Is This Media Company a Good Buy?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shareholders of Time Warner (NYSE: TWX) must be quite happy with the company’s strong second quarter results. Time Warner’s share price has reached its five-year high of more than $63.80. Along with these strong results, Time Warner also increased its full year guidance. Let’s take a closer look to see whether or not we should invest in Time Warner after its second quarter performance.

Growing second quarter earnings results

Time Warner is a leader in media and entertainment business, operating in three main segments: Networks, Film and TV Entertainment and Publishing. Most of its operating profits, $4.7 billion, or around 80% of the total operating income, are derived from the Networks segment, while the Film and TV Entertainment contributed more than $1.2 billion in profits.

In the second quarter, Time Warner managed to increase its revenue by more than 10.2%, from $6.74 billion last year to more than $7.4 billion this year. Excluding the Publishing segment, revenue experienced a higher year-over-year growth at 11.9% to more than $6.6 billion.

What impressed investors is the huge earnings growth of 87% to $771 million, or $0.81 per share. The spectacular growth in net income was due to higher revenue and lower asset impairments. Excluding the charge of $12 million for debt extinguishment, its EPS came in at $0.83 per share, much higher than analysts’ estimates of $0.76. Time Warner felt bullish about its full year operating performance, raising its guidance for 2013. It expects to grow its full-year earnings by a percentage in the mid-teens over the 2012 adjusted EPS base of $3.24.

In the first half of the year, the company produced as much as $1.8 billion in free cash flow, three times higher than during the same period last year. 

A lot of potential value with the Time Inc. spin-off

The investment community is looking at the upcoming spin-off of the publishing unit Time Inc. to focus the business solely on the “TV ecosystem.” The publishing unit will have the least predictable free cash flow in the next few years, while the TV businesses will generate a fairly predictable stream of free cash flow. Consequently, when Time Inc. is spun off, Time Warner will have a higher multiple due to a higher level of stable cash flow. At the current price of $63.80 per share, Time Warner is valued at 10.35 times its trailing EBITDA (earnings before interest, taxes, depreciation and amortization). Investors might keep their eyes on the upcoming spin-off in early 2014.

The business separation of News Corp.

One of its peers, News Corporation (NASDAQ: NWS) has also separated itself into the two different businesses: the new News Corp. and Twenty-First Century Fox (NASDAQ: NWSA). The potential for growth will be much higher at Twenty-First Century Fox, owning filmed entertainment, direct satellite broadcasting, and cable and television. On the other hand, the new News Corp. owns several prestigious, but slower growth publishing and newspaper assets including the Wall Street Journal, The New York Post and the book publisher Harper Collins. It also possesses the sports programming and pay-TV distribution business for Fox Sports.

The selling point for the new News Corp. is its strong, debt-free balance sheet. It has around $12.6 billion in equity, more than $1.5 billion in cash and $2.85 billion in investments. Although Twenty-First Century Fox has a lot more growth potential, it contains a lot of goodwill and intangible assets on its balance sheet. As of March, it had more than $30 billion in equity, $9.3 billion in cash, more than $7 billion in long-term investments, but as much as $20.85 billion in goodwill and intangible assets. Consequently, the tangible book value stayed at only $1.5 billion.

The new News Corp. has the cheapest valuation. It is trading at around $16.10 per share. The market values the new News Corp. much cheaper than Time Warner, at around 4.10 times its trailing EBITDA. Because of the higher growth, Twenty-First Century Fox has the highest valuation. The market values Twenty-First Century Fox at 11.5 times its trailing EBITDA.

Both News Corp. and Twenty-First Century Fox are good stocks, but for different reasons. The new News Corp, the owner of many prestigious newspaper and publishing assets, has a superb balance sheet and a low valuation. Whereas Twenty-First Century Fox will experience much faster growth, generating more predictable free cash flow.

My Foolish take

With the separation of the two different businesses, the publishing unit and the TV ecosystem” unit, Time Warner will definitely experience much better growth because it does not have to consolidate the declining newspaper business. In the long run, with the Time Inc. spin-off and fast-growing TV businesses, Time Warner will deliver good returns for its shareholders. 

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Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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