Time Warner: Buy, Hold or Sell?

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

Time Warner (NYSE: TWX) has recently unveiled plans to spin off some of its publishing business to enhance its core strategic focus. This transforms the company substantially into a pure-play media and entertainment business with vastly different income statement and balance sheet characteristics compared to its media and entertainment competitors like News CorpComcast and Walt Disney. Historically companies that have gone lean and slashed non-core assets, have managed to perform very well after a spin-off.

Earnings are on the rise

Revenue was largely flat from the previous year with 28.7 billion. However, Time Warner still managed to grow its bottom line by 4% on a year-over-year basis and ended the year at $3.0 billion. The TV Networks business consisting of Turner Broadcasting and HBO showed solid growth in terms of revenue, and aided substantially in ramping up the company's operating income of $5.9 billion, which represents an operating margin of 20.6% for 2012, which is up slightly from 2011. 

Time Warner’s has been generating decent amounts of free cash flow as well. In 2012, the company’s free cash flow stood at $2.9 billion which is up slightly on year-over-year basis. The EPS grew a healthy 13% and stood at $3.28 for 2012 aided by share repurchases worth $3.3 billion.

Turner and HBO are key drivers

Networks business consisting of mainly Turner Broadcasting and HBO had annual revenue of 14.2 billion, which is up 4% from 2011 revenues. These TV assets make up roughly 80% of the company's operating Income or $4.7 billion of the $5.9 billion operating income the company earned in 2012. And not surprisingly the TV business has a higher operating margin of ~33%, which is greater than the company's total operating margin of 20.6%.

The growth in the TV networks business was heavily driven by the subscription revenue the company earns. TV networks are seeing growth in advertising revenues due to higher pricing in Turner Broadcasting's domestic markets, as well as more NBA games primarily led to the increased advertising revenue. Turner continued to bolster its prime time lineup on both TBS and TNT, with a solid mix of original shows and a line-up of acquired shows.

Turner now has the second largest collection of sports rights only after Disney's (NYSE: DIS) ESPN, with long-term contracts with the MLB, NBA, NASCAR etc. In spite of having a fantastic portfolio of entertainment businesses, in recent years ESPN has been a major driver of Disney's profits, as it is generating a lot of revenue with its wide array of sports offerings.

Airing more original content; offering options to customers

Time Warner intends to increase the airing of originals on both TNT and TBS networks by more than 40%. In HBO, the company’s content lineup is very strong with some very popular shows among customers across the world, and quality of these shows keeps on rising. A greater emphasis on original shows in networks like TNT and TBS should drive revenue.

HBO and Cinemax are amongst the favorite brands at Time Warner’s major affiliate partners. Together, these two offerings got approximately 1.9 million new subscribers in the domestic market in 2012, which was aided by HBO GO and MAX GO. As a result, in the last quarter of 2012, Time Warner’s Network scored record profits. 

Warner's fortunes are flat

Warner Bros. saw revenue of roughly $12 billion in 2012, which marks a decline of 5% from the previous year. This was mainly due to lower theatrical releases and video gaming revenues. Overall, the segment’s operating profits declined by 3% and stood at $1.2 billion.  

However, the company has been getting more revenues from TV Entertainment. Warner Bros did get into newer contracts with Internet streaming companies. Warner Bros. achieved global success and acclaim with The Dark Knight Rises grossing $1.1 billion at the global box office. Digital home video revenue, including subscription on demand, on demand and DVD was close to $1 billion in 2012 for Warner Bros. and the company expects it to grow by 20% in this year.

Publishing is losing steam; spin-off justified

The publishing and print industry has been operating under troubling circumstances, as consumers are shifting their news and magazine habits online.  Time Inc. significantly expanded its digital efforts in 2012 by launching on iOS, Android and Kindle platforms, and got a number of newer subscribers. 

Time Warner’s publishing business segment had revenue of $3.44 billion in 2012, which represented a decline of 7% from 2011. The operating income stood at $420 million which marks a whopping decline of 25% from 2011.

And the operating margin of only 12% is substantially lower than the other business segments of Time Warner's huge entertainment operations. And the company has announced its decision to separate the publishing business and to take it public, just like the company did for other segments like AOL. 

Going forward

With the spin-off of its publishing business, Time Warner has now transformed itself into a full fledged TV and Movie Entertainment business. With the laggard in its portfolio out of the way there is upside to be realized. Industry-leading assets like HBO, Turner and Warner Bros will perform very well at the company's core, after the separation of its publishing business. Time Warner has been generating sizable amounts of free cash flow, and will be repurchasing an additional $4 billion worth of stock, and increased its dividend by 11%. And with great free cash flow, comes a great stock price. 

Ishfaque Faruk has no position in any stocks mentioned. The Motley Fool recommends Walt Disney. The Motley Fool owns shares of Walt Disney. 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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