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December 21, 2005

AOL-Google Deal Not That Big A Deal For Time Warner

I am generally unimpressed by the AOL-Google (GOOG) deal as far as Time Warner's valuation is concerned. I value Time Warner (TWX) on a sum of the parts basis and due to the compression in multiples throughout media over the past year I just don’t see a huge valuation discount for TWX unless all media multiples rise. That said, I believe the shares could be as much as 25% undervalued....

I base this opinion on the following table which was first published on Media Talk back in September. I have not yet adjusted for debt reductions or the Adelphia deal but I believe that my debt and cash figures net to an amount that is currently accurate.

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This table differs from the one I posted in September because I made two adjustments to multiples. First, I am now using 9.8 for AOL vs. 5.0 previously to reflect the implied value of the GOOG investment. Holding everything else equal this added $2.21 to my target value. Second, I dropped cable from 9.0 to 7.5 to reflect the fact that Comcast is trading at less than 7 times 2006 EBITDA. Holding all else equal, this reduced my target value by $1.33.

To be perfectly honest, in anything short of an asset sale, I think my multiples for Filmed Entertainment and Networks are a bit too high. The box office has been terrible this year and with DVD sales slowing sharply and potentially declining in 2006, I am not very confident that if Warner Brothers were public it would trade at 12 times EBITDA. Each multiple point is worth just 33 cents for the studio, however.

As for Networks, a 13 multiple seems aggressive given that the new Viacom (VIA.B), which is dominated by the faster growing MTV Networks, is trading at closer to 12 times EBITDA. Another comparable, Discovery Communications (DISCA), trades nearer to 10 times EBITDA, although there is clearly some discount warranted for the complicated structure, and both the company's leading channels, TLC and Discovery, are having very poor ratings years. Another potential but flawed comparable is E.W. Scripps (SSP), which now gets over half its cash flow from its cable networks. SSP is trading at less than 11 times 2006 EBITDA and if you put upper single digit multiples on the broadcast TV and newspaper cash flow, the implied valuation for the cable nets is closer to 12 times. Back to TWX, Networks is the second largest business after Cable, and each multiple point equals 69 cents of TWX share value.

The bottom line from this analysis remains that TWX shares look undervalued by about 25%, with a legitimate target in the $22-23 range. However, one could argue that to get to that target multiples on some of the businesses must be assumed that are slightly above current public comparables.

Finally, the key to realizing big value at TWX is for the markets to upwardly value cable industry cash flow. Cable is by far the largest business at TWX and likely to get larger when Adelphia closes in 1H06. AOL matters and a big multiple expansion will certainly help but for AOL to be valued anywhere near Yahoo (YHOO) and GOOG is probably a multiyear workout.

I am happy to share my rather simple spreadsheet with subscribers. Just email me here at Street Insight and I'll send it along. I intend to bring it fully up-to-date after the company files its 2005 10-K early next year.

Posted by Steve Birenberg at December 21, 2005 09:01 AM in TWX