Why You Should Own Time Warner

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Time Warner (TWX) is one of the world’s leading entertainment companies. The company owns AOL, 84% of Time Warner Cable (TWC) , Warner Brothers, HBO and a leading stable of cable networks including TNT, TBS and CNN. Time Warner also still owns its iconic magazine titles including Time, People and Sports Illustrated.
In early 2009, Time Warner will split off TWC, leaving TWX as a pure-play content company. Presently, TWC produces approximately half of EBITDA. After the split, the new TWX will get more than half its EBITDA from Cable Networks, with AOL and Filmed Entertainment (movie and TV production) generating another 20% each. The balance will be from magazine publishing. New TWX will have about $29 billion in sales and $6.4 billion in EBITDA. Debt will be $9 billion to $10 billion, less than 2 times EBITDA, leaving TWX with the best balance sheet in major media. Free cash flow will likely be $2 billion to $3 billion.
Adjusted for the TWC split, TWX is trading at less than 5 times 2009 EBITDA and about 7 times EPS. I am assuming that EBITDA will fall by 12% in 2009. This is below consensus, which is falling.
Short-Term Catalysts
Valuation-based ideas have not worked as the market crashed, but TWX is really cheap. In this case, cheap will matter because the split from TWC provides a catalyst to recognizing the value. TWC shares have outperformed TWX shares, making TWX shares cheaper post-split. Once the split is finalized, investors will look at New Time Warner and see a mix of assets that have low capital intensity and produce high free cash flow. The company will have a remarkably good balance sheet, making a material dividend or share buyback or an accretive acquisition a positive outcome.
Time Warner is also attractive at the operating level. AOL and Publishing are going to struggle in 2009, with double-digit declines in advertising. The film and TV businesses should be flattish in 2009; cable networks remain the best-performing media assets, and Time Warner’s nets have been leading the industry for more than a year. About 70% of Time Warner’s operating income should be down no worse than 5% in 2009, a good performance relative to media and many other consumer discretionary sectors.
Long-Term Drivers
Time Warner will have one of the most attractive asset mixes among diversified media companies after the TWC split. Both the growth and free cash flow profile will be attractive. Eventually, AOL will be resolved, either by turning it around or (more likely) by selling it. Any outcome for AOL wherein Time Warner reduces its exposure is bullish.
Time Warner will also benefit long term from the relatively poor management over the past decade. Time Warner’s margins are below peers such as Disney (DIS) and News Corp. (NWS.A) , as is the consistency of its financial results at its film studios and cable networks. It seems backward, but the historically poor performance gives Time Warner more room to pull its financial results up to its peers, thus driving superior growth.
After the split, look for a big share buyback, material dividend, accretive acquisition or possibly a combination of all three. Depressed valuations across media dramatically reduce the risk that Time Warner uses its stellar balance sheet to make a dilutive acquisition.
What Could Go Wrong
The overwhelming risk for TWX shares is that advertising deteriorates further, driving 2009 financial results significantly below even the lowest estimates. Given negative sentiment toward AOL and Publishing, any accelerated decline in cable network advertising would be especially painful for TWX shares.
There is also a risk that the TWC spilt falls apart due to the current turmoil in the credit markets and the need for regulatory approval, which continues to drag out. Spending all of its cash on acquisitions as opposed to share buybacks or dividends would also be a disappointment.
My Position
I am long TWX for my clients and in my personal accounts. I started buying my position in early August at $14.87. My most recent trades came this week when I averaged down for some clients between $8 and $8.60.
The Bottom Line
The pending split of TWC and creation of new Time Warner is a positive catalyst. Time Warner will be left with two business generating 70% of profits that should hold together fairly well in 2009. The balance sheet will be very strong, providing plenty of options for enhancing shareholder value. Margins are below par and management is just beginning to implement strategies that have worked well for peers. For the short term or over the long haul, TWX looks like a winner.

Why You Should Own Discovery Communications

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Discovery Communications (DISCA) is one of the world’s largest providers of cable networks, with projected 2008 revenue in excess of $3.4 billion. The company operates over 100 channels around the world in more than 170 countries reaching 1.5 billion subscribers. In the U.S., its best-known networks are Discovery Channel, TLC and Animal Planet.
DISCA is currently trading at $13.45. The 52-week high was $28.35 on Dec. 13, 2007. The 52-week low occurred on Oct. 24, 2008, at $10.02. The current market cap is $5.7 billion. Debt totals $3.9 billion. At year-end, cash should be over $300 million. DISCA should produce north of $500 million in free cash flow in 2009. Assuming flat 2009 EBITDA, net debt to EBITDA at Dec. 31, 2009, would be about 2.4 times, indicating the DISCA is not heavily leveraged. The debt currently consists of bank facilities, so some refinancing exists.
The consensus earnings-per-share estimate for 2008 is $1.09. For 2009 the estimate is $1.12. At $13.45, the price-to-earnings ratio for 2008 and 2009 is about 12.4. Media stocks commonly trade on EBITDA multiples. On the basis of my 2008 estimate, DISCA is trading at 7.1 times earnings. For 2009, the EBITDA multiple is 6.3 times. On both P/E and EBITDA, DISCA trades at a premium to the big four entertainment companies (Viacom (VIA.B) , Time Warner (TWX) , Disney (DIS) and News Corp. (NWS) ).
Why You Should Own DISCA for the Short Term

DISCA has the best earnings momentum among major media stocks. Recently reported third-quarter results were a significant positive surprise. DISCA raised its guidance for 2008. That is right, in the midst of all the gloom, DISCA just reported a good old-fashioned “beat and raise” quarter. As a result, analyst estimates for 2008 and 2009 have risen over the past 30 days. This relative strength in DISCA’s earnings profile is the best reason to own the stock today.
DISCA shares have responded to its earnings performance. The stock is down about 20% since mid-September, easily outperforming the market and massively outperforming other media stocks, many of which are down 50% to 80%. The relative performance of the shares leaves the technical status of the stock in fairly strong position.
DISCA has less exposure to advertising than most other media stocks (40% of projected 2009 revenue) and affiliate fees, its largest revenue stream, representing 48% of revenue, will grow to contractual increases in both subscriber counts and monthly subscriber fees. In addition, DISCA’s advertising revenue is somewhat insulated by a growing subscriber base internationally, solid ratings at its U.S. networks, and below-average pricing on its international advertising inventory.
Finally, in both the near term and long term, DISCA’s operating income growth is being driven mostly by margin expansion at its international networks, which are significantly less profitable than its U.S. networks despite more synergies than any other cable network provider.
Why You Should Own DISCA for the Long-Term

DISCA’s competitive advantage is its focus on nonfiction programming. Nonfiction programming provides the company with three distinct advantages. First, it looks great in high definition. Second, it is often narrated, allowing it to be easily used regardless of the spoken language of the viewer. Third, it is cheaper to develop and create.
Rising margins are driving DISCA’s long-term financial performance. Margin expansion is coming mostly from abroad, where the 34% margin in 2008 pales next to the 53% margin for the company’s U.S. networks. Because of the advantages of nonfiction programming, management should be able to increase margins steadily and independent of a weak advertising environment.
Margins should also benefit in the U.S. as certain channels are rebranded with the hope that ratings will improve. Planet Green, Investigation Discovery and the Oprah Winfrey Network are three examples of newly branded networks that offer upside, given that they are widely distributed (over 50 million households) but are producing no profits.
Finally, DISCA is an attractive acquisition for any of the major media companies. The dual revenue stream of subscriber fees and advertising make the cable network business attractive. Each of the big four entertainment companies would like to expand in cable networks. Several of these companies will be flush with cash when the credit markets normalize. Cable networks acquisitions historically have been at premium EBITDA multiples, providing upside of 50% to 100% if DISCA were to be sold in the near future.
What Could Go Wrong
DISCA trades at a premium to its peers and has had positive earnings momentum. A negative surprise would cause the stock to take a very hard hit. DISCA is also vulnerable to negative sentiment and further downgrades in advertising growth. The rebranding of channels could fail. Non-U.S. revenue is significant leaving the company’s financial results vulnerable to currency fluctuations.
My Position
I am long DISCA for my clients and in my personal accounts. I started buying my position in mid-September at $16.50. My most recent trades came in mid-October, when I averaged down for selected clients between $11 and $12.

The Bottom Line
DISCA has positive earnings momentum and lower estimate risk than most other media stocks. Operating income growth is under a greater degree of management control, since it is driven by margins more than revenues. The stock acts well, indicating an underlying bid that would make DISCA shares a leader if media stocks come back into favor. A takeover bid provides downside support.

Latest Market Comments

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The market has just been brutal. I have incorrectly thought the whole way down that stocks were reflecting a worse economic reality than was likely to occur. Obviously, this view has been proven wrong. I do believe that the market and the economic outlook are now in sync but that won’t help until the economic outlook stabilizes. If we magically could declare that the economy will be “really terrible but we promise it won’t be worse than terrible” the market would stage a very big rally. It is the fear of unknown, which grows every day the market collapses, that is now driving the devastation in individual stocks.
There is a total lack of confidence in any forward looking estimate. Therefore, even when it is obvious that a company’s business will not collapse the stock can be priced as though it will. For example, News Corp or CETV stocks are falling so rapidly that it suggests their revenues will collapse, down 50% or more. Yet, any realistic assessment of the likely demand for TV advertising or satellite TV subscriptions or subscriptions to the Wall Street Journal would show a worst case scenario where revenues fall 20%.
Maybe I am wrong and the downside is really as severe as the stock prices imply. One thing that makes it difficult for me is that I have an innate optimism. I have never believed doomsday scenarios. I just believe that things generally work out. The current market is telling me I am wrong.
There really seem to be just two things that can turn us hard upward. First, though it sounds stupid, we just need to go up. Investors are so scared and have been burned so badly with every buy since September that just a few days of upward momentum would remind us that you can in fact make money by buying. It may seem odd to those who don’t play in the market every day but what I am saying is that there will be many more buyers of a stock that has gotten destroyed at $20 or $30 or $40 than at $10. Right now, everyone is taking their signals from price. That needs to change.
Second, we need some good news. Either the macroeconomic outlook needs to stabilize or individual companies need to prove that the stock price is wrong compared to their ability to earn even in a severe global recession. I think lots of companies can do that. Just this week Dell and Hewlett Packard did that.
My optimism remains. This horrible period will pass. I know that Northlake’s strategies and stock picking work. They worked in 2005, 2006, 2007, and until late September 2008. They will work again.

Why You Should Own Dreamworks Animation

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This will be the first in a new series of columns I will write titled “Why You Should Own…”
The first stock is Dreamworks Animation (DWA) . DWA is currently trading at $21, a new 52-week low. The 52-week high was $32.73 on Sept. 2. The market cap is $1.9 billion. At the end of 2008, DWA should have about $350 million in cash and less than $100 million in debt. DWA pays no dividend.
The consensus estimate for 2008 is $1.82. For 2009, the estimate is $1.67. At $21, the P-E on 2008 is 11.5. For 2009, the P-E is 12.6. The lower 2009 estimate is because there are minimal revenues from Shrek, DWA’s most profitable franchise.

Why You Should Own DWA for the Short Term
DWA has very positive earnings momentum that should hold through at least the first half of ’09. The fourth-quarter 2008 estimate has risen over the last 90 days. The momentum is being driven by success earlier this year from Kung Fu Panda. Panda grossed $215 million domestically and $416 million abroad, making it DWA’s most successful film besides the Shrek series. Even with a $130 million production budget and another $100 million plus for marketing, the film is profitable before DVDs. The DVD just went on sale and immediately went to No. 1 on the charts.
DWA will also benefit in the near term from the successful release of Madagascar: Escape 2 Africa on Nov. 7. The film is on track to match Kung Fu Panda and exceed the original Madagascar. While the timing of revenue and expense recognition means that Madgascar 2 will not contribute greatly to EPS in the near term, the success is a great confidence boost for meeting or even beating 2009 estimates, something that very few companies can now offer.
DWA has two other near-term catalysts. First, on Dec. 10. the company will be holding its first- ever analyst meeting. DWA has lots of good things to say about the near term and long term, so the timing is good.
Second, Shrek the Musical debuts on Broadway in December. On its own, the musical will not be a big profit-driver, assuming it is successful. But if it is a success, it further diversifies DWA’s revenue stream and builds a greater base of long-term earnings power.
Finally, and maybe most importantly for the near term, DWA is a major media stock that has zero advertising exposure. There is minimal cyclical or secular challenge to DWA’s business model unlike almost every other media stock.

Why You Should Own DWA for the Long-Term
2009 has been a critical year for DWA. The massive worldwide success of Kung Fu Panda and the successful sequel to Madagascar has dramatically boosted the company’s long-term earnings power and the consistency of its financial results. Along with Shrek, DWA now has three franchises that can spin sequels. Each new film in each franchise boosts profits from the library via the films, merchandising and TV rights. Three franchises make it easier for DWA to release two films per year, one sequel and one original. It also takes the pressure off every original to be a resounding success. Wall Street rewards consistent long-term earnings growth. DWA exits 2008 in its best shape ever.
What Could Go Wrong
DWA trades at a premium to other media stocks, which now generally have single-digit multiples on 2009 estimates. The shares have also held up very well compared to other major media stocks that are down 50%-90%. DWA is subject to disappointing box office for any of its films. In the near-term, weak holiday sales for the Kung Fu Panda DVD or poor international box office for Madagascar 2 (it has only opened in Russia so far) are a risk. In 2009, DWA will be releasing two original films. Originals are not as profitable as sequels and present greater odds for a disappointment. DWA is also planning on a boost from 3-D for its films in 2009 and beyond. So far, the rollout of 3-D theaters has severely lagged expectations.
My Position
DWA was purchased in early November at just under $27. I have not added to positions since that time.
The Bottom Line
DWA has positive earnings momentum, minimal estimate risk, the potential for upside earnings surprises, a debt-free balance sheet and identifiable catalysts. These all support near-term performance while the long-term outlook has greatly improved, thanks to the broader portfolio of hit movies and franchises that now exist in the company’s library.

Trying to Explain Why I still Like CETV

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It is embarrassing to write about Central European Media Enterprises (CETV) given that I have owned it for Northlake clients and bought more and spoke positively about it all the way down, but I am not one to hide my screw-ups. This column is a bit long, but I owe clients and readers a detailed explanation.
The stock hit a new low on Tuesday on very heavy volume and is now down almost 90% this year, with most of the drop coming in a slide from $75 to $12 just since Sept. 12.
The stock is under siege from a bevy of macro problems, including
1. rapidly decelerating GDP growth in Central and Eastern Europe,
2. the almost daily collapse of the Russian stock market,
3. political instability and the IMF bailout in Ukraine,
4. very weak emerging-market currencies vs. the dollar,
5. global weakness in advertising, and
6. massive multiple compression for US-based media stocks.
Sadly, in hindsight, I can see how these factors would cause the stock to trade to current levels.
At its Oct. 23 analyst meeting when the stock was in the mid-$20s, CETV lowered guidance but only due to foreign currency. Almost all revenues are in currencies that have fallen by 30% since mid-September. In local currency, CETV maintained its 2008 guidance, with some countries performing better than expected (the Czech Republic and Romania) and others worse (Ukraine). On 2009, the company offered some preliminary comments with a reminder that it usually gives year-ahead guidance in May.
As of a month ago, the company was saying that in local currency, 2009 would be up about 10% and margins would be maintained. The company also said it could maintain margins in an environment as bad as local currency revenue down 20%. This final comment came with a reminder that in the last crisis in Central Europe in 1998 when Russia defaulted, none of CETV’s markets went to negative local currency growth.
Analysts have cut 2009 forecasts far beyond management’s preliminary guidance, with most expecting local currency growth to be up or down low single digits. With currency moving sharply against the company, U.S. dollar EBITDA estimates have fallen, with a worst-case estimate of down 25%; most estimates are around down 10%.
CETV does have two significant positive swings in dollar-denominated EBITDA in 2009 that will happen almost no matter what the ad environment, due to turns in Ukraine and Croatia. In Ukraine, CETV now has management control of the operations for the first time, which should lead to aggressive cost-cutting and improved efficiencies. CETV is also incurring one-time write-offs in 2008 due to bad programming decisions by prior management, which will disappear in 2009. In Croatia, CETV’s station has matured to the point that fixed costs are now covered, providing positive operating leverage, which virtually guarantees a swing from losses in 2008 to profits in 2009.
I believe flat dollar-based EBITDA in 2009 is a real possibility assuming there is positive local currency revenue growth. Obviously, the current stock price and those selling or shorting at these prices don’t believe management or me. They must be assuming a collapse in local currency revenue growth and/or the currencies to which the company is exposed. After all, the stock is trading at just 5.6 times the low EPS estimate and 4 times 2008 segment EBITDA.
The company has $1 billion in debt but has cash availability of almost $400 million via bank lines, which is far more than it needs to fulfill its operating plan for the next several years.
This stock price is absurdly low given the fantastic record of management, the long-term growth story of advertising in Central Europe, indications of growth from 40% of sales for 2009 in the Czech Republic already on the books, a private market value that is 5 to 10 times the current price if credit markets were functioning, and the fact that the company is presenting at a Morgan Stanley conference in Barcelona today and has already released its presentation, which affirms all commentary from the Oct. 23 analyst day.
You read that right. The company is another 30 days down the line in the meltdown of the global economy and its stock price is in the cellar, but the company is reaffirming its comments on local currency growth in 2009.
Others obviously disagree, and they have been right if the answer is measured solely by the stock price. I bought more stock yesterday, averaging down between $12.50 and $13.

“They Just Haven’t Seen It Yet”

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Yesterday, late in the day upon returning from a tech conference my RealMoney.com colleague Bob Faulkner wrote, ” Now the bear in me will say they just haven’t seen it yet but, who knows?” in relation to solar demand at MEMC Electronics.
I’ve got a longer column coming up today facing up to the pain and trying to explain Central European Media Enterprises (CETV). I think Bob’s comment is exactly what people would say about CETV’s ongoing confidence in local currency ad growth in 2009 throughout the Central and Eastern Europe markets where they own TV stations. They first said it a month ago and reiterated it today at a Morgan Stanley conference in Barcelona.
But the point of this comment is not solely CETV. You can read my column later. Rather, I think this attitude/question that Bob raises applies pretty broadly. I follow lots of stocks where the stock price has to be discounting far worse in 2009 and 2010 than management is indicating or willing to admit to at the moment even if they have already guided lower (Disney would be a good example).
I think for the market to stabilize and have a big sustainable rally we need a sense that the outlooks are not a black hole. Right now, pretty much everyone assumes that even where earnings and cash flow estimates have been slashed they are going to be even worse (DIS again). Visibility is poor so there is little defense against this view. We need something in the macro story to hang our hats on because we are already expecting terrible results. If we could find something that tells us they will not be worse than terrible, we will get a big and sustainable rally.
I doubt I can predict what it will be ahead of the time but I think it is important to consider all possibilities as the news flows. The last few weeks especially have taught me that in this market it is OK to wait and react. I’ll be watching.

Update on DWA Trade

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After sharp sell-off earlier this week, Dreamworks Animation shares reversed hard yesterday and are up again today even as the market trades to its daily lows. I got long DWA recently because of my confidence that (1) Madagascar 2 will exceed analyst estimates for domestic box office, and (2) Kung Fu Panda DVD sales will be solid. Following a positive surprise in 3Q results this would maintain the positive sentiment and set up 4Q08 and 1Q09 for more positive surprises.
We won’t know for sure about Madagascar 2 until we see how well the film holds this weekend but the opening weekend was excellent and an unprecedented surge on Veteran’s Day’s suggests interest in the film is high. Did the Veteran’s Day steal the weekend sales? We will know soon enough. A dorp of less than 40-45% for the weekend is good news.
DVD sales Panda just started this week so there is no hard data but anecdotal evidence is promising. See here and here.
DWA is a media stock with no advertising exposure. It had held up well relative to the group. There are catalysts and the earnings outlook has minimal risk. I think it has upside of 15-20% if the market stabilizes and moves up from here.

Dreaming of Gains. Again.

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The weak action yesterday in Dreamworks Animation (DWA) following the better than expected opening of Madagascar 2: Escape 2 Africa led me to buy DWA shares again for a trade. I am looking to for a move north of $30 assuming the film continues to track toward greater than $200 million domestically. The prior trade in DWA culminated with a very small loss when the shares were sold last summer just over $30.
The next catalyst for the shares will be second weekend box office. The two most comparable films are Madagascar and Kung Fu Panda. Madagascar 2 opened at $63 million, ahead of $60 million for Panda and $47 million for Madagascar. Panda and Madagascar opened on 6/8/08 and 5/29/05, respectively, so the summer run is not necessarily comparable as kids were out of school. As a result, it would be bullish for DWA shares if Madagascar 2 holds better than the other two films which fell by 40-44% in their second weekend.
Besides potential upside other positives exist for DWA. First, I’d expect analysts to reiterate buy recommendations after the big opening weekend followed by a decline in the shares. Second, the Panda DVD hit stores yesterday. Third, Shrek the Musical is opening on Broadway. If each of these items works positively the shares should respond especially flowing better than expected 3Q08 results announced at then end of October.
One last point is that DWA is a media stock with ZERO exposure to advertising. This makes it a good place for dedicated media investors to hide.

Box Office Surging

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The expected surge in the fourth quarter box office is back on track after an interruption for Halloween falling on a Friday night. Madagascar 2 brought in a better than expected $63 million and Role Models surprised with $19 million to push the weekend box office up 32% from a year ago for the top 12 films according to data form Box Office Mojo. The box office is now up 7.5% this quarter and in positive territory for the year.
As outlined previously, in 2008 the box office fell for 12 consecutive weeks from late September through early December. We are now about half way through that period with the 7.5% increase. The comps should improve dramatically the next two weekends. This coming weekend is the debut of the new James Bond film, Quantum of Solace. Quantum is already open in several overseas markets and is shattering box office records. Last year the #1 film on the comparable weekend brought in just $27 million and the top 12 for the whole weekend was $92 million. Quantum is going to bring in well over half of last year’s entire top 12 all by itself. Madagascar 2 and Role Models have no com[petition in their genres and should hold well despite the massive expected turnout for Bond….

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NIHD: Good Quarter, Good Business, Bad Stock.

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NII Holdings reported about ten days ago while I was on a plane to NY to visit CETV. The report occurred right as the market was in its most depressed state which was unfortunate as the results were quite good. As soon as I got off the plane I looked at my email to see an initial report from Goldman Sachs stating that HIHD produced an across the board positive surprise. I was excited and called a good friend who owns the stock is his hedge fund only to find out the stock was down 25%! I should have listened to Goldman and bought the weakness as the stock has almost doubled off that morning low and is now above where it was when they reported. I think the next few quarters will be volatile for the shares but more recovery remains assuming the bleak economic outlook does not worsen.
The biggest challenge faced by NIHD shares is the sharp weakening of the currencies of Mexico and Brazil which are the companies two largest and faster growing markets. As of now, the economies of these countries and NIHD’s businesses are still performing well. Weakening prospects for global economy will cut into 2009 growth but the bigger issue and risk is that the 30% drop in the currencies against the dollar will undermine positive economic fundamentals and pull NIHD’s growth down.
There is little the company can do about the negative impact on US dollar results due to the impact of currency translation. The company could easily growth 15-20% in local currency in 2009 only to see its US dollar results flat to down. I think investors will eventually look through the currency weakness as long as the bottom does not fall out of economic growth in Mexico and Brazil. That is the assumption I am making and why I am holing NIHD shares….

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