlement raises that to 20% if a federal tax credit of at least 20% is enacted, and to 30% after two years. Last week the tax credit became a real bill. A bipartisan group in both chambers introduced a 20% credit on U.S. labor, including above-the-line talent, that stacks on top of state incentives. It includes uplifts of up to 30% for independent productions and certain locations, among them an automatic uplift for Los Angeles County through 2030. It has received a fraction of the merger's coverage, yet for the middle market in which we operate it may matter more. Pro forma for the bill, a U.S. production stacking federal and state credits would be roughly competitive with Canada, Australia and the UK's standard incentive. We are watching this closely.
Much of the creative community has called the merger a disaster compared with the status quo of the two independent studios. That comparison was never rooted in reality. Warner had already announced plans to split itself in two, and it had signed a deal to sell its studio and streaming business to Netflix before Paramount outbid Netflix. On its own, each studio is sub-scale and the real question was which buyer would emerge, not whether there would be one. The job losses that come with more than $6 billion of targeted cost savings are real and unfortunate, but consolidation was coming either way.