Wall Street Considers Time Warner's Future

Time Warner's failure to lift its fortunes with the spinoff, sale and alternative management of some assets has elicited a sour response from Wall Street, which is making the same demands when Jeff Bewkes succeeds Richard Parsons as chief executive, expected by mid-2008.

Wall Street investors and analysts should be careful what they wish for.

There are no guarantees that transforming Time Warner into a pure content media play--by selling off AOL, Time Warner Cable and the Time Inc. publishing unit--will help it perform better or achieve stock price nirvana. Such a selloff would be increasingly difficult and risky in this volatile, credit-adverse environment.

CBS, spun out of Viacom several years ago, is a pure play content company that has since struggled for respect and a fully valued stock price. Most importantly, pure content plays are completely dependent on the cyclical fortunes of hits working their way through distribution platforms, such as syndication, which are undergoing extreme digital and economic makeovers.



The streamlined scenario sought by many on Wall Street is the inverse of the empire-building drive that led Time Warner and its rivals to buy companies and expand into areas they were ill-prepared to digest. Now that their core content production and distribution businesses are in the throes of unprecedented change, there are few signs that Time Warner or many of its media brethren are any better prepared to maximize the opportunities or dodge the bullets.

Bewkes, who masterfully relaunched Time Warner's HBO a decade ago, has been at the center of Time Warner's successes and struggles since it acquired AOL. He presumably has had the opportunity to redirect Time Warner from the inside, although it is possible he could launch more aggressive and provocative moves of his own as CEO, just as Bob Iger did after succeeding Michael Eisner at the helm of Disney. Even so, Bewkes will be constrained by business realities.

For instance, new concerns are being raised about Time Warner's operational growth, based on the under-performance of its cable and AOL businesses in the second quarter, as well as the lack of strategic positioning of its content businesses. In short, the $72 billion behemoth appears to be in need of more innovative, daring direction, which is not guaranteed by the anticipated leadership change.

In a Sept. 14 note titled "Curbing Our Enthusiasm for Time Warner," UBS analysts Michael Morris and Matthieu Coppet contend that the creative content development and strategic decisions that Bewkes oversees is lagging behind peers, such as News Corp., Google and Yahoo. These are mandatory requirements for entertainment companies seeking to capitalize on the digital technology revolution and international expansion.

The UBS analysts also frown on Time Warner's continued reliance on syndicated content at its Turner cable operations, the absence of "strong, new programming," dependence on purchased films at HBO and an international strategy that is too conservative to succeed.

The UBS analysts were the latest of their ranks to lower their rating on Time Warner to neutral from buy. They also lowered their 12-month target price on the stock to $21 a share from $25 a share, and lowered their estimated value of Time Warner's 95% stake in AOL to $13 billion from $16 billion as the "challenges outweigh opportunities" for its current advertising-based operating model.

Earlier this month, Pali Research analyst Richard Greenfield lowered his rating on the company's stock to neutral, declaring he has "simply lost faith in Time Warner's executive management team and board of directors," citing complacent, dysfunctional direction and focus at all levels of the company. Parsons' contract is set to expire May 2008 and CFO Wayne Pace's contract expiring at year's-end. "We are simply surprised (given the lackluster performance of Time Warner's assets and especially its stock price) that the board is willing to allow a 'lame duck' situation," Greenfield said.

In fact, Time Warner may be unable to demonstrate significant, sustainable upside without a radical change in visionary leadership and management, which is the most unlikely scenario of all.

For years, investors and analysts hounded Time Warner to spin-off its second-largest domestic cable operations. Today, intensified broadband, phone and pay television competition has taken the value edge off of stand-alone Time Warner Cable, majority owned and controlled by the parent company. Time Warner Cable stock is down about 15% for the year (the same as Time Warner) on the deceleration of its legacy revenues and broadband subscriber additions.

Likewise, Time Warner's efforts to transform AOL from a subscriber-based to an ad-based business is being stymied by the company's legacy structure and attempts to gain ad dollars in a hotly competitive online ad market. The management style of new AOL CEO Randy Falco, and the career-long network television orientation he brings to the job, has had its ups and downs. Many analysts have concluded that the only way out is for Time Warner to align AOL with or sell it outright to a leading Internet portal or platforms, such as Yahoo or Microsoft as a major competitor to Google.

Although AOL represents "the strongest digital strategy among the traditional media companies," according to Lehman analyst Vijay Jayant, it must regain its relevance in the Internet space by differentiating its products, attracting incremental users and page views, and spinning a minority stake to a portal-and-platform focused major Internet player. Jayant values AOL, which carries no debt, at $20 billion.

Bernstein Research analyst Michael Nathanson points to the technical catalysts that could spark dramatic structural change in Time Warner. A sell-off of its cable and AOL operations could be triggered by the company's ability to distribute shares of Time Warner Cable in a more tax efficient way after the second quarter of 2008. Also, Google can float its 5% stake in AOL to the public beginning July 1, and possibly expand its holdings and partnership with the company. However, the latest string of caustic analyst reports suggest that neither Time Warner's balance sheet nor its stock price will truly benefit from playing musical chairs with its distinctive and often misunderstood assets. The most effective antidotes are difficult to come by. Chief among them is a more innovative, enterprising management of the company's prime assets that embrace the new expectations and opportunities of a digital media market-a key, but elusive ingredient for most major media concerns.

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