February 15, 2009 - 11:41am EST by
2009 2010
Price: 8.67 EPS $0.90 $0.98
Shares Out. (in M): 3,587 P/E 9.6x 8.8x
Market Cap (in $M): 31,103 P/FCF 8.8x 7.8x
Net Debt (in $M): 34,858 EBIT 8,293 8,859
TEV (in $M): 75,961 TEV/EBIT 9.1x 8.5x

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The Time Warner Stub, adjusted for the spin-off of Time Warner Cable trades at a significant discount to its NAV. Several catalyst could help close the gap.

 TWX Company Overview

  • Media Conglomerate with well diversified (pro-forma for spinoff) revenue sources - subscriptions 54% (33%), sale of content 25% (38%) and advertising 19% (26%)  

Time Warner Inc. (TWX)

Time Warner Cable

Time Cable Networks

Filmed Entertainment

America Online (AOL)

Time Inc. Publishing

  • Publicly Traded - ticker is TWC
  • 85% owned by TWX
  • 2nd largest cable transmission company in US


  • One of the largest cable networks collection in the world
  • Includes basic cable brands Turner Networks (TNT, TBS), CNN, Cartoon Network, Court TV, Boomerang and Premium channels such as HBO
  • Commands most advertising dollars and highest ratings among cable networks


  • Top 3 TV and film entertainment content producer
  • Studios include Warner Brothers, New Line, Warner Independent Pictures and PictureHouse
  • TV programs include (ER,OC, Gossip Girl, Two and Half Men, Smallville, Gilmore Girls etc.)
  • The online business has two components: Access and Audience / Advertising
  • Access in decline but profitable
  • Advertising /Audience is growing (display ads, paid search and ad serving/ targeting)
  • AOL.com ranks 3rd after GOOG and YHOO in unique visitors and 5th in page views.
  • Oldest, smallest and slowest organic growth business
  • Includes titles such as People, Time, Sports Illustrated, In Style, Fortune etc.
  • Majority of Publishing revenues are derived from top 10-15 magazines out of 130

Why is this an Attractive Investment Opportunity

18 month ago TWX's top management changed.

  • Since his arrival last summer, the new CEO, Jeff Bewkes, has initiated a company-wide restructuring, steering the company towards a more streamlined, simplified content and advertising based business model.
  • 1. Consolidation and spin off Time Warner Cable (TWC) (i.e. each share of TWX will receive 0.25 shares of TWC)
  • 2. Balance sheet strength through a large dividend from TWC to TWX (i.e. $9.2bn of cash - $2.59 a share)
  • 3. Strategic opportunities for AOL - divestiture / separation (numerous recent media reports of a pending deal)
  • 4. Sale of non-core publishing operations (recent sales of certain European publications, more to come)
  • 5. Cost reductions (significant opportunities for cost reductions, recently announced $0.5+bn of cost cuts at AOL)
  • 6. Excess cashflow for dividend increases, stock buyback, strategic acquisitions (TWX could buy 1/3 of its stock)
  • Of the above listed initiatives only #1 and #2 are "guaranteed", or as close as possible to that. The remaining four represent additional positive optionalities if they were to be executed successfully. (N.B. The method under which the spin off is executed, yet unknown, can represent additional value accretion if it includes a split off).
  • FCC granted aproval of the transaction and it should occur in q1 09.
  • Adjusting TWX valuation for the TWC spin off and dividend, the remaining core TWX ("TWX Stub") is attractively valued

Spin Off Transaction and Dividend Payment

  The stub can be constructed by TWX - 0.20 x TWC.

 Reasons for Stock Price Underperformance - Industry Specific

  • Industry-wide challenges
  • Ø Cyclical Concerns
  • 1. Soft Economy - weaker discretionary spending on entertainment / media products
  • 2. Soft Economy - expectations of weakening advertising revenues for 2H08 and 2009 (1H08 was decent)
  • 3. Labor Strikes - writers' strike and potential actors' strike impact entertainment content creation
  • Ø Secular Concerns
  • 1 Internet distribution channel rapidly gaining audience share -> harder to monetize than other channels, would ultimately lead to lower profitability and greater content piracy
  • 2 Audience fragmentation - increasing number of entertainment options vying for audience attention
  • 3 Rise of reality shows, serialized dramas have limited repeat value -> lower "library values"
  • 4 Switching to rent vs. ownership of video content, with the former being less profitable
  • There is no clear visibility currently as to if, how and when these challenges will be resolved.
  • However, given the high correlation (75-85%) between TWX' stock and a basket of the comparable companies' stocks, these risks can be largely hedged out if one desires to do that.

Reasons for Stock Price Underperformance - Company Specific Concerns and Responses

TWX-Specific Concerns




  • Dial-up access is in decline -> Impact on the AOL brand
  • Expansion into an ad-driven model into a softening economy
  • Integration issues / "Questionable" M&A



  • AOL dial-up access has declined but margins still 30+%. Likely to be sold to EarthLink. The CEO has initiated a strategic review of the whole business.
  • Despite significant membership churn, AOL.com has 3rd highest number of unique visitors after YHOO and GOOG. Page views and unique visitors are flat to up.
  • AOL's ad network (targeting ad campaigns to third parties/non premium websites) is the largest one. It serves as offset to AOL portal display business as audience fragments (although both business are affected by soft advertising). AOL's ad network reaches 90% of all internet users - it has one of the leading behavioral targeting platforms.
  • GOOG owns 5% stake in AOL -> AOL search powered by GOOG - 90+% margin
  • Opportunities for significant additional cost cuts ($0.5+bn in identified savings -> lower hosting, marketing, customer service and technology costs)

Filmed Entertainment:

  • Slower Growth
  • Lower margins


Filmed Entertainment:

  • TWX studio business is the largest with the highest number of movies produced - difficult to grow a box office business of that size, but this year the company has had some good hits most recently the Dark Knight, Sex & City etc
  • Margins have risen 200bps in the last 10 years to 10% below the 12.5% for the industry. Opportunities to raise margin through cost cutting (fewer, more profitable movies), studio consolidation, international distribution (40%) and exploiting its distribution scale across channels (Video-on-Demand is 2-3x more profitable/more upside than physical distribution)

Cable Networks:

  • Competition from other broadcast networks - ratings impact
  • Challenges at Turner / HBO - need for original content


Cable Networks:

  • Despite some recent ratings decline due to increased competition from other cable networks, TWX still has the most dominant cable network (largest share of A18-49 and A25-54 audience) and it continues taking share from broadcast network (writer's strike helped)
  • TWX has begun to create an increasing amount of original content - Gossip Girl, The Closer, My Boys, Ten Items or Less, House of Payne as well new HBO series, pushing content onto new platforms such as VOD and YouTube. Sports and other events also added.

TWX-Specific Concerns




  • Print business challenges
  • Speed of monetization of unprofitable magazines



  • Huge Free Cash Flow generating business. Although transition to digital monetization has historically lagged some of its competitors, management is committed to strengthening it online presence - recently online revenues contributions have been increasing.
  • Due to low tax basis and high FCF of the business, company is slowly proceeding with monetization having sold 20 magazines over the past year. Other divestitures are more pressing at the current state.

Management / Corporate:

  • Would the management squander the large cash infusion on "ill-conceived acquisition"
  • Is the management shareholder friendly?


Management / Corporate:

  • Jeff Bewkes appears much more shareholder friendly and accessible than previous CEO. He announced a major restructuring within weeks of his arrival. He has had a great track record at HBO previously.
  • Despite the poorly perceived Bebo acquisition, management has demonstrated its discipline by walking away from the Weather Channel bidding process and deciding to invest in the business instead
  • Company has repurchased $22.5 bn of stock in the past few years (a quarter of its float) and is committed to further repurchases
  • Post-cable spin, dividend yield will increase to 2.3% and the $9.2bn of incremental cash could buyout a third of the company's stock. In addition the business generates strong FCF.
  • One of the few major media companies that is not family-controlled

  • Furthermore on a relative basis TWX is much more diversified than its competitors
  • Ø Advertising Revenues (TWX - 26%, CBS - 73%, News Corp - 46%, Viacom - 34%, Disney - 21%,)
  • Ø Content Revenues (TWX - 38%, Disney - 70%, Viacom - 47%, News Corp - 24%, CBS - 11%)
  • Given that CBS is much more reliant on advertising and includes radio, broadcast networks and outdoor advertising business, we have excluded it from the comparable analysis

Relative Valuation and Sum-of-the-Parts Analysis

On a Sum-of-the-Parts basis the TWX Content Stub is trading at $5.04, while valueing the various components of the business at 2009E figures - TW Networks ($4bn EBITDA, 8x EV/EBITDA), Filmed Entertainment ($1.2bn EBITDA, 5x), AOL ($1.1bn, 4x EV/EBITDA),  Publishing ($775mm, 4x EV/EBITDA) and Corporte Overhead ($250, 5x EV/EBITDA) and 9bn of net debt at the stub level and 3.5bn shares.  At this conservative valuation, the stub is worth around $10.  On a relative basis, the stub trades in line with the comps although it has a more "recession proof" revenue composition (see description above). Although TWX Stub has exposure to online advertising and publishing that is not universally present across all the comparables, all of the peer companies have exposures to cyclical and secular challenged businesses - e.g. New Corp -> newspapers (37%), Disney (35%) etc.


Ø Cost reductions: Every $100mm in cost reduction, all else constant, results in $0.20 increment value

  • Spin-off: Completion of TWC spinoff
  • AOl Sale: Potential sale of AOL 
  • Cost reductions: Every $100mm in cost reduction, all else constant, results in $0.20 increment value
  • Stock Buybacks: Every $1bn of share buyback leads to $0.16 of incremental value. If the TWC Spin-off is combined with a partial Split-off, some of this upside would be captured.
  • Increased Dividend: Based on the current dividend of $0.25 the company will have the highest dividend yield among the large media conglomerates in the US. Any incremental dividend payments, above the current guideline of 20% of free cashflow, will be well appreciated by investors.
  • Other: Margin expansions at Film Entertainment, disproportionate share of movie/show hits (i.e. more Dark Knights less Speed Racers), monetization of library or other assets, sale of publications etc.



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