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August 04, 2006

Time Warner Still Offers Little Upside

Time Warner (TWX) shares have responded well to 2Q earnings, regaining much of the losses since early July. However, the shares still remain well below the $17.50 level of early June. I think further upside is limited unless the market continues to revalue the cable industry upward. Cable is by far the company’s largest business and is the only business with strong operating momentum. In fact, outside of cable TWX is not growing as Publishing and AOL are flat, Filmed Entertainment is struggling at the box office and in home video, and Cable Networks growth continues to moderate to the mid single digits.

Looking at valuations of pure play companies in each of TWX’s businesses suggests minimal upside for the stock. I think this is the correct way to value TWX despite many analyst reports which assume higher multiples based on historical valuations that are no longer applicable given the challenges to traditional media that are causing a secular slowdown in growth.

Here are some brief comments on TWX's operating divisions....

Cable had another great quarter. Between Comcast’s revived growth and TWX’s great results it should be clear that for the time cable is in the sweet spot of its growth profile. With the closing of the Adelphia division and eventual spin-off of Time Warner Cable, improved valuation for cable assets is the best chance for TWX shareholders to see a move above the mid $17 level that has capped the stock for most of 2006.

Filmed Entertainment has some near-term issues. Tough comparisons at the box office, fewer syndication sales, sharply slowing home video sales, and a horrible summer box office for Warner Brothers will likely pressure results over the next 12 months. I still think we could see writedowns on some of the summer film slate, especially Poseidon.

Publishing had a weak first half but guidance implies growth will resume in the second half. Given revenue trends it seems like this must be driven by cost cutting. That is acceptable but investors won’t pay a premium multiple for this business unless top line growth returns.

Networks looked like it had a big quarter with growth of 9% but adjusting for some acquisition activity growth was morel likely around 5%. This is TWX’s second largest business and the growth slowdown evident over the past year is a big issue for valuation. Cable networks have held a premium valuation but with slowing growth the lift to TWX overall is no longer significant.

Finally, the AOL announcement largely paralleled press reporting form a few weeks ago. I still think that AOL is a weak brand and the strategy will ultimately fail. However, cost cutting and improved advertising monetization should limit negative impact through 2007. The old AOL was doomed to declining subs, declining page views, and severe market share loss in advertising. The new AOL will lose more subs but has a chance to stabilize or grow page views. In turn, the advertising reliant has a chance. Yahoo no longer has a huge valuation and I think we can all agree that AOL doesn’t hold a candle to Yahoo. Consequently, I still believe that implied valuations on the AOL business leave little upside for TWX shareholders.

The bottom line is that 2Q06 results changed little. TWX is still growth challenged leaving little potential for multiple expansion. Since operating results are only growing modestly this leaves little upside for TWX shareholders.

Posted by Steve Birenberg at August 4, 2006 09:12 AM in TWX