Time Warner Severs Publishing Arm to Focus on Threat from Streaming Video

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The rumors have finally been confirmed; Time Warner (NYSE: TWX) announced that its Board of Directors has authorized the “complete legal and structural separation” of its publishing unit, Time Inc. Once the transaction is completed, Time will become an independent, publicly traded company.

It is a move that many analysts have been speculating for quite some time now. The decision of the board, however, comes at a time when media (film and TV entertainment) companies in the U.S. have found a new source of income: subscription video on demand.

Considering the series of rich deals made in the past, licensing content to internet companies such as Amazon.com and Netflix has a great deal of potential for high profits. The decision to separate Time as an independent company apparently sounds like a good decision –  separating a bad unit from a good unit – for investors. But is it really as good as it sounds?

Why is Time being separated?

Despite Time owning some of the best known and widely read magazine brands in the country, it was struggling to grow and pulling the parent company down.

Besides the publishing segment that is slated for separation, Time Warner operates in two other segments: Networks (television networks and television services) and Filmed Entertainment (feature film, television, home video and videogame production and distribution).

In fiscal 2012, out of total revenue of $28.73 billion and operating income of $5.92 billion, the segments relative shares of the total revenue pie were as follows:

<img alt="" src="http://g.fool.com/editorial/images/24607/1_large.jpg" />

(figures in billions), Source: http://www.companyspotlight.com/viewer/17283

Evidently, the publishing business, which comprises 12% of total revenue and 8% of the company’s operating income, is bogging down the company.

Is online streaming a threat?

The relationship between online streaming video companies and broadcasting and cable TV companies started with licensing of old content from the library of prime time shows. However, there is a great likelihood of it becoming an addiction of sorts. Last week, CBS (NYSE: CBS) announced that the first three seasons of “The Good Wife” will be available on Amazon Instant Video and the fourth (which started in September 2012) will be available later this year.

If this catches on, will it not eat into their own revenues? If viewers know that they will soon be able to watch a series at a time of their own choosing where is the need for rushing home in time for the show. The choice is between newness of content and content without advertisements. With the trend shifting towards watching online streaming, there is a great possibility of online streaming winning the battle. As it is, the present generation is already more comfortable with watching online content.

It can be argued that the as subscribers grow, media companies will be able to demand higher prices from the likes of Amazon and Netflix, which can compensate for any loss in ad revenue.

Although this is theoretically true, there is a caveat attached to it. There is no guarantee that both Amazon and Netflix may emerge as competitors by offering original content, either produced or outsourced, which they are already doing in a small way. In addition, online sites can refuse deals that they consider costly, something that Netflix has already demonstrated.

The subscription video on demand market is presently not a very big market and comprises only 1% of total revenue of the six largest media companies. However, it forms roughly 5% of their total operating incomes because of the high profit margin. The Wall Street Journal quotes Sanford C. Bernstein that spending on content is estimated to be in the region of $4 billion in the next few years.

Impact of individual companies

CBS has the highest exposure with 10% of its operating income coming from licensing content to subscription on demand. Time Warner and Discovery Communications get 5% and News Corp and Viacom (NASDAQ: VIAB) get about 4%. Walt Disney is the least exposed with 3%.

The extent of impact depends largely on each company’s dependence on advertisement revenue. For example, CBS and Viacom are likely to be affected the most as they derive less revenue from affiliates and more from advertisements.

The media companies mentioned here have strong balance sheets. Barring Discovery Communications, all are dividend paying companies. With exceptionally high debt to equity ratios. Viacom appears weaker than the others, but at the same time it has the highest EPS.

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Conclusion

For Times Warner, separation of the publishing arm is a welcome step and likely to unlock hidden value. As it continues to increase focus on Networks and Film and TV Entertainment segments, investors can expect the company to come up with better than expected results in the coming years.

For the industry as a whole, it needs to be noted that in the last three years, popularity of online streaming video has not been able to make much of a dent in traditional television viewership. This indicates that it is seen more as an alternative to DVDs and for viewing on mobile devices where TV is not available than as a threat to TV networks.

Sooner than later, media companies will realize that newness carries a premium and will be more disciplined in licensing new content. No matter where the threat comes from they need to protect their TV ratings and ad and affiliate revenues.


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