Time Warner: A Buy on the Dip?

Time Warner will be more valuable after the spin-off of Time Inc.

Jan 29, 2014 at 10:15AM

Media and entertainment giant Time Warner (NYSE:TWX) has been a stellar company with strong growth in earnings. The company's TV content has become extremely valuable and the company remains focused on creating lots of value for its shareholders.

Time Warner's compelling and highly acclaimed library of original content gives the company a lot of leverage in its negotiations with distributors. The recent pullback in Time Warner's stock provides a good entry point for a company with steady growth in its earnings. 

The TV business is growing
Time Warner's TV networks business has been performing very well. Owing to the growth of Turner broadcasting and HBO, the segment grew its revenue 6% year-over-year to $3.5 billion. The TV segment also posted its highest quarterly operating profit ever at $1.47 billion as operating margin surged to 41.7%.

Time Warner's TV networks business makes up 80% of its total operating margin and the margin of the segment has increased for six consecutive quarters. Turner Broadcasting saw growth in advertising revenue in the last quarter driven by improved pricing and demand and TBS was the No. 2 ad-supported cable network.

HBO has been a standout in the Emmy Awards, winning 27 Primetime Emmys. In addition, HBO acquired the interests of its partners in HBO Asia and it now owns 100% of HBO Asia. As a result, future revenues from HBO should see healthy increases driven by growth in the form of newer subscribers in the Asian continent. The company is making big investments in developing original programming for both HBO and Turner, and these investments should bear fruit in the form of more subscription revenues in the international market.

HBO has roughly 30 million subscribers in the U.S. and it faces strong competition from other premium channels like Starz (NASDAQ:STRZA) and also over-the-top players like Netflix (NASDAQ:NFLX). Starz and Encore lead the premium TV category in the US with a combined subscriber base of 57 million, which includes 22 million at Starz and 35 million at Encore. Starz has constantly been adding original programming as it just recently unveiled Black Sails and it is in the process of adding more shows.

On the other side, Netflix has made its mark as the leading Internet TV network and it hopes to have 48 million subscribers at the end of the first quarter of 2014. Netflix has invested heavily in its original programming slate as well. Competition from other players is a concern for HBO, but HBO offers high-quality originals like Game of Thrones and it is well ahead of competitors with 114 million subscribers across the globe.

CNN had previously seen dips in its ratings, but the company saw notable increases in its ratings for two consecutive quarters even though its main competitors have seen their ratings decline. CNN's operating income has trended down in 2013, but the segment is making investments in programming to grow its revenue again.

Warner Bros. leads in domestic box office
Warner has done very well in 2013 and it has been the leading film studio at the domestic box office. The company saw great commercial success in 2013 with movies like Gravity, The HobbitMan of Steel, and The Great Gatsby.

Revenue from the Film and TV entertainment businesses made up roughly 40% of total revenue for Time Warner, but the consolidated entity only collects 17% of its operating income from these businesses. 

The Warner Bros. TV business has been producing more and more shows. In the current TV season the segment is producing 63 shows, versus 55 shows in the prior season.

In the first nine months, revenues from over-the-top players like Netflix and Amazon were roughly $200 million. Business in this area should see healthy growth as over-the-top video consumption becomes a major source of entertainment across the globe.

Time spin-off will lead to higher valuation
Time Warner has announced the spin-off of its publishing unit, Time in early 2013. And this is a major positive for the company because it will enable the company's core media assets including HBO, Warner Bros, and Turner Broadcasting to get a higher value in the public markets.

Worldwide newspaper and print media revenues are on the decline due to shifts in consumer demand. However, in spite of declining revenue and operating profit, Time is still holding onto its lead in overall domestic magazine advertising revenue with a roughly 22.3% share, according to Publishers Information Bureau.

This spin-off will make Time Warner a pure-play entertainment and media player which will lead to higher valuation multiples. Time Warner's peer group includes Walt DisneyCBS, AMC, and other companies that trade at much higher relative multiples, and this discrepancy should narrow after the spin-off.

Going forward
Time Warner's assets are very valuable with Turner and HBO doing very well. HBO is seeing growth in Latin America and it is expanding its footprint in Asia. The company is executing its stock buyback plan very well as it repurchased $3 billion worth of stock in the first three quarters of 2013, and this has aided its EPS growth. 

The company's planned separation of its publishing unit will make it a pure-play content company. This will result in higher valuation multiples, so the recent pullback in Time Warner stock warrants a buy. 

Is Time Warner one of the companies hinted at below? Where should you put your money?
You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple.

Ishfaque Faruk owns shares of Netflix. The Motley Fool recommends Netflix and Walt Disney. The Motley Fool owns shares of Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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