Don't Worry. There's Upside at Time Warner

Bewkes sells opportunities in spending on content and cutting other costs
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Time Warner CEO Jeff Bewkes told investors "our message today is don't worry."

Having turned down an $85 billion takeover bid from Rupert Murdoch's 21st Century Fox, Bewkes and his senior executives at Time Warner's investor day Wednesday presented their plans to prosper during what appears to be increasingly troubled times in the media industry.

Lower ratings. Slowing ad sales. Huge payments to the NBA. Cord cutting, Bundle busting. Consolidation. Competition. Netflix. None of those will prevent Time Warner from delivering the growing profits Bewkes promised investors. His plan will generate "close to $6 per share in adjusted EPS by 2016 and over $8 a share by 2018. That means we're going to more than double our earnings over the next several years," he said.

The plan includes a couple of ideas that could be worth hundreds of millions of dollars more. HBO will go over the top, allowing consumers to buy subscriptions via broadband without buying a traditional cable bundle.

Turner Broadcasting and Warner Bros. are getting together in the kids business and aim to create global characters and franchises and make more hundreds of millions by ramping up the tiny consumer products and licensing business closer to Nickelodeon or Disney levels.
"Yes, there are risks, but we think we are best positioned to handle them," Bewkes said.

If things break in Time Warner's direction, there is even more upside. Turner Broadcasting is doubling original programming spending at TNT and TBS. It projects big rises in affiliate fees but isn't banked on creating a hit or reversing their ratings slide.  "I'd be really disappointed if these were to occur," said Turner CEO John Martin. "There are hundreds of millions of upside to the plan."

Analysts liked the detail contained in Time Warner's five-year forecasts as well the HBO over-the-top announcement. "This should redirect the debate around the stock from increasingly less relevant ratings to the potential upside at HBO. We think the valuation gap with peers is becoming harder and harder to justify and we expect it to close," said Vasily Karasyov, of Sterne Agee, who rates Time Warner a "buy."

The key to Time Warner's plan is to pump up spending on programming while cutting costs everywhere else.

CFO Howard Averill said that Time Warner's content investment would grow by $4 billion to $18 billion between 2013 and 2018.

To help pay for that investment, the company is cutting costs, including eliminating nearly 1,500 positions at Turner and 1,000 at Warner Bros.  The company will take a $400 million restructuring charge to cover severance, but expects to generate about $450 million in annual savings, Averill said.

Time Warner will take another $400 million charge against earnings to cover programming Turner doesn't plan to air anymore because it doesn't fit with its brands.

Turner's John Martin said programming spending on TNT and TBS is $2 billion, with $500 million invested in original programming. By 2018, original programming spending on TNT and TBS will double to $1 billion.

Martin said the big rights fee increases in TNT's new NBA contract was anticipated and planned for. He added that sports drives viewership, helping the networks win nights and distribution by making the networks "must-have" advertising.

While sports account for just 4% of Turner's programming lineup, it accounts for 25% of advertising, he said. CPMs for sports average twice what Turner gets for other programming, and in some cases five times and six times the CPM.

Martin said he expected viewership on all devices will get measured and that Turner is working with advertisers to better monetize video-on-demand. "We're going to experimenting with a number of different models there."

Martin said Turner also aims to better monetize other digital consumption, which generates $200 million now, but could be worth $100 million more, and explore over the top opportunities for Adult Swim and Cartoon Network.

Turner's kids business now generates $1.3 billion in annual revenue while getting just 5% of that from licensing. Working in concert with Warner Bros and by greenlighting only series and characters with potential global appeal, the company plans to increase the value of its networks, created series with value and ramp up its consumer products and licensing business, Martin said.

Analysts found other things to like in Time Warner's presentation.
While they liked the HBO announcement, they expressed concern that going direct to consumers could hurt relations with distributors and potentially bust the cable bundle that enriches Turner.  HBO CEO Richard Plepler responded to questions saying that he didn't expect the new service to cannibalize HBO's cable base. He said he's spoken to the CEOs at the distributors and they plan to "lean into" an opportunity to add customers. "The great preponderance of this is additive," he said.

"The Time Warner investor day was way more eventful than we thought it would be. Not only did we get a detailed 5-year revenue, expense, and adjusted operating income outlook for all segments (Turner, HBO and Warner Bros.), but we also we got the big domestic HBO OTT announcement that we had not expected," said Marcy Ryvicker of Wells Fargo. "One of the things we really liked about the day (and by the way, this was by far one of the best investor events we have ever attended) was the granularity around management's forecast—both for the 'base' and the 'bull' case scenarios. At the end of the day, Street numbers should move up, particularly in the later years."

Ryvicker said she thought the biggest surprise was the outlook for Warner Bros, which talked about its plans to ramp up TV production as well as its slate of movies.

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