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February 08, 2006

Time Warner: The Icahn Report

I was talking with a good friend last week who runs a media-centric hedge fund. I was doing my usual rant regarding the mounds of analysis about Time Warner (TWX) coming from analysts, website commentators, and CNBC and noting that it had to be the most overanalyzed stock on the planet. My buddy noted it also hadn't gone anywhere staying in a pretty narrow $2 range for the past twelve months. He then noted that TWX must have the highest "chatter to beta" ratio of any stock he followed.

Of course, today the chatter about TWX has heated up again thanks to the unveiling of the Icahn report. I have not read the report yet, just a few news stories about it, but from what I have read I stand by my analysis that the problem with all the analysis claiming that TWX is massively undervalued is that it just isn’t true. Break it apart or leave it together and you got the same businesses. The company is well enough analyzed to value those businesses efficiently and for the last year, or last three years, the market has valued them between $16 and $19.

The only way that value goes up significantly, is if Wall Street decides to value these businesses higher. That will happen in one of two ways. First, multiples on traditional media businesses rise as the Street gains confidence that growth rates of operating and free cash flow have stabilized. Second, growth rates of operating cash flow accelerate because fundamentals improve in the company's business – ad growth picks up, cable capital spending declines, AOL makes headway as a portal or broadband distributor, home video picks up, etc...

Icahn wants us to believe that breaking apart the company will make the pieces more nimble and thus accelerate the growth rates of each individual business. He also claims there are "hundreds of millions" in overhead savings. He might be right about smaller is better as it relates to growth rates. However, that is no overnight panacea for the stock price. Investors won’t reward the company just for breaking up. They haven’t done that at Viacom (VIAB) or Cendant (CD). Investors will wait for proof that on their own growth rates pick up.

As for the overhead savings, let's say he is right and the company can save $500 million in operating expenses. Let's be generous and put a 10 multiple on the savings, above the 8.5 multiple that all of TWX is trading at on 2006 estimates. The value enhancement is $5 billion, or $1.07 per share, just 6% of the current stock price.

TWX is worth $21-22 valuing the individual businesses at the current trading multiples of their peers using 2006 estimates. Modest upside, but not enough to justify or alter the "chatter to beta" ratio.

Posted by Steve Birenberg at February 8, 2006 04:14 PM in TWX