Last week Time Warner Inc. (TWC)’s CEO Rob Marcus announced that after merely a few months in the position he would be agreeing to sell the company to media conglomerate Comcast Corp. (CMCSA). While the $45 billion deal will largely benefit Marcus, who will receive an $80 million severance payment, the goal behind this merger is for the companies to gain more leverage in negotiations with suppliers and TV-network programmers.
Although the buyout is yet to be approved, it won’t necessarily hurt current investors, as these will receive 2.875 Comcast shares for each of their Time Warner shares. Thus, some investment gurus like John Burbank (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio) recently bought the company’s stock, hoping to gain profits from the merger. But let’s see how the firm did this past year and what business model Comcast will be taking over.
A Strong Portfolio with High Quality Content
Time Warner’s portfolio consists mainly of cable networks like HBO, TBS, TNT and CNN, which generate over 70% of the company’s overall $3.7 billion cash flow. The networks have shown industry-leading growth and are among the most widely distributed. The stream of affiliate fees attained through long-term agreements with distributors and online streamers, such as Netflix Inc. (NFLX) and Amazon.com Inc. (AMZN), as well as advertising dollars, have helped the firm maintain a revenue growth rate of 10.4% throughout 2013. HBO has been particularly important in boosting growth, due to its position as the largest distributed premium pay TV service. Also, its hit series like Game of Thrones, have attracted a 4% increase in international subscriber growth rate last year. The networks profitability should continue in spite of the merger, as deals with movie studios like Twenty-First Century Fox Inc. (FOXA)’s are bound to occur looking forward.
Furthermore, the company’s film and TV entertainment studio Warner Bros., which generates 20% of overall cash flow, is a strong compliment to the cable networks, as it provides high quality video content to the networks. In fact, this segment contributed 3.9% of the 4.9% quarterly revenue increase, and the studio will be crucial for management’s plan to increase spending on original programming at TBS and TNT by 20%. Moreover, while growth was somewhat stumped this quarter, due to the loss of political advertising revenue, this quarter’s ad-growth should range around 8% with the airing of Elite Eight NCAA basketball tournament games.
What to Expect
Although the merger with Comcast will surely bring some modifications to subscriber fees and overall pricing, EPS growth should continue at the currently solid 18.8%. Revenue should average annually around 4.5% growth rate, offset mainly by flat sales in the company’s magazine publishing business. Nonetheless, the cable network business should continue to enjoy 7% average annual affiliate fee increases, as well as 3% ad growth over the next five years, consequence of the Time Warner’s international expansion. Furthermore, the company’s focus on containing costs and expenses in the non-programming segment should offset management’s content investment, and drive operating margins to 24% by 2017, compared with the current 22.17%.
While EBITDA experienced a 43.7% increase in 2013, reaching a peak level of $14.7 billion since 2008, returns on equity have also grown at a solid 12.3% pace. While Time Warner’s 1.81% dividend yield is below the industry median, I remain impressed by the share buyback rate of 6.3. However, the company’s current share price of $65.33 hasn’t been that high since 2001, which makes me sceptical about now being the best time to invest. Nonetheless, I would advise current shareholders to keep their current shares, as the buyout will benefit them the most.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.