Time Warner Looking Solid from Where We Sit - David Bank, RBC Capital Markets

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Time Warner has provided a convincing framework for high-teens adj. EPS growth through 2018 driven by visible affiliate revenue, content monetization, brand/product expansions, and expense management. Completion of select carriage deals at Turner and an HBO affiliate revenue ramp could provide further support to sentiment.

Key points:

Long-Term Outlook Remains Unchanged. TWX reiterated its 2015 adj. EPS guidance of $4.60-$4.70 despite 2Q15 coming in $0.22 above our in-line forecast, which we believe was largely a result of timing. Management indicated that it would not update multi-year guidance on a quarterly basis which caused some investor confusion, especially in light of commentary from peers over the long-term outlook of cable networks. However, we already had not expected TWX to revisit long-term guidance – in either direction – every quarter in addition to the company's typical update on current-year guidance. While FX headwinds are a reality and sub growth could end up being less robust than anticipated when the guidance was initially issued resulting in vulnerability to adj. EPS targets of "close to $6" for 2016 and "over $8" for 2018, our forecasts are largely unchanged and we remain convinced in a high-teens adj. EPS growth outlook for TWX.

Turner and HBO Affiliate Revenue Ramp on Track. Management stated that domestic sub revenue at Turner is still on track for teens growth in 2016 and 2017, and we continue to believe that wrapping up carriage deals with the final two of the top five/ten affiliate partners (expected by CYE-16) will support sentiment and help investors to refocus on the attractive nature of Turner's relatively more contractual and less advertising-exposed revenue mix compared to peers. While it's too soon to evaluate either the demand or the revenue potential for HBO Now as the initial wave of trial-subs roll off and the offering expands to new platforms (e.g., Amazon, Google, etc.), we are encouraged that less than 1% of HBO subs thus far have left the Pay-TV bundle to get HBO Now, which should alleviate near-term concerns over cannibalization of the existing sub base. We continue to expect an affiliate revenue ramp at HBO from 4.0% in 2015 to 7.3% in 2016 driven by increased sub growth and its monetization from improved terms with the distributors plus the launch of HBO Now.

Lowering 2H15 Estimates; 2015E Remains Unchanged. Given the 2Q15 beat and reiterated 2015 guidance, we are lowering our 2H15 forecasts primarily on: (1) trimmed Turner affiliate and ad revenue on guidance/FX partially offset by lower costs, now more 4Q-weighted; (2) lowering HBO forecasts as the Amazon delivery hit 2Q plus higher HBO Now costs; and (3) tempering our 3Q Warner Bros. OI forecast. Our 2015 adj. EPS estimate remains at the midpoint of the reiterated guidance of $4.60-$4.70 at $4.65 while our FY16 forecast comes down $0.02 to $5.73.


Based on our valuation methodology, we derive a $95 price target for Time Warner based on the average of our sum-of-the-parts, DCF, and P/E multiple valuations.

Price target impediments:

Continued deterioration in global macroeconomic conditions could have an adverse effect on Time Warner's businesses. Virtually all of Time Warner's businesses are exposed to the global economy. A continued deterioration would likely have negative consequences for Time Warner's cable, film, print, and interactive businesses, among others, and consequently our price target.

Much of Time Warner's business is based on consumer preferences for content, which can be difficult to predict. The hit-driven nature of the company's content-driven business can be volatile and is based on consumer preferences, which can change rapidly. An unexpected shift in these preferences could affect Time Warner's operating results and, therefore, our price target.

Excess cash could be a dilutive acquisition waiting to happen. With a significant amount of cash or cash availability on its balance sheet, Time Warner could choose to make an acquisition with unfavorable economics to the business. Any such acquisition could be dilutive to earnings and/or have an adverse effect on the company's multiple.

A decline in advertising expenditures could materially affect Time Warner's operating results. The company's business has significant exposure to overall advertising expenditures. An adverse change or decline in overall advertising expenditures could negatively affect many of the company's business units and also our price target.

The loss of carriage agreements presents risk. A large portion of Time Warner's businesses depend heavily on the carriage of the company's cable channels on multi-system operators (MSOs). A loss of these carriage agreements could adversely affect affiliate and advertising revenue as well as our price target.

Growth in piracy could threaten Time Warner's business. The company's business depends heavily on the protection of its intellectual property. Significant growth in the distribution of the company's intellectual property by others without proper authorization or compensation (piracy) could materially affect the company's operating results and also our price target.

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