Time Warner (NYSE:TWX) this week posted surprisingly strong third-quarter earnings results as content across its portfolio of television, movies, and video games showed off its growing economic value. Yet the stock slumped immediately after the report on a downgraded outlook for subscriber growth in the U.S. advertising business. Time Warner's TV channels are losing viewers at a higher pace than management expected as the market continues to slowly shift away from those expensive cable package plans.
Strong third-quarter results
Before we get to that outlook, let's look at the latest results. Time Warner booked an impressive 5% third-quarter sales increase to $6.6 billion as profit almost doubled to $1.8 billion. Two of its three major entertainment divisions, Warner Bros. and HBO, logged strong gains -- which helped offset weakness at the Turner broadcasting segment.
HBO grew sales by 5% as profits jumped 37% higher. Subscribers rose at a "mid-single-digit" pace, management said in a conference call. And higher subscription prices, combined with lower content spending, helped power huge profit gains despite ramped up investments in its HBO Now streaming service.
Warner Bros. booked 15% higher revenue thanks mainly to rising video game sales. Hit titles like Batman: Arkham Knight and LEGO Dimensions are allowing Time Warner to compete with major video game publishers, and the games are also making up for a relatively weak box office year. Theatrical revenue fell 5% compared to the prior-year period, but video game sales spiked 54% higher this quarter. Profit at Warner Bros. jumped 61% to $147 million.
Yet its most profitable business, Turner broadcasting, showed signs of strain this quarter. Sales ticked lower by 2% thanks to a decreasing cable TV subscriber count (in a conference call with investors, management pegged the losses at around 1.5%). Yet the company still succeeded in pushing advertising profits higher. "We are encouraged by the improvement in advertising trends and we posted another quarter of profit growth despite significant FX headwinds," CFO Howard Averill said.
Outlook for 2016 and beyond
Looking ahead, executives forecast continued subscriber declines in the neighborhood of 1% over the next year, which should pressure sales and profits at Turner networks such as TNT, TBS, and CNN. Time Warner plans to adjust to the new reality of a slowly shrinking U.S. TV market by cutting costs, and by looking for other ways of getting its content into peoples' homes, like stand-alone streaming offerings. "We are in talks with numerous interested parties to potentially launch [over the top] services, Turner Broadcasting CEO John Martin said.
The company is also considering mounting more defense by keeping its content exclusive to television for longer, and thus withholding it from online video providers like Netflix (NASDAQ:NFLX). "This would effectively push the streaming video on-demand window for content on our networks to a multi-year period more consistent with traditional syndication," CEO Bewkes said.
The fact that it can only be found on TV would raise the perceived value of that content in the eyes of cable subscribers. But from Netflix's perspective, the market is big enough that even a revolt by several big owners like Time Warner wouldn't derail the business. "Some studios will choose to license content to services like Hulu, Amazon Prime Instant Video and Netflix. Others may not. We have a lot of content to select from," Netflix CEO Reed Hastings said last month.
In any case, Time Warner's management sounded confident that it can navigate the slow shift from a TV-channel-based entertainment model to the app-centric model that Hastings is pushing for. "We could even stem losses altogether and maybe even get back to a position of growth in the United States," Martin said.
Demitrios Kalogeropoulos owns shares of Netflix. The Motley Fool owns shares of and recommends Amazon.com and Netflix. The Motley Fool recommends Time Warner. 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.