Description

There have been a few Time Warner write-ups, including the most recent, very good write-up from Aggie.  There has also been an active thread.  Please refer to those for background.

TWX currently has an Enterprise Value of ~$83B.  The individual value of TWX’s businesses, HBO, Turner, and Warner Bros., is well over $83B. 

HBO

In 2015, HBO can earn at least $2.3B in EBITDA.  At 15x EBITDA, HBO is a $34.5B business.  15x EBITDA may be low, given that Netflix is trading at ~40x EBITDA and now has a market capitalization roughly 40% of TWX’s entire market capitalization.  Netflix is HBO’s only real peer company.  Some may view Netflix’s EBITDA multiple as a misleading valuation reference because Netflix is reinvesting domestic profits into international losses.  That is fair.  What matters more is that the market is going to ascribe a higher valuation to a high-growth, global, branded subscription video business with an addressable market that will include every broadband subscriber that pays for video.  The subscription business is easier to evaluate, less economically sensitive, and can maintain pricing power with great programming and service.  

            HBO’s multiple should also benefit from the fact that HBO has growing strategic value to other content companies that would may want to bundled and sold with HBO, and to video distributors that will need to have exclusive, original programming to compete with Amazon Prime, Netflix, Hulu, and the multitude of other streaming services. 

Turner

Consensus EBITDA for Turner for 2015 is $4.4B.  At 10x EBITDA, in-line with peers, Turner is a $44B business.  One could argue that Turner should have a higher multiple given that CNN and Cartoon Network are distinct branded content platforms with monetization potential across different platforms.  Few channels have the brand recognition and digital reach to become stand-alone businesses.  Turner’s leading scale in Latin America, it is the largest pay-television provider in the region, may also command a premium because of the favorable growth characteristics of the Latin American television market. 

HBO + Turner

HBO + Turner equals between $78B-$90B, depending on the multiple given to HBO.  This means that an investor is paying not very much, or is getting paid, for Warner Bros., which owns probably the most valuable film and television library, the most valuable television production business, and the second most desirable portfolio of branded intellectual property outside of Disney (i.e. Looney Tunes; Hanna Barbera; DC Comics).  DC Comics itself could be worth anywhere from $5-$10B, based on the p/s multiple of the Disney/Marvel transaction in 2009.  DC would have immense value to any foreign strategic buyer that wants to collect enduring branded content properties. 

            Warner Bros. should do between $1.4B-$1.7B in EBITDA in 2015; these projections are subject to fluctuations depending on box office variability.  American Sniper is a good start (though I am not sure what the economics are to Warner given that it was a co-production with Village Roadshow).  Lions Gate and MGM, the two closest pure-play movie and television production assets with valuable libraries, trade at 14-17x EBITDA (MGM figure is LTM Sept 2014 from Capital IQ-MGM trades over the counter).  Warner Bros. is more valuable than both of them due to the depth of its library, its scale in movie and television production, and the quality of its intellectual property portfolio.   If there is any strategic transaction involving a control premium for Lions Gate or MGM, Warner’s discount will become apparent.    

At the big investor day on October 15, 2014, TWX projected 2016 EPS of $6.  The $6 does not include any incremental profit from a stand-alone HBO service.  Based on TWX’s estimates, the stock currently trades at 13.4x 2016 earnings, a good price for a business with assets of this quality.

 Why Does this Matter Now

The sum-of-the-parts valuation disconnect matters now because of a few key events of the last year:      

            First, TWX rejected a bid from Fox to acquire TWX for a value of ~$85/share in June-July 2014.  TWX did not negotiate.  TWX stock is currently trading $5 below the offer price.  TWX is also trading a lower p/e than Fox or Disney, its two closest peers.

            Second, in 2015, TWX is going to offer a stand-alone HBO offering for the first time.  While TWX has not given any indication when the product may debut, it is reasonable to expect that it would be by April, to coincide with the season 5 premiere of Game of Thrones, which is HBO’s most popular show.  The fanfare and publicity would benefit both the stand-alone service and Game of Thrones.  HBO’s domestic subscriber growth has been restrained by the size of the premium, linear subscription video market.  Offering a stand-alone HBO product should help expand HBO’s growth and valuation.

            Third, Netflix is growing quickly, both domestically and abroad.  This poses a threat to incumbent video distributors who are now forced to enter the streaming business to protect their video subscribers bases.   To compete with Netflix, these distributors will need to offer subscribers exclusive, premium original programming.  HBO is the best alternative to Netflix.  This should give HBO meaningful leverage in any licensing agreement or distribution arrangement, should HBO choose to partner with distributors.     

Risks

1)TWX could delay the HBO offering.  This is doubtful but possible

2)The HBO OTT offering could disappoint; people may not sign up; the service could be slimmed down and unattractive; or less people than forecast sign-up.  If one were going to make a bet on people signing up, now would be a good time because of the strength of HBO’s current programming line-up. 

3) The advertising market could get worse, thereby hurting Turner’s earnings (~45% of Turner’s revenue is advertising related).  However, if advertising is down across the board, presumably streaming, on-demand services are benefitting.  That should make HBO more valuable

4) My multiple assumption on HBO could be aggressive.  The market may not give HBO a high valuation for fear of competitive threat from Amazon and Netflix.  I think my multiple assumption of 15x EBITDA for HBO is low.

Catalyst

The value of the individual businesses continues to grow but the multiple of the combined business does not