Late last Thursday, AT&T (T, Financial) was rumored to be considering an acquisitioin of Time Warner (TWX, Financial). A few days later, the two giants decided to give it a go with AT&T paying as much as $85.4 billion and leaving it committed to pay Time Warner $500 million if the deal gets blocked, and Time Warner will pay the other $1.7 billion if a higher bid comes in.
"This is a perfect match of two companies with complementary strengths who can bring a fresh approach to how the media and communications industry works for customers, content creators, distributors and advertisers,” Randall Stephenson, AT&T chairman and CEO, said. “Premium content always wins. It has been true on the big screen, the TV screen and now it’s proving true on the mobile screen."
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"Joining forces with AT&T will allow us to innovate even more quickly and create more value for consumers along with all our distribution and marketing partners," Jeff Bewkes, Time Warner chairman and CEO, said.
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After being burnt with the Salesforce (CRM, Financial), among others, potential bid for Twitter (TWTR, Financial) just few weeks ago, I seem to have learned from this faulty mistake, and this time would rather just focus whether or not Time Warner's business would be a good arbitrage bet, given that its shares were trading at a good 24% discount from the $107.50 a share offer by AT&T.
The AT&T-Time Warner deal has far different reasons to be discontinued when compared to the Salesforce/Disney-Twitter speculation. First, the deal has already been made between the two and its up to the regulators to approve it. More likely, the size of the deal should be considered like as that of the $160 billion failed Pfizer-Allergan deal. But then again, the reason for the termination of the pharmaceutical deal was that of tax inversion-related concern by the Department of Justice.
Meanwhile, AT&T described this proposed takeover as a ‘vertical merger’ and there would be no overlap between the two companies. The acquirer hopes that such a tie-up will get the regulatory green light by the end of 2017.
What I could do right now is see if Time Warner’s recent operations performance, alone, would actually be worth the gamble (1).
Earnings performance
On Aug. 3, Time Warner delivered its second quarter 2016 earnings performance. Six months into this fiscal year, the $67.5 billion media company delivered -1.49% sales growth to $14.26 billion while it had 11.59% profit growth to $2.17 billion. Time Warner shares closed +2.7% for the day, while the broader S&P 500 closed +0.31%.
“We had a strong first half of 2016, which puts us ahead of our original goals for the year. Our performance reflects the creative excellence resulting from investments we’ve been making in the very best content. At the same time, we’re capitalizing on new distribution opportunities to take advantage of the growing demand for high-quality video content around the world.
As an example of our creative excellence, Time Warner received 148 Primetime Emmy nominations - more than any other company - with HBO’s 94 again setting the pace for the industry. In the second quarter, TNT and TBS finished as the two highest rated ad-supported cable networks in primetime among adults 18-49, and Warner Bros. once again came out of the upfront as the leading supplier to broadcast television.
Warner Bros. also gained momentum in film with recent successes, such as Central Intelligence and The Conjuring 2, and anticipation is running high for Suicide Squad, which debuts this week.
Today, we also announced our 10% investment in Hulu LLC and that Turner has separately signed an affiliate agreement for its full suite of networks to be carried on Hulu’s live-streaming service slated for launch early next year. These are just the latest examples of our commitment to supporting innovative digital services that allow consumers to access high-quality content however they want it across a variety of platforms. We’re confident the multiple investments we’re making in these types of services position the Company to benefit from growing global demand for the strongest network brands and very best video content.”
-Time Warner Chairman and Chief Executive Officer Jeff Bewkes
(Time Warner, Quarterly Presentation)
Time Warner
The media conglomerate was founded about 26 years ago. Through numerous corporate developments, including the ‘biggest mistake in corporate history’ – referring to then $164 billion AOL-Time Warner merger in 2001, Time Warner eventually ended up to what it is now – a sought out media company being valued at $85 billion by AT&T (2).
(Read: Time Warner’s history)
As per Time Warner’s recent annual filing, the company claimed to be a leading media and entertainment company with three reportable segments: A.) Turner, which consists principally of cable networks and digital media properties; B.) Home Box Office, which consists principally of premium pay television and streaming services domestically and premium pay, basic tier television and streaming services internationally; and C.) Warner Bros., which consists principally of television, feature film, home video and videogame production and distribution.
In fiscal year 2015, Time Warner derived 73%, or $20.43 billion, of sales from the United States; 16% from Europe; 6% from Asia/Pacific Rim; 5% from Latin America, and 1% for all other countries.
Turner
Turner owns and operates about 180 channels globally, which also involves a leading portfolio of domestic and international cable television networks.
The segment had the following networks in the U.S.: TNT, TBS, Adult Swim, truTV, Turner Classic Movies, Turner Sports, Cartoon Network, Boomerang, CNN and HLN. These networks reach consumers in more than 200 countries (3).
Turner’s also owns the digital properties bleacherreport.com and the CNN digital network. Turner also owns tntdrama.com, TBS.com, adultswim.com and cartoonnetwork.com. The segment also manages and/or operates for sports leagues including NBA.com, NBA Mobile, NCAA.com and PGA.com.
Turner’s digital properties collectively averaged approximately 115 million monthly domestic multi-platform unique visitors as of the last year.
Turner generates revenues principally from providing programming to affiliates that have contracted to receive and distribute the programming to subscribers, the sale of advertising on its networks and the digital properties it owns or manages for other companies, and the license of its original programming to SVOD and other OTT services and its brands and characters for consumer products.
In fiscal 2015, the Turner segment had 1.9% sales growth to $10.6 billion. The segment contributed 37.7% to total Time Warner sales and delivered a 38.6% operating margin.
In the first half of 2016, Turner delivered 6.8% sales growth to $5.9 billion, compared to the same period last year, with a 40.1% operating margin.
Home Box Office
Home Box Office owns and operates leading multichannel premium pay television services, HBO and Cinemax. Home Box Office licenses both individual programs and packages of programs to television networks and subscription video on demand services in over 150 countries.
Home Box Office businesses consist principally of premium pay television services and the HBO NOW streaming service domestically and premium pay, basic tier television and streaming services internationally, as well as home entertainment and content licensing (6).
In 2015, Home Box Office received a record 43 Primetime Emmy Awards, the most of any network for the 14th year in a row, with Game of Thrones winning 12 awards. In 2015, Home Box Office also won Academy Awards for Best Documentary Feature (Citizenfour) and Documentary Short Subject (Crisis Hotline: Veterans Press 1), a Golden Globe Award (The Normal Heart), three George Foster Peabody Awards for documentaries and two Sports Emmy Awards.
At Dec. 31, 2015, Home Box Office had approximately 49 million domestic premium pay subscribers, including HBO NOW. HBO was the most widely distributed domestic multi-channel premium pay television service.
Home Box Office generates revenues principally from providing its programming to domestic affiliates and other distributors that have contracted to receive and distribute the programming to their customers who subscribe to the HBO and Cinemax services.
In fiscal 2015, the Home Box Office segment had 4% sales growth to $5.6 billion. The segment contributed 20% to total Time Warner sales and delivered a 33.4% operating margin.
In first half 2016, the segment delivered 4.8% sales growth to $2.97 billion, and had a 32.5% operating margin.
Warner Bros.
Warner Bros. is the largest television and film studio in the world based on total studio revenues as of Dec. 31, 2015. Warner Bros. is a leader in the global television production and distribution business.
The segment consists principally of the production, distribution and licensing of television programming and feature films and the distribution of home entertainment products in both physical and digital formats, as well as the production and distribution of videogames and consumer products and brand licensing.
Warner Bros. is the number one producer of primetime television series for the U.S. broadcast networks for the 2015-2016 television season. In addition, Warner Bros. licenses its U.S. programming in over 190 countries as of Dec. 31, 2015 (7).
Warner Bros. has been the number one or number two film studio in domestic box office receipts for 9 of the past 12 years and the number one or number two film studio in global box office receipts for 10 of the past 12 years.
Warner Bros.’ portfolio of leading brands includes DC Entertainment’s brands (DC Comics, Vertigo and MAD Magazine) as well as the Looney Tunes and Hanna-Barbera brands. DC Comics’ characters include such iconic characters as Batman, the Flash, Green Arrow, Superman and Wonder Woman, while Warner Bros.’ other characters include Harry Potter, Bugs Bunny, Scooby-Doo and Tom and Jerry, among many others.
Warner Bros. generates revenues from its television business, feature films, home entertainment and videogames.
Warner Bros. segment had 3.7% sales growth to $12.53 billion in fiscal 2015. The segment contributed 46.2% (largest among the segments) to total Time Warner sales and delivered a 10.9% operating margin.
In first half 2016, the segment delivered -11.2% sales growth to $5.77 billion, and had a 11.1% operating margin (9).
Overall, Time Warner’s five-year sales and profit growth averages were 0.90% and 8.26%, respectively (5).
Cash, debt and book value
Time Warner’s unaudited financial statements as of June 30 revealed that it had $2.5 billion in total cash and $24.47 billion in debt with a debt-equity number of 1.02. The company also had 55.5%, or $7 billion, of its $64 billion assets in goodwill and intangibles.
Time Warner had a book value of $23.89 billion.
Cash flow
(Time Warner Cash Flow, Quarterly Filing)
In first half 2016, Time Warner grew its operational cash flow by 9.2% to $1.97 billion, which mostly was driven from deferred income taxes and profit growth.
Time Warner allocated $162 in capital expenditures, leaving it with plenty of free cash flow at $1.8 billion. The company also placed $293 million in investment and acquisitions, while spending 113%, or $2 billion, of its free cash flow in dividends and share buybacks.
In the past three years, Time Warner allocated 174% of its free cash flow in dividends and buybacks.
Time Warner also took in $638 million in debt, including debt repayments in the first half.
Market performance
Time Warner provided a 22.33% average annual total return for its shareholders in a five-year return time frame, excluding the recent run up secondary to acquisition proposals (10). Including the recent AT&T deal, Time Warner returned 22.95% in the last five years (11). The broader Standard & Poor’s 500 index returned 14.41% in the same period.
Time Warner returned 36.64% year-to-date, while the broader index performed 6.7%.
Valuations
Time Warner had a trailing 12-month earnings multiple of 17 times (industry median: 23), book value multiple of 2.8 times (industry median: 2) and price-sales ratio of 2.5 times (industry median: 1.96).
The company also had a trailing 12-month dividend yield of 1.8% with 30% payout ratio and a 5.2% buyback ratio.
Conclusion
In review, Time Warner has a very impressive and an outstanding list of brands carried by its world-renowned business segments. The now supposedly valued $85 billion American media company also had achieved a steady growth in its corresponding segments in recent years, except for Warner Bros. in the first half of 2016 (9). Time Warner also appears to have some work to do to reduce its leverage found in its balance sheet.
Current market valuation, despite the recent agreed deal, revealed that Time Warner was still undervalued compared to its peers.
Most analysts, such as Wedbush and MKM Partners, now have adjusted their target prices for Time Warner at $105 and $107.50 a share. But using historical figures would indicate a value of $80 a share (12).
(Time Warner Shares, Google Finance)
In summary, an average of -17% loss and 22% gain seems to be reasonable for a speculative investment (13). With the end of 2017 as a suggested closing date, speculators should again ask themselves if they can stomach this duration, accompanied by hiccups along the way and also the possibility of antitrust concerns, which could lead to certain capital loss – at least, hopefully, in the short term.
Notes
(1) I am no good in the options market. I wish I could just buy call options and hope for the best and until any updates are to be announced, but owning the company’s shares may also be as beneficial.
(2) Wikipedia: In 2014, 21st Century Fox tried to buy Time Warner for $80 billion. Time Warner declined.
“Our business plans will create significantly more value for the company and our shareholders, and that’s superior to any proposal that Fox is in a position to offer.”
Jeffrey L. Bewkes, the chief executive of Time Warner, in a video for employees that was made public.
(3) Annual filing: Turner is also pursuing non-traditional distribution options for its programming and has made some of its programming available through SVOD and other OTT services, including DISH’s Sling TV and Sony PlayStation.
(4) Annual filing: The CNN digital network is a leading digital news destination, and bleacherreport.com is the number two digital sports destination, according to Time Warner.
(5) Morningstar data.
(6) Annual filing: Home Box Office is also expanding the scope of its programming to appeal to viewers who are watching programming on demand on non-traditional platforms and devices.
(i) Home Box Office’s on-demand products, HBO On Demand and Cinemax On Demand; (ii) its HBO GO and MAX GO streaming video-on-demand platforms; (iii) HBO NOW, Home Box Office’s domestic streaming service, which launched in April 2015; and (iv) its international streaming services.
(7) Annual filing: Warner Bros. also ranked as the number three U.S. videogame publisher, with two titles, Mortal Kombat X and Batman: Arkham Knight, ranked in the top 10 videogame releases in 2015.
(8) Annual filing: Warner Bros. is also actively collaborating with Turner to significantly expand their global kids businesses and maximize the related consumer product opportunities.
(9) Quarterly filing: Revenues decreased 19% ($640 million) to $2.7 billion, primarily due to lower videogames, home entertainment and television licensing revenues. Videogames revenues declined as the prior year quarter included the releases of Batman: Arkham Knight and Mortal Kombat X. Home entertainment revenues declined due to fewer theatrical home video releases in the current year quarter, including the comparison to the release of American Sniper in the prior year quarter, and lower carryover revenues. Television licensing revenues declined as the prior year quarter benefited from the second-cycle syndication of The Big Bang Theory and the subscription video-on-demand licensing of Seinfeld.
(10) Dividend Channel.
(11) Morningstar data.
(12) Five-year earnings multiple and profit growth rates. 20% margin indicated a value of $64 a share.
(13) Includes the 20% margin value as low point in case the deal did not proceed as planned.
Disclosure: I do not have shares in any of the companies mentioned, except for Twitter.
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