January 07, 2015 Time Warner Inc. Current Recommendation Prior Recommendation Neutral Date of Last Change 01/07/2015 Current Price (01/06/15) $82.30 Target Price $90.00 SUMMARY DATA OUTPERFORM 52-Week High $87.36 52-Week Low $61.52 One-Year Return (%) 22.29 Beta 1.17 Average Daily Volume (sh) 3,224,498 Shares Outstanding (mil) 838 Market Capitalization ($mil) $69,007 Short Interest Ratio (days) 2.17 Institutional Ownership (%) 83 Insider Ownership (%) 1 (TWX-NYSE) SUMMARY We believe Time Warner s initiatives such as foraying into new markets, divestment activities and digital endeavors augur well for its operating performance. This is quite evident from the company s better-than-expected third-quarter 2014 results. Moreover, the company s investments in programming, production and marketing, coupled with its focus on operating and capital efficiencies bode well. Also, the company has been expanding its digital presence to facilitate consumers to enjoy contents on more platforms and devices. In our view, management s projection of high-teens growth in earnings per share for 2014 seems quite achievable. The stock also looks attractive from valuation perspective. The above factors highlight the strong fundamentals and unveil the hidden bullishness in the stock. Consequently, we upgrade our recommendation to Outperform. Risk Level * Below Avg., Type of Stock Large-Blend Industry Media Conglomerate Zacks Industry Rank * 224 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $1.27 Dividend Yield (%) 1.54 5-Yr. Historical Growth Rates Sales (%) 2.1 Earnings Per Share (%) 16.9 Dividend (%) 10.2 using TTM EPS 19.2 using 2015 Estimate 17.4 using 2016 Estimate 14.3 Zacks Rank *: Short Term 1 3 months outlook 2 - Buy * Definition / Disclosure on last page 2013 6,207 A 6,608 A 6,042 A 7,599 A 26,456 A 2014 6,803 A 6,788 A 6,243 A 7,574 E 27,408 E 2015 7,057 E 7,132 E 6,693 E 7,952 E 28,834 E 2016 30,669 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.76 A $0.76 A $0.91 A $1.17 A $3.60 A 2014 $0.91 A $0.98 A $1.22 A $1.06 E $4.17 E 2015 $1.12 E $1.13 E $1.16 E $1.32 E $4.73 E 2016 $5.77 E Quarterly figures may not add up to annuals due to rounding off. Figures adjusted for divestment of Time Inc. Projected EPS Growth - Next 5 Years % 13 2014 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Based in New York, Time Warner Inc. is a media and entertainment company. The company s businesses include interactive services, cable systems, filmed entertainment and television networks. Time Warner aims to gain competitive advantage from opportunities for constructive collaboration. The company is a vertically integrated media conglomerate with a material online presence. In addition, the company has the largest collection of content and distribution assets in the industry. Furthermore, Time Warner uses its industry-leading operating scale and brands to create, package and deliver high-quality content globally through multiple distribution outlets. The company has three reporting segments: Turner, Home Box Office and Warner Bros. In a strategic move to unlock the value of its core business activities, Time Warner spun off Time Inc. magazine into a separate, publicly traded company. REASONS TO BUY Healthy 3Q14 Results, Lays the Foundation for Future Quarters: The strength witnessed across Turner, Home Box Office and Warner Bros. facilitated Time Warner to deliver better-than-expected third-quarter 2014 bottom-line results. Lower shares outstanding also provided cushion to the bottomline. Including the positive surprise of 29.8% for the recent concluded quarter, the company has surpassed the Zacks Consensus Estimate in the last 10 quarters. We believe the company s initiatives such as foray into new markets, divestment activities and digital endeavors would help it to continue with its upbeat performances in the coming quarters. The company s investments in content and technology in the recent years have also boded well. Management now expects high-teens growth in adjusted earnings per share for 2014 against low-teens increase forecast earlier, which seems quite achievable. Management expects to attain earnings per share of about $6.00 and over $8.00 by 2016 and 2018, respectively. Significant International Presence: Time Warner s significant international presence has helped broaden its client base and product portfolio. Time Warner operates in the United Kingdom, Germany, Canada, France, Japan and other countries apart from the United States. We believe that its strong international exposure will drive growth in the coming quarters. Turner is now concentrating to enhance its reach in existing territories through investments in local production and gaining distribution right for new networks. It is also augmenting its operations in Western Europe. It also entered into a partnership with China s leading media and entertainment investment fund, China Media Capital. In our view, the move is a perfect fit for Time Warner as it has been looking to expand its presence in the Chinese entertainment market. Moreover, Time Warner with its strong content and industry leading portfolio of renowned brands is likely to benefit from the largest and fastest growing Chinese media sector. In recent years, China has emerged as an important market for media and entertainment companies. Augmenting Digital Presence: The company has been expanding its digital presence to facilitate consumers to enjoy contents in more platforms and devices. Time Warner enhanced the reach of HBO GO streaming service to mobile devices. Time Warner will also launch an independent online streaming service from this division to target consumers who have access to the Internet but are not subscribers of cable. Moreover, Warner Bros. became the first movie studio to offer video on demand, and acquired Flixster, a movie search application on smartphones and mobile devices. The company also launched a digital movie technology UltraViolet that facilitates consumers to watch movie on their preferred Internet-connected devices. The device is available in the U.S., Canada and the U.K., and is making technology available in Australia, France, Germany, Ireland and New Zealand. Equity Research TWX Page 2
Expanding Reach: Time Warner entered into agreements with both Time Warner Cable and Cablevision that helped bring availability of HBO GO and MAX GO to HBO s entire domestic subscriber base. HBO GO is now available on the Xbox, Samsung TV, the Kindle Fire and Android tablets. The company also launched HBO Netherlands. Warner Brothers and Turner Broadcasting System have also entered into a content deal with Netflix. The company now has 100% stake in HBO Asia and HBO South Asia. Active Management of Cash Flows: Time Warner has been actively managing its cash flows returning much of its free cash to shareholders via dividend and share repurchases. During the third quarter, Time Warner incurred capital expenditures of $110 million and generated free cash flow of $575 million. From Jan 1 through Oct 31, the company bought back about 69 million shares, aggregating approximately $4.9 billion. As of Oct 31, the company still had $5.1 billion remaining at its disposal. RISKS Advertising an Inherent Risk: Time Warner derives considerable revenue from advertising on its networks, syndicated programming and online properties, and a decline in advertising spending overall or fall in demand for the company s offerings could significantly affect its performance. Advertising depends upon the health of the economy, and it has been seen that the demand for advertising drops during recession. In such a scenario the upfront advertising purchases may get cancelled and the company will be under tremendous pressure to lower the pricing. Competitive Pressure: The company faces intense competition across its different segments. To compete effectively in the Networks and Filmed Entertainment segments, Time Warner has to provide high-quality, popular entertainment products, adapt to new technologies and distribution platforms and achieve widespread distribution. Competitors will always look to grab market share by offering lower prices, new services or services that are different from those offered by Time Warner. Adverse Foreign Currency Fluctuation: Even though Time Warner s international presence helps to widen its customer base among other positives, fluctuations in currency exchange rates can adversely impact the company s international sales. RECENT NEWS Time Warner Beats on Q3 Earnings, Raises Earnings Outlook November 5, 2014 Time Warner Inc. posted third-quarter 2014 adjusted earnings of $1.22 per share that surpassed the Zacks Consensus Estimate of $0.94, reflecting strength across Turner, Home Box Office (HBO) and Warner Bros. The company's investments in video content and technology continued to show results. Management now expects high-teens growth in adjusted earnings per share for 2014 against low-teens increase forecast earlier. Time Warner's total revenue of $6,243 million jumped 3% year over year and came ahead of the Zacks Consensus Estimate of $6,129 million. Equity Research TWX Page 3
Adjusted operating income plunged 38% to reach $993 million due to restructuring and severance costs witnessed across all divisions as well as charges associated with the stopped airing of certain Turner programming. In a strategic move to unlock the value of its core business activities, Time Warner spun off its magazine division into a separate, publicly traded company, Time Inc. (TIME). Time Warner had earlier divested Time Warner Cable Inc. (TWC) and AOL Inc. into independent companies. The company now concentrates purely on television networks and film and TV production businesses. After thwarting an $80 billion bid by Rupert Murdoch, CEO of Twenty-First Century Fox, Inc. (FOXA), Time Warner has taken restructuring aggressively. As per an internal memo, Time Warner, which is confident of performing better as a standalone company, will be focusing on original programming, reducing costs and increasing investments in key areas to enhance profitability. According to media reports, the company has undertaken headcount reduction as part of its restructuring. Segment Details Turner division's revenues rose 5% to $2,446 million, driven by growth of 10% in subscription revenues and 17% in content revenues, partially offset by a 2% decrease in advertising revenues. Higher subscription revenues were primarily attributed to a rise in domestic rates and international growth. Advertising revenues declined due to fall at Turner's international networks. Adjusted operating income for the segment plummeted 64% to $350 million due to steeper in programming expenditures and higher restructuring and severance charges. Time Warner's HBO segment revenues grew 10% to $1,304 million driven by growth of 10% in subscription revenues and 7% in content revenues. Higher subscription revenues were primarily attributed to a rise in domestic rates and subscribers and the merger of HBO Asia and HBO South Asia. On the other hand, content revenues increased on account of a rise in home video revenues. Time Warner will also launch an independent online streaming service from this division to target consumers who have access to the Internet but are not subscribers of cable. Adjusted operating income for the division declined 4% to $380 million because of increased programming and distribution expenses as well as higher restructuring and severance charges. Warner Bros. revenues advanced 3% to $2,775 million buoyed by an increase in video-on-demand revenues for television product, rise in licensing of theatrical product and growth in television production, partially offset by a sluggish theatrical performance. Adjusted operating income for the division fell 20% to $241 million due to higher restructuring and severance charges, increase in film costs for television product and a value added tax accrual. Other Financial Aspects Time Warner ended the quarter with cash and equivalents of $3,210 million, long-term debt of $21,389 million and shareholders' equity of $25,230 million. During the quarter, Time Warner incurred capital expenditures of $110 million and generated free cash flow of $575 million. From Jan 1 through Oct 31, the company bought back about 69 million shares, aggregating approximately $4.9 billion. As of Oct 31, the company still had $5.1 billion remaining at its disposal. Equity Research TWX Page 4
VALUATION Time Warner s current trailing 12-month earnings multiple is 19.2X, compared with 17.5X, the industry average and 18.6X for the S&P 500. Over the last five years, Time Warner s shares have traded in a range of 11.4X to 20.4X trailing 12-month earnings. The stock is also trading at a discount to the industry average based on forward earnings estimates. Our target price of $90.00, 19.0X 2015 EPS, reflects this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Time Warner Inc. (TWX) 17.4 14.3 12.9 6.4 19.2 20.4 11.4 Industry Average 20.2 18.2 9.9 7.8 17.5 132.5 14.3 S&P 500 16.1 15.1 10.7 15.9 18.6 19.4 12.0 Walt Disney Co. (DIS) 19.9 17.1 8.7 16.0 21.4 22.3 11.9 CBS Corporation-A (CBS.A) 14.1 17.9 26.1 11.3 Viacom Inc.-B (VIAB) 12.2 10.7 10.6 4.5 13.5 18.2 10.2 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Time Warner Inc. (TWX) 2.9 2.9 1.0 13.9 0.8 1.5 6.0 Industry Average 3.6 3.6 3.6 23.6 1.2 1.3 7.3 S&P 500 5.1 9.8 3.2 24.8 2.0 Equity Research TWX Page 5
Earnings Surprise and Estimate Revision History Equity Research TWX Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of TWX. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1143 companies covered: Outperform - 15.6%, Neutral - 78.5%, Underperform 5.7%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research TWX Page 7