Time Warner’s key business risks are cyclicality and its competitive position. Advertising accounts for about 25% of overall sales, which is lower than media conglomerate peers but still an important part of the company’s business model. Time Warner’s best business, its cable networks (about 60% of cash flow), generate about 30% of its sales from national advertising (the other 70% are affiliate fees). Many forecast long-term cash flow declines in the firm’s AOL, filmed entertainment, and publishing businesses.
The company continues to return capital to shareholders through share repurchases and dividends. Since the start of 2009, Time Warner has repurchased more than 25% of its outstanding shares, and in the first quarter of 2013, the firm repurchased 12 million shares. Still, Time Warner’s net leverage has remained just under its target of 2.5 times, and we are not concerned with such high returns to shareholders. Additionally, the strong growth at the cable networks and filmed entertainment businesses that continues to boost the firm’s results gives us comfort.
The firm’s five-year Cash Flow Cushion is above 1 times the base-case expense and obligation forecast, indicating that Time Warner should have no difficulty meeting its debt maturities. Still, share repurchases are not included in this calculation and have the potential to eat away at cash available to debt holders, leaving the company to refinance debt instead of repaying it. Financial Health Time Warner’s financial health is solid. The firm’s EBITDA is set to cover its interest expense 8 times, on average, during the next five years.
Time Warner’s current capital structure is reasonable and likely to be sustained. The firm targets a net debt/EBITDA ratio of between 2 and 2.5. Debt/capital and total debt/EBITDA are 0.33 and 2.4, respectively. Enterprise Risk Time Warner’s results could suffer if the company doesn’t adapt to the changing media landscape. Basic video service rates have continued to increase, which could cause consumers to cancel their video subscriptions or reduce their level of service.
The cost of HBO for U.S. subscribers is $15 per month on top of the cost of a basic video package. DVD sales are a key profit contributor to its filmed entertainment segment and sales have been pressured due to cheaper rental alternatives, which generate less revenue Time Warner’s portfolio of cable networks, which includes HBO and owned HBO content, generates about 70% of overall cash flow.
Establishing a new basic cable network that reaches 100 million households, developing worthy content, and gaining distribution agreements require a huge up-front investment. For example, a new or up-and-coming network may be rejected by some distributors, and even willing partners could require incentive payments over several years to get carriage. Networks such as TBS, TNT, and CNN are among the most widely distributed and watched cable networks and generate a steady stream of affiliate fees through long-term agreements with distributors as well as advertising dollars.
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