HBO May Be The Answer To Unlocking More Value For Time Warner

| About: Time Warner (TWX)


To unlock value Time Warner may become under increasing pressure to offer an HBO digital subscription service.

Time Warner would have to balance an HBO subscription service by probably offering a time-delayed service.

The company may offer tiered options, with one being delayed and the other a premium service which would cost more than offered via traditional content distributors.

There aren't a large number of brands that can be counted on to generate significant and consistent revenue and earnings year after year in the entertainment industry, but Time Warner (NYSE:TWX) has one of them with its HBO brand, and it has potential to increase the value of the franchise in a major way if it is willing to take a little risk and can execute a plan that makes sense with its current customers, as well as open up a new revenue stream with new customers.

What is powerful about this is Time Warner won't have to do much else with its content, so most of the costs would be associated with setting up a streaming platform potential customers could use to access the content online, via a subscription model.

Recently Barclays analyst Kannan Venkateshwar offered up a couple of ways this could be done, which could add up to $600 million in new earnings to the company. Assuming that is a close estimate, it could boost the share price of the company by as much as $5 per share, or possibly higher.

(click to enlarge) source: StockCharts.comClick to enlarge

Pressure on Management after Rejection of Fox Offer

There is no doubt the decision by Time Warner's management to reject the solid offer of Fox to acquire the company will have repercussions for a long time. It won't be just a question-and-answer session where it may temporarily placate shareholders and analysts who want to know how the company will make up for the premium price offered for it, and which it could have made a deal by asking for even more, which would have added much more value to shareholders.

That means the company will have to prove it has unlocked value, and I see HBO as the prime brand it has to do so, which is why I find a digital subscription model for HBO one of the best answers to that I can see.

Time Warner's Balancing Act

First of all it has to be understood that Time Warner has stated at this time it isn't interested in offering a digital HBO subscription service to customers. Because of that, it will have to show shareholders and potential investors where the unlocked value is going to come from that justified in its eyes the rejection of the Fox acquisition offer.

I think over time it will be pressured to offer HBO as a digital subscription, so with that in mind, the company would have to balance its existing model, which includes content distributors like Comcast and others.

It's not feasible to think any distributor would stop showing HBO if it didn't like a potentially competitive service they perceive may cut into their revenue, but upsetting some of its biggest revenue sources isn't the best way to do business.

The likely scenario would be Time Warner would have to offer a time-delayed release of its HBO brands in order to keep its existing partners happy.

Potential Digital Subscriber Base

At this time the thought is there are several million people that have a broadband Internet connection that will probably never pay for access to television. That number is sure to grow in the future, and Venkatshwar, when extrapolating an HBO digital subscription model, assumes as many as 20% of customers now accessing HBO via cable or satellite, will eventually cut the cord.

The assumption is many of them will acquire a digital HBO subscription that includes a time delay if the price is right. Here's how he breaks it down:

source: Barclays Research

Keep in mind that these are Venkateshwar's numbers, and based upon a projected model, and not on sources within Time Warner. Having said that, something close to this would make sense, and it certainly has the potential to generate some big numbers for the company.

Another reason I like this is broadcast advertising is becoming very challenging, and entertainment giants like Disney are rebalancing their exposure to an ad revenue model for more predictable revenue streams. That's why a digital subscription model for HBO makes a lot of sense as a long-term strategy.

Going forward and over the long haul, the numbers related to cord-cutters in the model provided may actually be understated, which would be good news for shareholders of Time Warner with a longer investment timeframe.

New Paying Customers

The point of all of this from a strategic point of view is the reality of cord cutting is upon us, and even more, those that never buy the cord in the first place. That demands a response from the entertainment industry, which is notorious for dragging its feet over innovation, and many times choose to fight legal battles rather than quickly adapt.

With Time Warner is has potential for millions of new digital customers for its HBO service, which will continue to command a premium price if its content remains high quality. So to placate its existing partners at the expense of a potentially huge revenue stream makes little sense, especially when it can provide a lower-cost time-delayed service, or a higher-cost premium package for the same service offered to content distributors. Either way, the existing relationships should remain strong when the distributors admit to themselves they're not going to get any of the cord-cutters and those who have no intention of buying a cable or satellite TV package.

It's unlikely people will abandon the content distributors in any significant numbers with a digital alternative that requires patience to wait for the delayed show, or which would cost more than a TV package including HBO. Time Warner would of course have to show and convince distributors of this new reality, which won't have much if any of an impact on them.


Last year operating earnings for Time Warner came in at $1.7 billion. If it comes close to generating the approximate $600 million under the scenarios mentioned above, it does have the potential to boost the share price of Time Warner nicely. It would also prove the company in fact has a plan in place to increase shareholder value.

It appears that management is a cautious of offering a digital subscription service because it would anger existing content distributors. But I believe if it was explained to them, Time Warner would at least ease the tension.

But to leave this type of money on the table makes absolutely no sense, and I think at this time it's not just concern over its current partners (although that's part of it), but also the fact HBO is still generating an amazing amount of revenue and earnings for the company.

That's not a good way to look at it if I'm correct in that assessment, and now would be the time to take HBO to the next level with a digital subscription model, as it would immediately boost the top and bottom lines of the company while providing a long-term revenue stream that would improve the performance of Time Warner and increase the value of its stock.

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