Zaz’s “Equity Story” & Credit Suisse’s Demise

Warner Bros. Discovery C.E.O. David Zaslav.
Warner Bros. Discovery C.E.O. David Zaslav. Photo: Kevin Dietsch/Getty Images
William D. Cohan
February 26, 2023

During his presentation of Warner Bros. Discovery’s fourth quarter results, on Thursday, I wouldn’t say that David Zaslav put lipstick on a pig, as the old Wall Street saw goes, but he definitely put a great spin on some rather tepid news. For instance, the company’s $12 billion Adjusted EBITDA projection for 2023 has been adjusted downward by Zaz to the “low to mid” $11 billion range—“pro-forma adjusted EBITDA,” as Zaz put it. 

I am on record as having great admiration for Zaz and what he’s trying to pull off here. But I just don’t understand what “pro-forma adjusted EBITDA” even means, other than that WBD would probably be making less than $11 billion in EBITDA in 2023 if it weren’t for the adjustments and the pro-forma jujitsu. Nor am I a big fan of the way Gunnar Wiedenfels, Zaz’s hard-charging C.F.O., spun the 2022 performance—pro-forma adjusted EBITDA of $9.2 billion—and the outlook for this year. “I’m very pleased with where we ended the year and encouraged with our ability to balance choppy macro tides with success in repositioning the company for future growth,” he said. “I remain very optimistic about the range of potential outcomes in 2023 and beyond. These outcomes will reflect an incremental $2 billion of synergy and transformation efficiency capture, while additional puts and takes to consider include positive revenue inflection in D2C, the broader release slate at Warner Bros. Pictures and Games, balanced by cyclical advertising headwinds.” I am reaching for ChatGPT here. What’s he trying to say? 

On the other hand, I give Zaz and Gunnar high marks for focusing on Job No. 1: Paying down debt. There’s better news on that front than I would have expected. On the earnings call, Gunnar reported that WBD has paid down $7 billion of debt since the deal closed nearly a year ago, bringing the company’s long-term debt down to $49.5 billion, with some $4 billion in cash. The company’s net debt therefore is starting to look nearly manageable at around $45 billion, and as Gunnar said, the company’s leverage ratio is now “just below 5x.” Zaz added that he expects the company’s “net leverage” to be “below” 4x by the end of this year. Gunnar expanded on that assertion by telling Wall Street analysts that he sees net leverage being “very comfortably” below 4x by the end of 2023. He then took the predictions even further, suggesting that WBD’s debt would be investment grade by mid-2024 and the company’s leverage ratio would be 2.5x to 3.5 by the end of 2024. (Those numbers, Gunnar added, do not include “some opportunities” that are “below deck, as we like to say.”)

Perhaps the best way to think about WBD is like a publicly traded leveraged buyout that did things in reverse order. Usually in a L.B.O., a sponsor or private equity firm loads a company up with debt to take it private and then, if things go well, pays down the debt and increases EBITDA sufficiently to make the equity “story” once again attractive to public equity investors. When the L.B.O.-ed company goes public again, it’s usually a financial windfall for the private-equity firm. 

In the case of WBD, the combination of TimeWarner and Discovery was loaded up with debt—some $55 billion worth—and there was also a publicly traded equity stub, if you will. The WBD equity became a referendum on the leveraged deal structure and what Zaz called “a year of restructuring.” The market voted with its feet in 2022. Since WBD started trading in April until the end of December, the WBD stock fell some 63 percent. But the worm seems to have turned since then, and for the better. Since the beginning of 2023, the WBD stock is up more than 65 percent. Is Zaz right that 2023 “will be a year of building” and that it “promises to be a very exciting year for our company”?

Time will tell, of course, but if the Zaz can continue to pay down debt and get the company an investment-grade credit rating, the WBD equity should continue to outperform the broader market. This is not investment advice, of course, but that’s part of the alchemy of a successful L.B.O.: As the debt gets paid down, the equity value can increase nearly exponentially. There’s a reason that private equity has become such a wealth creation vehicle. The tax-deductibility of interest and the magic of debt reduction can work wonders for the equity story. Zaz is optimistic, of course. “We have full command and control of our business, and we are one company now,” he said. “We have a fantastic leadership team moving us forward, everyone rowing in the same direction. And together, we are focused on making our businesses better and stronger.” 

So, sure, Zaz and Gunnar have lowered the bar by reducing WBD’s 2023 “pro-forma adjusted EBITDA” to around $11.5 billion. But they have promised that the debt on the company will continue to be paid down and that the company will soon be investment grade. That’s the thing to focus on now. If Gunnar is wrong, and WBD doesn’t become investment grade by 2024, then the whole promise of WBD could come a cropper. If Zaz and Gunnar pull it off, though, then the prospects for my long anticipated combination of WBD and Comcast’s NBCU will have never looked brighter.  

As a final aside, and as a nod to my partner Dylan Byers, Zaz did have a little to say about CNN and its embattled C.E.O., Chris Licht, during the Thursday afternoon call. Zaz still stands behind both CNN and Licht, and the strategy of moving CNN back to the middle of the road seems to be working, or at least still has the boss’s backing. “We are already seeing a more inclusive range of voices and viewpoints, as demonstrated last month, when over 70 Republicans came on our air during their Congressional speaker election process, a first in a very long time, and we intend to continue advancing on this balanced strategy,” Zaz said. “Chris Licht and the team are focused on building an asset for the long term across cable and digital that is worthy of that great global brand.” Of course, Zaz and Gunnar also must get the balance sheet right. And CNN and the balance sheet seem inextricably yoked together.

The Wizard of Ozy

I am always surprised when a high-profile person is held accountable these days. We seem to have lost the art of accountability for bad behavior. So in addition to being surprised that Ozy Media C.E.O. Carlos Watson, now 53 years old, was actually indicted and arrested, I was also quite surprised to see the extent of Watson’s scam. 

It turns out, it was worse than we thought we knew. Ben Smith, now at Semafor, uncovered the outlines of the Watson fraud in his breathtaking October 2021 stories about Ozy Media in The New York Times. I had a window into Carlos’s derangement in my brief interaction with him when I was in Los Angeles in November 2021. (I wrote about the saga here, in Puck.) But the extent of Watson’s alleged wrongdoing, as outlined in the 43-page grand jury indictment handed up in the Eastern District of New York, is simply stunning. 

The indictment charged Watson with “conspiracy to commit securities fraud” and “conspiracy to commit wire fraud in connection with a scheme to” Ozy Media’s investors and lenders by “making material misrepresentations about Ozy’s financial and business assets.” He was also charged with “aggravated identity theft for his role in the impersonation of multiple media company executives in communications with Ozy’s lenders and prospective investors in furtherance of the fraud schemes.” (At the same time, the S.E.C. also charged Watson and Ozy with defrauding investors of about $50 million “through repeated misrepresentations concerning the company’s basic financial condition, business relationships, and fundraising efforts.”)

The allegations in the grand jury indictment go well beyond the impersonations of one of Watson’s key executives, who has pleaded guilty, in a call trying to raise money from Goldman Sachs. It seems that Watson and his colleagues were also trying to deceive a bank into loaning Ozy Media money based on a forged contract to have an Ozy Media television show carried on a cable network. “As alleged, Carlos Watson is a con man whose business strategy was based on outright deceit and fraud,” Breon Peace, the U.S. Attorney for the Eastern District of New York, said in a statement. “He ran Ozy as a criminal organization rather than as a reputable media company.” That’s quite an indictment. At his arraignment Thursday, Watson pleaded not guilty to the criminal charges against him.  

Peace claimed that Watson and his co-conspirators sought to “defraud” lenders and investors in Ozy Media by misrepresenting financial performance, debt obligations and audience size and that they also “lied” to potential investors about who else was participating in equity rounds of fundraising and then “assumed the identities of and impersonated actual media company executives to cover up their prior fraudulent misrepresentations.”

The attempted bank scam seems to be the most brazen of the alleged bad behavior by Watson and his co-conspirators. According to the indictment, Watson “directed” Ozy’s then C.F.O. to send the bank “a fake” signed contract between Ozy and the cable network pledging to air the second season of an Ozy television show, which of course would help the bank to think that revenue related to the show was real and worth banking on. When the C.F.O. refused to send the fake contract to the bank, Samir Rao, Ozy’s chief operating officer, who has since pleaded guilty to felonies, sent the fake signed contract to the bank anyway, with Watson’s approval. Rao copied the C.F.O. on the email to the bank. The then-C.F.O. promptly resigned and then allegedly told them, “this… is illegal. This is fraud. This is forging someone’s signature with the intent of getting an advance from a publicly traded bank.” She continued, “To be crystal clear, what you see as a measured risk—I see as a felony. Did either of you (Carlos, when you asked me to put together a contract and/or Samir, when you sent the email) have any idea (or did it even occur to you to care) that I could go to jail for forgery and bank fraud?” 

Despite her resignation, the indictment alleged that Rao and Watson continued to try to bamboozle the bank into making a loan to Ozy, going so far as to create fake email addresses in the name of an actual cable executive whom Rao then impersonated and then communicated with the bank about the potential loan. As Smith reported in 2021, Rao and Watson used the same scam to try to induce Goldman Sachs into investing some $45 million of equity into Ozy, of which some $6 million would have gone to Watson personally, the indictment alleges. (Goldman wised up to the scheme and did not invest.) 

Suffice it to say, the Watson indictment is far worse than what Ben had uncovered at the New York Times and much worse than anything I thought Carlos Watson did or said. It’s worth a read for that reason alone. It’s as if, according to the indictment, Ozy Media was nothing more than a sham organization and that its financial performance was fictionalized and then used to get investor after investor, from the U.S., the Middle East and Korea, to give money to Ozy Media. Once again, one wonders, just as one did with FTX/Alameda, where was the due diligence and why weren’t these unnamed firms—with the notable exception of Goldman Sachs—not doing the investigation of Ozy Media that they were professionally obligated to do? 

It was so bad, in fact, that according to the indictment, during the summer of 2020, the child of one of the company’s unnamed venture capital lenders was an intern at Ozy. But of course Watson, Rao and a third co-conspirator were so afraid that the son of the lender would find out that Ozy’s purported financial performance was little more than a pure fabrication, that they went out of their way to make sure he never overheard them talking about the reality of the situation. According to the indictment, on August 11, 2020, the third co-conspirator sent a text message to Watson and Rao in which she stated: “Need to be careful as [Venture Lender 1 C.E.O.’s child] is on … [His] dad thinks we had a good q2.”

A month later, on September 17, 2020, she sent a text message to Watson and Rao, in which she stated: “Be careful what [VentureLender 1 C.E.O.’s child] heard … Hears … [Venture Lender 1 CEO] thinks we’re doing 52”—a reference to the fact that Watson had represented to the venture capital lender that Ozy would be generating $52 million in revenue in 2020, an impossibility. Watson responded: “Assume he is listening … Unequivocally [s]ay we are doing well.” A month after that, on October 23, 2020 the venture lender wired Ozy a fresh $1.5 million, its fourth loan to the company.

Suisse Cheese

As the news broke this week that Deutsche Bank mulled the acquisition of Credit Suisse’s wealth management and asset management units, amid the latter’s ongoing spiral, I was reminded of how hard it is to kill off a global investment bank, especially one that has been part of a Swiss bank that has been around since 1856. But, in truth, the investment bank, once known as First Boston (and to be so known as such again soon) has been deteriorating for decades, pretty much ever since the mid-1980s when Bruce Wasserstein, who was then running First Boston’s investment bank, along with Joe Perella, decided First Boston should make committed bridge loans available to corporate raiders and L.B.O. sponsors as a way for First Boston to compete with the then junk-bond king Mike Milken. It was a nearly unprecedented level of risk that First Boston was taking in providing these bridge loans, and it nearly sank the firm. 

Credit Suisse first became affiliated with First Boston in 1978 when the two banks created a London-based investment banking joint venture. In 1988, Credit Suisse took First Boston private by buying out the 44 percent stake in the investment bank that was trading publicly. In 1990, Credit Suisse increased its stake to majority ownership after the bank had to bail out several of First Boston’s soured bridge loans, including one to the L.B.O. of Ohio Mattress Company, the maker of Sealy mattresses. The deal was dubbed “the burning bed” because it was so bad. 

In 1996, Credit Suisse bought the rest of First Boston it didn’t already own. Since then, Credit Suisse First Boston, or just Credit Suisse as it was known, has had its ups and downs. But in the past few years, starting with the leadership of Tidjane Thiam, the bank’s C.E.O. from 2015 to 2020, Credit Suisse’s situation has gone from bad to worse. Hired in March 2015, Thiam was the first Black leader of a major European financial institution. He was born into a prominent patrician family in the Ivory Coast capital of Yamoussoukro, which was named after his great-grandmother, Yamousso, a queen in the matriarchal tribe of the Baoule. His mother was the niece of Felix Houphouët-Boigny, the first President of the Ivory Coast after the country gained its independence from France. He was raised in the Ivory Coast and in Paris and had stints at McKinsey and as C.E.O. of Prudential plc, the big British insurer. 

But Thiam’s leadership of the bank went off the rails in and around 2019 because of what became known as “spygate,” when a dispute between Thiam and a rival Credit Suisse executive, Iqbal Khan, led to Khan being spied on by a private investigator paid for by the bank. In February 2020, Thiam resigned as a result of the scandal. 

More scandal followed. There was the bank’s $5.5 billion loss related to ill-advised margin loans that it had made to Archegos Capital Management, a family office run by the billionaire investor Bill Hwang, who then made huge, ultimately mistaken, leveraged bets on the direction of the stocks of several entertainment companies, including ViacomCBS and Discovery, Inc. There was also the insolvency protection filing of Greensill Capital, a German lender, which had teamed up with Credit Suisse to offer what turned out to be risky investments to some 1,000 Credit Suisse wealth-management clients. 

That news caused Credit Suisse to freeze the $10 billion or so invested by its clients in Greensil’s so-called “supply-chain” securities. (The Financial Times has estimated the losses that could be suffered by Credit Suisse clients to be around $3 billion.) There has also been plenty of management turmoil and turnover. It’s been a nearly unprecedented level of mistakes and they have taken their toll on Credit Suisse’s stock price, to say nothing of the bank, its employees, and their morale. In the last year, the stock is down 64 percent and the bank now has a market value of less than $12 billion, a chip shot on Wall Street.

Last October, the bank announced that it was resurrecting the First Boston name and was spinning out Credit Suisse’s fledgling investment bank as First Boston under the direction of Michael Klein, the former Citibank investment banker turned SPAC mogul. The decision has been yet another bonanza for the hugely wealthy Klein, who will become the C.E.O. of the spun-out First Boston. On February 9, Credit Suisse announced that it was paying $175 million in stock for Klein’s small M&A boutique, The Klein Group. Since then, Klein has been looking for investors for the revived First Boston, to be based in New York, and to design and to implement what the firm will focus on, from M&A advice and debt and equity underwriting to perhaps investment research. It’s not often that Wall Street sees a newly redesigned old-fashioned investment bank, but that’s apparently what Klein is trying to pull off in the next few months.

The fact that another struggling European investment bank, Deutsche Bank, thought about buying parts of Credit Suisse, before the bank opted to go the Michael Klein route, just shines a spotlight on the sorry state of European banking, which has still to recover fully from the 2008 financial crisis. By contrast, the U.S. banks are in far better shape than their European counterparts. 

Where First Boston goes under Klein’s leadership is anyone’s guess. The guy does have a proven track record of getting deals done and of enriching himself. I’m told he’s not the greatest manager or an inspirational leader. My guess is that once First Boston gets spun off as an independent entity, it will get scooped up by another bank in short-order, as long as it doesn’t go down the tubes first. After all, it would be a small deal—it’ll probably be valued around $5 billion, is my guess, and therefore won’t be blocked by the Federal Reserve should a suitor come calling. No one would mistake the revived First Boston as a SIFI, a systemically important financial institution. And Klein has every incentive to sell First Boston since the $175 million Credit Suisse paid for his boutique would only become cash upon a sale. If no buyer for First Boston emerges, Klein could also try to take the firm public, in an I.P.O., which might be a tough sell these days. Either way, it seems, the end of the road for First Boston is probably just around the corner.