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May 02, 2007

Time Warner 1Q07: Stock Looking As Good As It Has In Some Time

Time Warner (TWC) reported slightly better than expected 1Q07 results highlighted by strong operating profits at AOL and Cable and better than expected performance against a tough comparison in Filmed Entertainment. The shares are reacting appropriately, up 2-3% so far. I think more upside remains with $23-24 being a legitimate target over the next few months.

Revenues of $11.2 billion matched consensus estimates while EBITDA of $3.1 billion was above consensus and equaled the highest estimates on the street. EPS of 22 cents were ahead o the 20 cent consensus. Guidance for revenue and EBTIDA was maintained but EPS guidance was bumped up by 5 cents attributable to lower interest expense, faster share buybacks and the better than expected operating profits.

The conference call Q&A was mostly focused on AOL. Many analysts, myself included, remain skeptical that the year-over-year gains in EBITDA and big increases in advertising revenue are sustainable. The outcome of this debate will be the greatest driver to TWX shares over the next year. In 1Q, AOL revenues fell by $500 million but EBITDA increased by $100 million or about 25%. Lower marketing and networks costs related to the dial-up business and 35% growth in the high margin advertising revenue is driving the EBITDA gains....

Management is pleased that pageviews are stabilizing and expects growth to occur within the next several quarters. Increased monetization of ad inventory is driving the growth along with a big new customer who began buying advertising a year ago. Management admits that advertising growth will begin to slow but still expects to at least match industry growth rates. I worry that without a sharp acceleration in pageviews, monetization efforts will no longer be enough to drive advertising especially as inventory sellout ratios reach normal levels. SO far, my view is not the popular one. As comparisons toughen starting next quarter, we'll soon find out if my opinion has any validity.

Filmed Entertainment was the other source of upside EBITDA surprise in the quarter as revenues held in better than expected due to TV sales and the box office hit 300. Margin performance provided substantial upside to EBITDA vs. consensus. IT is worth noting, however, that forecasts of revenues and EBITDA in the film business are often way off. TWX has a strong lineup of films later this summer that should drive very good financial results in the fourth quarter via DVD sales.

Cable Networks showed decent revenue growth of 6% adjusted for divestitures. Margins were solid allowing flow through to EBITDA. I still think analysts value this division too highly given that it has moderated to mid to upper single digit growth but the as long as growth stays in this range, this segment should not be a factor in the share price.

Publishing was poor although management attributed the problem to non-magazine businesses held within the segment. Publishing produces less than 3% of EBITDA.

For comments on Cable, please see my earnings summary for Time Warner Cable (TWC).

Posted by Steve Birenberg at May 2, 2007 11:04 AM in TWX