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November 08, 2007

AOL and Cable Dragging Down Time Warner

Time Warner reported a solid quarter, ahead of analyst estimates. However, 2007 guidance was maintained suggesting that the 4Q will be weaker than expected. At the same time, segment results showed bad news at AOL and Cable which are the two key drivers of TWX shares. The cable news really wasn't bad relative to collapsing expectations off of Comcast's earlier results and cautious management commentary over the past few months. It did get put in a worse light though when DirecTV's results, particularly on subscriber metrics, beat estimates.

The larger issue was at AOL. Advertising growth decelerated again and came in at a worse than expected 13%. AOL lost a lot of market share to Google and Yahoo last quarter. Earlier this year, AOL's advertising growth was outpacing the industry and optimism about the new portal based strategy was running high. I have always been skeptical because I feel that AOL is a weak brand with weak demographics. Further, AOL is particularly challenged by MySpace and Facebook given its historic reliance on families. This view appears to be accurate now that the boost from initiating a new strategy is wearing off....

....In fact, according to Jessica Reif of Merrill Lynch, Time Warner's latest 10-Q suggests that the outlook for AOL advertising is even worse than 2Q and 3Q results imply. Loss of a large customer and display growth is the mid-single digits means that advertising growth is going to decelerate further. The 10-Q states this fact and notes that growth will remain under pressure in 1Q08 as well.

Without a turn a upward in AOL's advertising growth and renewed investor enthusiasm for cable, TWX shares are going to have a hard time gaining any upside traction. This is the case even in a break-up of the company as public market values of comparables to TWX's segments don’t justify a sum of the parts valuation much above $20.

Posted by Steve Birenberg at November 8, 2007 02:10 PM in TWX