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February 06, 2008

News But Nothing Exciting at Time Warner

I find little to get excited about regarding Time Warner's quarterly results, guidance, or commentary. The results were quite close to expectations pretty much across the board. The guidance contained no surprises. Commentary about business conditions and strategic actions offered little new insight. The shares are trading up 5% in a strong tape for media stocks. Disney and News Corp reminded investors that media companies can perform against economic headwinds. This is allowing depressed valuations to lift slightly and in the case of TWX and NWS estimates are rising slightly. I can construct an upside scenario for TWX shares based on either operating results or sum of the parts but the upside is not huge and the risks are higher than at DIS or NWS because TWX's businesses do not have the same operating momentum. If I were long TWX, I could justify holding on. If I weren't long and wanted media exposure, I'd look elsewhere.

In 4Q07, TWX reported EPS of 28 cents on revenues of $12.64 billion. Both figures almost exactly matched estimates. EBITDA rose 16% aided by acquisitions. For the year, EPS were 96 cents, up 20%. Guidance for 2008 includes EBITDA growth of 7-9%, free cash flow of at least $3.6 billion, and EPS of $1.07 to $1.11. I think the guidance is slightly below current estimates but nothing that will cause a problem or be a surprise. On the call, management indicated that AOL and Cable Networks would not fare well in 1Q08 so the year looks a bit back end loaded.

With the reported numbers and guidance providing little excitement, the focus was even more on new CEO Jeff Bewkes commentary on strategic actions. He announced significant actions with a tight timeline for resolution by the end of April but the news was nothing that had not been widely speculated by investors.

In terms of a broad approach to the business, Bewkes discussed the need to invigorate the content engine with an eye on news distribution channels such as VOD, digital downloads, and streaming. He also said that TWX could do this with another round of cost savings. Given the recent content run at Disney and News Corp, these comments were not surprising. They do point out that TWX has lost its focus as a content company. Getting back to basics is helpful.

As far as corporate restructuring goes, there were two key announcements. First, the access business of AOL is being separated from the advertising driven businesses. This is designed to increase the strategic options of the total AOL business but it was not clear what they had in mind. Second, formal discussions have begun with the independent directors of Time Warner Cable with the most probably outcome being a complete split. The impetus behind the discussions is the differing capital needs of the cable system and content businesses. Third, another round of cost cutting will be completed with corporate costs coming first and major changes coming for the New Line studio.

These actions seem unlikely to be warmly greeted by investors. AOL has issues and it is not clear that any premium to the current implied is warranted. 4Q ad growth again severely lagged broader internet trends and 1Q08 ad growth may be negative. Is this just a cyclical adjustment or is AOL a weak brand? Separating cable makes sense long-term as the financing strategies are incompatible. However, cable is TWX's faster growing business and the valuation is very depressed. The only way this creates near-term value is if TWC shares enjoy multiple expansion.

To reiterate, an upside scenario to $18-20 can be easily constructed based on EBITDA, free cash flow, or sum of the parts. But getting from here to there is tricky given the lack of positive momentum in most of TWX's businesses.

That's all I got. Plenty of numbers to analyze at the segment level but I don’t think they currently matter and I can’t provide value added.

Posted by Steve Birenberg at February 6, 2008 11:16 AM in TWX