Ben Graham, one of the world’s most successful investors operated with an important precept. He would consider any company whose price-to-earnings ratio (over a 3-year average) multiplied by its price-to-book was higher than 22.5. Over the years, I have modeled my own investment analyses by incorporating this sound fundamental principle. While I would be the first to admit that I diverge from this from time to time, I always come back to what has worked in the market over the past 100 years.
As many have become aware, I sold off my position is Sirius XM (NASDAQ:SIRI) earlier this week for a very nice profit. But feeling the need to stay in the media space, I have diverted my attention to Time Warner (NYSE:TWX), another media giant that has been on somewhat of resurgence since spinning off its holdings in AOL two years ago. To keep up with Ben Graham’s principle, I have found that Time Warner does indeed fit the criteria. Not only is their current product 18.8, (using a 2-year average), so too are its P/S and P/CF; all well within Mr. Graham’s guidelines.
Time Warner reported its Q1 earnings on Tuesday (5/4). At first glance it was a bit disconcerting to learn that profits fell 9.9% due to struggles in its film division. The company attributed the loss to fewer DVD releases. I suspect that this is a trend that is likely to continue. However, the rebounding advertising market more than made up for the weakening film business as the company's television networks division fueled growth.
Though the company beat analysts' expectations, the stock declined a little bit before bouncing back. The majority of the selling was in line with the broader stock market decline. They reported a profit of $653 million, or 59 cents a share, down from $725 million, or 62 cents a share, a year earlier. The latest and prior-year results each included a penny in net gains from items such as investment impacts and a gain on operating assets in the year-earlier period. Revenue rose 5.7% to $6.68 billion.
Analysts had forecast a profit of 56 cents a share on $6.44 billion in revenue. The company still expects its full-year adjusted earnings per share to grow by a low-teens percentage rate from the $2.41 it posted in 2010. Profit at the company's networks business--by far its biggest by that measure--rose 2.3% as revenue jumped 18%. Filmed-entertainment earnings dropped 50% on a 3.3% revenue decline. At the publishing segment, Time Inc., earnings rose 26%. Shares closed Tuesday at $37.73 and were inactive in recent premarket trading.
The company announced its acquisition of Flixster, a social networking service for movie enthusiasts. There has been concern about the company's plans for the $3 billion of cash on its books; an always welcome challenge. The rumor is, Time Warner plans to make Flixster, which includes the film review site Rotten Tomatos, part of its digital strategy as it focuses on transforming its traditional media businesses into content for the digital age. Clearly it is positioning itself for the inevitable trend of social media. To date, the company has not disclosed the terms of the deal.
The two acquisitions continue a series of shake-ups and restructuring that the company has undertaken which started with its spinning off its cable division as well as AOL. Since then, Time Warner has improved its financial performance and is now moving aggressively to adjust its business models for the rise of digital media, which the company should view as a viable threat. Based on these recent acquisitions, these threats are not being taken lightly.
The company has been actively working on its "TV Everywhere," model. The company sees the future wherein its cable TV subscription business moves onto the cloud. To that end, not only did the company recently launch mobile apps for HBO Go, it also reached a pretty significant agreement with Apple (OTC:APPL) to make an iPad edition of the company's magazines available free to subscribers. The company is also testing an early, premium video-on-demand offering with DirecTV Group Inc. (DTV) and the company's film studio started renting select films through Facebook in hopes of improving the economics of its film business, which is suffering from a decline in DVD sales.
It’s worth noting that Time Warner also recently announced its partnership with Comcast (CMCSA) to allow cable subscribers to watch its properties such as TNT and TBS over the internet. As mentioned previously, its "TV Everywhere" concept reportedly will be in approximately 70 million homes by the middle of this year. It can be expected that the additional affiliate fees it will receive from Comcast and others will be a major driver of growth in the coming years. More importantly, it signals that people are still willing to pay for television content and while its plans have been slow moving until now, the announcement suggests it will profit nicely.
Time Warner looks to make more money from its Warner Brothers division, implementing "premium" video-on-demand in the second quarter. Its movies will be available a month sooner on cable and the internet, just 60 days after theater release and before DVD release. The cost to customers will be between $30 and $60. In concert with this move, the company likely will revisit its DVD distribution agreements with Netflix (NFLX) and Red Box, both in terms of the time the companies would have to wait to get films and how much they'd pay. It's too early to tell what this means to the bottom line but you have to give the company credit for pushing the envelope. It's about time movie companies got aggressive.
With a 2.4% yield and its entire business performing well, I see a stock that's trading below its future potential value. Overall, I have to say that there are many things about Time Warner to be excited about. The year has started on a high note and there does not seem to be a decline in sight. The company posted strong metrics this quarter including almost 20% revenue growth on its Networks segment. Though it would have been nice to beat estimates across all metrics, by and large, the results arrived in line with expectations which puts the company firmly on track to achieve its guidance for the year.
The excitement lies in its progress toward longer-term strategic objectives; in particular, its efforts to allow consumers to purchase content and have that same content be accessible across various different platforms; the future of media.
Disclosure: I am short SIRI. I have no positions in any stocks mentioned, but may initiate a position in TWX over the next 72 hours.