Investors are curious about how S&P Global Ratings calculates adjusted leverage for major U.S. media companies. To address these questions, we are providing our annual update to our analytical adjustments for EBITDA and debt for the five major U.S. media companies we rate: Discovery Inc., Fox Corp., Netflix Inc., ViacomCBS Inc., and The Walt Disney Co. Two major acquisitions closed in 2019 (CBS's merger with Viacom and Disney's acquisition of much of Twenty-First Century Fox Inc.). All five companies finally adopted the new lease accounting standard, Financial Accounting Standards Board (FASB) 2016-02, "Leases (Topic 842)" (Disney was the last, having done so as of its quarter ended Dec. 28, 2019). Finally, three companies (Discovery, Disney, and Netflix) have adopted Accounting Standards Update (ASU) 2019-02, the updated accounting standards for film and TV production costs. Fox and ViacomCBS are still evaluating the effects of adopting the standard.

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Frequently Asked Questions

What debt adjustments does S&P Global Ratings make for the five major U.S. media companies?

Many of our adjustments to a company's as-reported debt balance, such as tax-effected unfunded portion of pension and other post-employment benefits (OPEB), and netting of accessible cash and liquid investments, are common across most corporate issuers. However, we make several less-common adjustments to debt for the five major U.S. media companies we rate. These adjustments include guarantees on third-party debt and put options to purchase minority stakes in investments and joint ventures. (For more details on our methodology and adjustments, see "Corporate Methodology: Ratios And Adjustments" and "Guidance: Corporate Methodology: Ratios And Adjustments," both published April 1, 2019).

When a company buys or merges with another, do you assess the rating based on pro forma adjusted leverage?

When a company makes an acquisition, we do not use pro forma EBITDA in assessing the ratings impact. Pro forma has a number of limitations. Firstly, it reflects the financial performance of the acquisition under a different management team, so at best it's an approximation of how the larger company will perform. Each company may have different accounting standards, especially for how they treat programming costs. Finally, pro forma estimates that companies provide to the market generally reflect a recognition of all immediate synergies. Most synergies are realized over time (and some may not be achieved at all), and most companies' pro forma guidance does not include the costs (i.e., severance, restructuring) needed to achieve those synergies. For example, ViacomCBS's pro forma guidance recognizes all $750 million in expected synergies, even though the company expects to achieve those synergies over three years. Thus, when we refer to pro forma leverage (usually alongside our S&P Global Ratings-adjusted leverage), it is to be illustrative.

Will ASU 2019-02 reduce the importance of leverage as a measure of credit quality?

In 2019, the FASB updated its film and episodic television service programming cost accounting standard, to bring the accounting for TV in line with film accounting. We believe this change better reflects the reality of today's media universe as more content moves onto streaming platforms. Fully capitalizing production costs means that costs will be recognized over time rather than immediately, giving a near-term boost to EBITDA. We believe the near-term effect on the legacy media companies will be minimal because the number of television shows created internally among streaming services is currently small. However, as more content is made for streaming platforms, this could lead to a growing divergence between reported EBITDA, cash EBITDA, and free cash flow. Accordingly, while we have always assessed a company's financial risk profile based on ratios within our forward-looking forecast, going forward, we will likely increase our focus on cash flow metrics relative to leverage.

How do you treat programming guarantees?

We don't consider these obligations as debt. We believe they are future operating costs that will be paid with future cash flow generation. In addition, if a media company defaults on its programming obligations, we believe these contracts would be voided, and depending on how attractive the programming guarantee is, the owner could easily sell those rights to a third party.

How do you calculate EBITDA for diversified media companies?

We define EBITDA as a company's revenues minus operating expenses (excluding depreciation, amortization, and noncurrent asset impairment and impairment reversals). We include any cash dividends companies may receive from investments accounted for under the equity method, and we exclude the company's share of these investees' profits. We also exclude share-based compensation expense payable in shares. We include acquisition-related restructuring costs in our EBITDA calculation but exclude asset impairments and write-downs. We treat programming amortization as a cost of sales (for example, an operating cost) and therefore include the amortization (and any related write-downs) in our EBITDA calculation. However, we will exclude step-up amortization expenses, if material, related to the step up in carrying value of a film and television library. Our adjustments to EBITDA include the interest and depreciation expenses associated with capitalizing operating leases.

How frequently do you update your adjustments?

We update our adjustments for pension and OPEB once each year, when the companies release their Form 10-K annual reports. However, we will make midyear adjustments when they're deemed material. For example, we made an adjustment for Disney, which closed on its acquisition of most of Twenty-First Century Fox Inc. on March 20, 2019, after Disney disclosed its revised pension and operating lease liabilities. We update all other adjustments quarterly.

This year, for the first time, because of the complications created by the merger of Viacom and CBS and one-time charges for Discovery, we will also be providing a reconciliation to our as-reported EBITDA calculation for both ViacomCBS and Discovery. In the former's case, we start with the company's as-reported adjusted operating income before depreciation and amortization. For Discovery, we start with as-reported operating income.

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Related Criteria

• Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Key Credit Factors For The Media And Entertainment Industry, Dec. 24, 2013
• Corporate Methodology, Nov. 19, 2013

Related Research

• Credit FAQ: How Does S&P Global Ratings Calculate Leverage For U.S. Diversified Media Companies? (2019 Update), June 20, 2019
• Guidance: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• S&P Global Ratings Requests Comments On Proposed Revisions To Its Methodology For Ratios And Adjustments, Jan. 3, 2019
• Credit FAQ: What Do New Lease Accounting Changes Mean For Corporate Credit Ratings?, April 16, 2018