MFI Stock Review: Time Warner (TWX)
Time Warner (TWX) is one of the largest media conglomerates in the world, with four distinct operating units. Cable Networks is the largest portion of the company, driving about half of operating earnings. This unit runs some of the most widely distributed and largest audience channels in cable, including TBS, TNT, CNN, and HBO. AOL, representing just under a quarter of profits, is the infamous Internet company that derives most of its income from dial-up service, but also has a sizable advertising business and operates numerous highly-trafficked sites like MapQuest and AIM (AOL Instant Messaging). Filmed Entertainment is the movie arm, consisting of the Warner Brothers and New Line Cinema studios, providing about 17% of profits, although this is a cyclical business. Finally, Publishing, representing the remaining 10% or so of profits, produces such well known and widely circulated magazines as Time, People, Sports Illustrated, and Fortune.
The Time Warner of today is significantly different than the Time Warner of just 10 months ago, as Time Warner Cable (TWC) was spun off in March. Before the spin, TWC contributed close to 25% of sales. The Time Warner of 3 months from now will be significantly different from today, as AOL will be spun off in December. That is quite a transformation in a single year, with the company jettisoning over a third of total revenues! New CEO Jeffrey Bewkes, a veteran of Time Warner's cable channel arm, has wasted no time in the long overdue breakup. The goal is to transition Time Warner into more of a pure play on content, similar to MagicDiligence Top Buy Viacom (VIA-B)
MagicDiligence believes this is the right strategy. Time Warner's competitive advantages in content are extraordinary. Warner Brothers is probably the best and most profitable movie production studio in Hollywood, with a long and deep library of blockbusters, including 8 of the top 15 grossing films of all time (no other studio has more than 2). Movie properties like Harry Potter and Batman can be monetized, "sequel-ized", licensed, and put into alternative content formats over and over again. Warner also has an excellent TV production studio, producing more television shows than any competitor (and all without a broadcast network). Two current hits are Two and a Half Men and The Big Bang Theory.
The cable channels are also incredibly valuable. TBS and TNT are mainstays of basic cable, with large audiences for both syndicated and original series. CNN is considered the premier "straight news" cable network, trailing just Fox News (NWS) in viewership. HBO is possibly the most attractive property, with 40 million high-rate subscribers and a number of great television series like The Sopranos. This gives Time Warner a very wide moat in an attractive business with both subscription and advertising revenue streams. Cable networks have consistently been the best performers in the portfolios of "big media", and that should be no exception here.
So, we are confident that Time Warner is a wide-moat company. Let's quickly go over financial health and growth prospects. First, the company is in fine financial shape after the TWC spin-off, in which the parent company received a $9 billion dollar dividend and now faces a debt load just 48% of equity, with operating earnings covering interest expense nearly 5 times over (a minimum requirement at MagicDiligence). Free cash flow should come in around $5 billion a year at 12-15% of sales.
Revenue growth potential is harder to predict. Time Warner's competitive advantages in content will allow the company to take the lead in monetizing nearly any form of content distribution out there, including digital. While ad rates for the publishing business will decline, magazine readerships remain strong, and Time Warner doesn't have any significant exposure to the quickly declining newspaper business. The company will not grow revenues in double digits, but with the declining AOL unit headed out the door, I see no reason sales cannot increase in the 5-7% range annually.
Lastly, let's do a quick valuation of the company without AOL. Time Warner's last 10-Q filing allows us to do this. Using an annual run rate for Q3 performance without AOL, Time Warner looks to be a company with about $25-26 billion in annual sales and an operating margin of about 19.5%, which is in-line with Viacom. At the current price around $32, this puts TWX at a 9.6% earnings yield. This doesn't consider that the mothership will probably add some cash to the balance sheet with the AOL spin-off, if it follows the example of the cable business, which will lower the enterprise value. Overall, the forward earnings yield should be about 10%.
That is a cheap price to pay for this kind of quality business. Adding to the attractiveness is the safe 2.4% dividend yield. Margins should be able to improve and capital more wisely allocated once the company is focused on content and not a myriad of unrelated businesses. Time Warner is a solid MFI buy and a consideration for a future Top Buy recommendation.
Steve owns no position in any stocks discussed in this article.