<THE RULE MAKER PORTFOLIO>

Time Warner's Time

by Matt Richey (TMF Verve)

ALEXANDRIA, VA (May 13, 1999) -- On Monday, Tom wrote about entertainment giant Walt Disney Co. and its current struggles. Today, in our continuing look at companies that have some Rule Maker characteristics but fall short, I'm going to discuss another colossal entertainment company -- in fact, the world's largest media and entertainment company -- Time Warner (NYSE: TWX).

With the acquisitions of Warner Communications in 1989 and Turner Broadcasting System (TBS) in 1996, New York City-based Time Warner became owner of numerous brand-rich interests in television, publishing, music, movies, and cable systems. The company has the leading position in magazine publishing (Time Inc.), pay-TV services (Home Box Office), and cable systems (Time Warner Cable). I could ramble on and on about its many well-known brands, but instead, let me point to this picture that says it all. At the newsstand, on TV, in the movies -- Time Warner's brands are everywhere we turn.

Among the company's many thriving lines of business, the Cable Systems division is both the most important right now, accounting for 37% of fiscal 1998 earnings, and offers the most opportunity for the future. Time Warner Cable is one of the nation's largest cable system operators, with 12.6 million customers. In recent years, the company has been aggressively upgrading its system with fiber-optic (read "broadband") technology that will enable more and better programming, new digital program tiers for high-definition television, high-speed Internet access, and cable telephony. The company expects to have 85% of its system upgraded by the end of this year, and the whole shabang should be good to go by the end of 2000. With these system upgrades in place, the company should be well-positioned to capitalize from the long-vaunted convergence of Internet, television, and telephony.

During 1998, Time Warner Cable continued to roll out Road Runner, its jointly-owned high-speed Internet access service. Also during 1998, the company began testing of digital set-top boxes, which will provide consumers with more channels, near video-on-demand capability, and parental lock-out features. By the end of this year, the company is expected to roll-out the first phase of its new digital service, which will include 150 channels of analog and digital video, plus a multi-channel digital audio service. With the planned addition of video servers, the company will be able to offer even more features, such as full video-on-demand and virtual-VCR functionality (with pause, fast-forward, and rewind functions). Cool stuff, indeed.

In February of this year, Time Warner took a major step forward on the cable telephony front with the announcement of a strategic relationship with AT&T (NYSE: T). The 20-year joint venture, of which Time Warner owns a 22.5% stake, is expected to offer cable telephony service in 33 states at some point in 2000. The long-awaited two-way cable is finally becoming a reality, and Time Warner is set to benefit.

But as for now, the company is awash in debt and sorely lacking the high margins and sales growth expected of a Rule Maker. When compared to Disney, Viacom, and Yahoo!, the company scores a measly 29 points on the Ranker (click to view), which places it in the fourth-tier non-Rule-Makerhood. After a perfect showing on the Brand category and a decent 8 points out of 12 on Financial Location, the party came to an abrupt end with only 9 out of 18 on Financial Direction and 4 out of 20 on Monopoly Status.

In the last year, the company has considerably improved its financial performance, finally achieving a positive net income in the most recent quarter. Prior to this, here are the abysmal bottom-line results for the past five years: 

Year         Net Loss ($ millions)
1998         -372
1997          -73
1996         -448
1995         -218
1994         -104
Amazingly enough, despite all these losses, Time Warner stock has performed quite well. Over the past decade, the stock has appreciated at an average annual rate of 18.9% (including re-invested dividends) versus 15.8% for the S&P 500. In reality, the company's negative net income understates the economic returns because of the hefty annual amortization expenses brought about by the numerous acquisitions over the years. Looking at free cash flow, as measured by cash from operations minus capital expenditures, the picture makes a little more sense: 
Year         Free Cash Flow ($ millions)
1998         1,333
1997           834
1996          -228
While free cash flow is looking increasingly positive, these acquisitions have left the company swimming in debt. For the past five years, the company has made no progress in freeing itself from debt's mighty grip: 
Year         Cash-to-Debt Ratio
1998         0.04
1997         0.05
1996         0.04
1995         0.12
1994         0.03
But, even with the many acquisitions and resulting debt, revenue growth has failed to emerge. Since 1995, revenue-per-share has grown only 5.1% annually. Ouch!

So in Time Warner, we have non-existent profits, a boatload of debt, sparse revenue growth -- but also a world of opportunity as digital cable opens up new revenue streams. For a fourth-tier company, this is quite an interesting company. If digital cable takes off, it might finally be Time Warner's time to excel.

But Time Warner faces threats, too. Not the least of which is a new economy company like Yahoo! (Nasdaq: YHOO) that offers compelling branded media content without the capital-intensive burden of owning and servicing the distribution system.

What do you think? Can Yahoo! unseat an entrenched media giant like Time Warner? Come to the Rule Maker Companies board (linked below), and let's discuss.

See ya on the boards,

Matt

05/13/99 Close

Stock Change    Bid
AXP   -1 1/4    124.75
CHV   -  5/8     94.44
CSCO  -1 1/16   117.69
EK    +  9/16    79.06
GM    -2 3/8     86.00
GPS   -  3/16    62.06
INTC  -2 7/16    60.06
KO    -  11/16   65.75
MSFT  -1 3/8     79.13
PFE   +2 1/16   117.81
SGP   +  1/2     49.81
TROW  +  15/16   40.88
XON   +  5/16    79.38
YHOO  -9 9/16   160.38


                  Day     Month  Year    History
        R-MAKER  -0.96%  -1.44%  10.47%  39.79%
        S&P:     +0.26%   2.43%  11.57%  37.99%
        NASDAQ:  -0.94%   1.54%  17.75%  56.21%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   48 Microsoft     39.13     79.13   102.19%
   6/23/98   34 Cisco Syst    58.41    117.69   101.48%
    5/1/98   55 Gap Inc.      34.37     62.06    80.57%
    2/3/98   22 Pfizer        82.30    117.81    43.15%
   2/13/98   44 Intel         42.34     60.06    41.87%
   2/17/99   16 Yahoo Inc.   126.31    160.38    26.97%
    2/6/98   56 T. Rowe Pr    33.67     40.88    21.39%
   5/26/98   18 AmExpress    104.07    124.75    19.88%
   8/21/98   44 Schering-P    47.99     49.81     3.79%
   2/27/98   27 Coca-Cola     69.11     65.75    -4.86%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Eastman Ko    63.15     79.06    25.20%
   3/12/98   20 Exxon         64.34     79.38    23.38%
   3/12/98   17 General Mo    72.41     86.00    18.78%
   3/12/98   15 Chevron       83.34     94.44    13.31%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
   6/23/98   34 Cisco Syst  1985.95   4001.38  $2015.43
    2/3/98   48 Microsoft   1878.45   3798.00  $1919.55
    5/1/98   55 Gap Inc.    1890.33   3413.44  $1523.11
    2/3/98   22 Pfizer      1810.58   2591.88   $781.30
   2/13/98   44 Intel       1862.83   2642.75   $779.92
   2/17/99   16 Yahoo Inc.  2020.95   2566.00   $545.05
    2/6/98   56 T. Rowe Pr  1885.70   2289.00   $403.30
   5/26/98   18 AmExpress   1873.20   2245.50   $372.30
   8/21/98   44 Schering-P   2111.7   2191.75    $80.05
   2/27/98   27 Coca-Cola   1865.89   1775.25   -$90.64

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Eastman Ko  1262.95   1581.25   $318.30
   3/12/98   20 Exxon       1286.70   1587.50   $300.80
   3/12/98   17 General Mo  1230.89   1462.00   $231.11
   3/12/98   15 Chevron     1250.14   1416.56   $166.42

                              CASH     $70.09
                             TOTAL  $33632.34

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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