AOL Time Warner (NYSE: AOL) announced its first quarter as a newly combined company, and before unusual charges, it outperformed expectations.

Sales rose 9% to $9.1 billion. Earnings per share rose 21% to $0.23. Free cash flow rose 409% to $651 million. Free cash flow is expected to at least double to $1.8 billion this year. Apparently, it might do much better than that. After 2001, management expects free cash flow to grow at least 50% per annum for several years.

Free cash flow is the most important metric in measuring a company's value creation, and therefore stock valuation. However, for the next few years, AOL's earnings before interest, taxes, depreciation, and amortization (EBITDA) will be -- gasp -- a more meaningful valuation yardstick. The company is expensive on a price-to-free cash flow basis, at a 90 forward multiple, but with free cash flow growing so quickly, this multiple will quickly contract.

EBITDA, meanwhile, is growing more predictably at about 20% to 25% annually. AOL Time Warner's stock could trade near a 25 multiple to its annual EBITDA. In the first quarter, EBITDA increased 20% to $2.1 billion. For the year, management projects a 30% rise in EBITDA to $11 billion, alongside a 12% to 15% gain in sales, to about $40 billion. Achieving these numbers this year will be challenging, but we cautiously believe it is possible. Consider our long-term valuation projections.

            Price Range Projections
Estimated Stock Price Year Est. EBITDA at 20x at 25x at 30x 2001 $11.0B $44 $55 $66 2002 $14.3B $57 $72 $86 2003 $17.8B $71 $89 $107 2004 $21.7B $87 $109 $130 (Assumes 5 billion shares outstanding.
EBITDA estimates in billions.)

Our estimates are less aggressive than those of company management. Using the middle column (25x EBITDA), if the new company can grow EBITDA as it expects, a stock price nearing $100 toward the end of 2003 is likely. This isn't different from what we said one year ago.

The following table shows where the company's value is derived by division. These numbers are pro forma (assuming the two companies were combined) and approximate for all of 2000. Knowing these results, we can focus on the most important divisions, by EBITDA -- those are the Cable and AOL divisions, followed by Networks.

      2000 Results by Division
   (as a percentage of the whole)

          2000 Revenue    2000 EBITDA
AOL           21%             27%
Cable         16%             33%
Film          22%              8%
Networks      19%             18%
Music         11%              6%
Publishing    11%              8%    

In the first quarter, the AOL division reported a 17% sales gain to $2.1 billion. For this division, that year-over-year growth is almost anemic. Advertising and commerce sales for AOL rose only 5% from the December quarter, intimating that AOL is not immune from industry woes.

Cable, which includes cable TV subscriptions and advertising, grew revenue 12% from last year's first quarter to $1.6 billion. Cable's EBITDA grew 15% to $768 million. Networks, which includes CNN, TBS, TNT, and others, grew revenue 6% to $1.7 billion. Network ad sales grew 1% to $589 million, while EBITDA rose a strong 34% to $589 million amidst cost cutting.

My intuition is that this stock will perform well -- topping the S&P 500 -- for the next two to three years as the combined AOL Time Warner benefits financially from its early years together, and from investor excitement about those early years. After that, however, growth will slow, and the company will likely begin to look like another sprawling media giant with a lot of debt (unless it pays down its $20 billion in debt before then) and, likely, with less-than-thrilling long-term growth prospects.

This theory makes me believe that the Breaker Port should hold most or all of its AOL Time Warner shares for the next few years, during the company's potentially lucrative start, and then, assuming this slowdown scenario looks likely sometime around 2004, work to sell at least a large portion of the shares to buy companies with higher growth prospects.

However, we'll take this one day at a time. I am, after all, the guy who wrote in 1999 that AOL will one day be more valuable than Microsoft (Nasdaq: MSFT). AOL is now valued at $215 billion and Microsoft is at $365 billion. I don't see a reason to go back on my word from two years ago.

eBay doesn't deliver products, but delivers earnings
(Nasdaq: EBAY) rocked the house Thursday by reporting pro forma earnings of $0.11 per share, up from $0.03 last year, and well above the average estimate of $0.08. The results matched Motley Fool Research estimates from early this year. The Fool's Rex Moore covered more of the numbers in Fool News.

As a user, one exciting announcement is that eBay is broadening to include electronics and computers, among other new items. If you haven't used for books, music, or videos, give it a try. I've had only good experiences so far -- both buying and selling. Brian "Call me Tardior" Lund will have more on eBay on Monday.

Speaking of predictions, a few years ago we wrote that eBay would eventually be more valuable than the then five-times more valuable Yahoo! (Nasdaq: YHOO), partly because eBay has such a protective moat around its business, and partly because Yahoo! is reliant on advertising dollars -- not the most dynamic revenue source to say the least. So far, eBay is proving this out, surpassing Yahoo!'s valuation last month.

Ah, the fun of general predictions. Have a good weekend.

Jeff Fischer owns shares in eBay and AOL Time Warner. He's sorry to read in The Washington Post that Ted Turner was basically given the boot by the new company and is feeling bummed. He believes Ted Turner is a Rule Breaker, and he isn't sure how many other bigwigs at AOL Time Warner are. AOL Time Warner has a stake in The Motley Fool. The Motley Fool has a full disclosure policy.