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A Proposal to Time Warner to Combine Two Companies

August 10, 2014 | About:

In this article, let´s take a look at a possible deal in a $1 trillion global Media industry, where a few weeks ago Twenty-first Century Fox (NASDAQ:FOXA) confirmed in a statement that its offer for Time Warner (TWX) had been rejected.

Time Warner Inc. operates as a media and entertainment company in the United States and internationally. The company operates in three segments: Networks, Film and TV Entertainment, and Publishing.

Growth Prospects

China is one of the key markets for entertainment companies. As a consequence, Time Warner wants to take position on the growing Chinese media and is investing hard. Moreover, it has launched a digital movie technology, UltraViolet, which made it possible for DVD buyers to also access movies remotely. This new tech will encourage people to keep buying movies, instead of renting or pirating them. Looking forward, upcoming affiliate contract renewals and international opportunities will be the key drivers for the firm in the upcoming future.

Fox Takeover Bid

Murdoch’s Twenty-First Century Fox is willing to pay more than $85 a share for Time Warner. The U.S. media giant has rejected an initial takeover approach from its rival, estimated at $80 billion.

The deal could reshape the media industry by giving the TV-and-film companies bargaining power in negotiations with cable operators such as Comcast Corp. (NASDAQ:CMCSA) and Time Warner Cable Inc., which are in the process of their own merger.

Guru´s Opinions

Ken Griffin, chief executive officer of Citadel LLC, who has a $20 billion investment firm held stakes in both companies as of March 31. This guru said the deal makes sense for the company’s shareholders. “Murdoch has a history of being willing to go the extra mile to get deals done that are important to him” Griffin said.

Further, Mario Gabelli (Trades, Portfolio), CEO of Gamco Investors Inc., who holds about 4 million shares in Time Warner and 10 million shares in Fox, called it “hard for a board to turn down”in reference to the deal. Lastly, John Paulson (Trades, Portfolio), from Paulson & Co., said the surge presents arisk for investors still pondering whether to purchase Time Warner ahead of a potential deal. Time Warner's share price jumped in the first 20 minutes by more than 16% on the exchange to $82.62 per share. In Paulson opinion “if you buy Time Warner stock at $83, is Murdoch comingback and how high would he pay to make sense for shareholders …. And if he doesn’t comeback, the stock is up $12 today and could potentially fall. It’s not a slam dunk as to what the outcome will be”.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 20.2x, trading at a discount compared to an average of 23.0x for the industry. To use another metric, its price-to-book ratio of 5.5x indicates a discount versus the industry average of 2.74x and the price-to-sales ratio of 1.85x is above the industry average of 1.7x.

Earnings Per Share (EPS) rose significantly by 7% in the most recent quarter compared to the same quarter a year ago ($1.76 vs $1.64). Also, it has demonstrated a positive trend in EPS growth over the last years. In the next graph we can see the stock price evolution because growing EPS often lead to appreciation in share price.


Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The company has a ROE which is at a level of 28.14% and is higher than 93% of the companies in the industry. This valuation might attract investors.

Final Comment

Time Warner appears to be in a bullish trend due to a huge potential media deal. In addition to the advantages we discussed in the article, Time Warner’s sports coverage rights andtelevision production studio would be very valuableto Fox. I think that combining resources would generate more savings by not having to run duplicative functions.

Time Warner still has good upside potentialdespite the fact that it has already risen in the past year.I believe it was undervalued and because of that share price increased by more than 16%, so I would advise fundamental investors to consider adding Time Warner to their portfolios as it seems to be an attractive option.

Hedge fund gurus Jim Simons (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Andreas Halvorsen (Trades, Portfolio), Steven Cohen (Trades, Portfolio), Murray Stahl (Trades, Portfolio) and Scott Black (Trades, Portfolio) added this stock to their portfolios in the first-quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned

About the author:

Omar Venerio is capital markets, derivatives, corporate finance and financial management professor. He is passionate about the stock market and providing independent fundamental research and hedge fund and insider trading-focused investigation.

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