The recent action in Time Warner (NYSE:TWX) highlights the reasons for avoiding extreme negativity in the market. The stock along with the general media sector had a horrendous 2015, but the valuation presented an opportunity.
Suddenly to start 2016, news of an activist and a potential offer have surfaced. The stock has shot up to over $71 in the midst of a market selloff from a low below $65 to end last year. Is Time Warner still worth owning?
According to The New York Post, activist Corvex Management wants to pressure Time Warner into spinning off HBO. With Time Warner only worth $56 billion as a conglomerate and Netflix (NASDAQ:NFLX) now worth $48 billion alone, one can quickly see some logic.
At a Q3 runrate, HBO has an annual revenue potential of $5.5 billion. This compares to the $6.8 billion for 2015 by Netflix. The only problem is that HBO doesn't have the 23% growth rate of the competitor.
One can probably argue that HBO is being mismanaged as part of the Time Warner conglomerate, but it is a giant leap to suggest a spinoff would quickly unlock those values.
Will Fox Offer Again?
While HBO is an opportunity that could possibly unlock value down the road, another offer from Twenty-First Century Fox (NASDAQ:FOXA) would quickly provide returns for shareholders.
Time Warner originally traded above $90 last July when it appeared that Fox would top a $85 offer for the competitor. Though quickly denied, rumors are swirling that Fox has rekindled a desire to bid for Time Warner.
No better incentive exists to accept the deal this time than the sharp decline in the stock last year. The BOD can hardly recommend to shareholders that not accepting the offer was rewarding.
One big hurdle to the deal is that Fox trades at the lows similar to the other media stocks. The original deal had Fox trading near $35 and the stock is now at $26. The rumored $105 appears all but a pipe dream considering the stock declines.
The original deal included 1.531 shares of Fox and $32.42 in cash for every share of Time Warner. The cash portion is very attractive to both sides, with Time Warner's shareholders able to cash out part of the investment at a premium and Fox able to fund the cash portion with cheap debt before rates rise.
The better way to view the potential offer is that Time Warner's shareholders could get stock in the new entity at an attractive price - cash in Time Warner's stock trading at a premium multiple while collecting stock in the new entity trading at a discount to the market.
TWX P/E Ratio (Forward 1y) data by YCharts
The original estimate was for $1 billion in synergies that amounts to only 3% of Time Warner's revenues. At something close to 10% of revenues, the deal would offer something exceeding $2.5 billion. Between the synergies and the cheap debt, Fox could quickly work out an accretive deal, making accepting shares in the new entity very appealing.
Despite the denials, the stock action suggests some of the rumors have a hint of truth. At $71, Time Warner is attractively priced with the catalysts of unlocking value in HBO and or an offer from Fox. The offer prices swirling around don't appear realistic, but the value opportunity exists with Time Warner trading at these levels.
The recommendation is to own the stock at an attractive value and collect the 2% dividend with the potential for a quick gain from a bid by Fox. Time Warner's investors win either way.
Disclosure: I am/we are long TWX, VIAB.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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