Time Warner takes a hit

Company is not immune to softening ad market, says 4Q earnings will be lower than expected

In early October, Time Warner's stock was trading at $91.25, after peaking earlier in the year at almost $105. Investors were beginning to worry about the advertising economy, which affects important units within the company, including its cable networks, cable systems and the WB network.

About the same time, News Corp.'s and Fox Entertainment Group's stock started to come down, too, on the same concerns. News Chairman Rupert Murdoch acknowledged that TV advertising had hit a soft spot and that the near-term prospects "for us and our competitors looks a little uncertain."

Time Warner head Gerald Levin and AOL chief Steve Case disagreed with that assessment, vehemently denying any weakness in their advertising-driven businesses. Levin said such a notion was "spurious..That's not even an issue for us" during a teleconference with analysts to review third-quarter results. "AOL-Time Warner advertising will be the fastest-growing part of the company." His comments gave Time Warner's stock a nice upward push, some $3-plus per share.

Turns out: Murdoch was right, and Levin was wrong, a fact that Time Warner acknowledged last week, albeit in a comment deeply hidden in a press release on the restructuring of the Road Runner high-speed Internet service provider. Time Warner is assuming operating control of the service and upping its ownership stake to just over 91%.

The press release said fourth-quarter earnings will be lower than expected because of "recent softness in cable network advertising revenues."

Wall Street wasn't pleased and hammered Time Warner with a 24% drop in its stock price over three days after the company issued a revised fourth-quarter outlook statement. From Dec. 18 to Dec. 20, the stock plunged from $72.72 to $55.50.

The company also cited lower-than-expected music sales and the poor box-office performance of recent theatrical release Little Nicky
as contributing factors.

Media analysts quickly revised earnings estimates downward for the company for both the fourth quarter and next year.

Jessica Reif, top entertainment analyst at Merrill Lynch, cut fourth-quarter pretax-earnings growth estimates for the company almost by half, from 14% to 8%, or by about $100 million, to $1.95 billion. She also lowered her 2001 earnings estimate for the company by $230 million, to $7.5 billion.

Reif estimates that Time Warner's cable networks are "performing at the lower end of industry growth, for a number of reasons." Among them: declining ratings at CNN, due largely to ratings momentum at Fox News and, secondarily, at MSNBC.

In addition, Reif cites the performance of World Championship Wrestling, which lost roughly $80 million for the Turner cable networks in 2000. She predicts that Turner will either cancel or sell WCW soon.

Meanwhile, on Dec. 20, Time Warner and AOL executives reiterated previous statements that they intend to close their merger by "early January" at the latest.

Reif maintains her long-term buy rating on Time Warner but cautions that the merged entity faces "tough comparisons" in first half 2001, given the exceptionally strong ad market that existed a year ago," coupled with uncertainty in the current ad marketplace.

As for the Road Runner restructuring, Time Warner will buy out AT&T's direct interest in the ISP; AT&T will retain a very small indirect interest through its acquisition of Media One, which holds a 25% stake in Time Warner Entertainment, the Time Warner division under which Time Warner Cable is organized. Microsoft and Compaq are also selling their combined 20% stake in Road Runner (Time Warner will pay a total of $570 million to buy them out) while Advance/Newhouse will retain a small (8.8%) stake in the service. Road Runner will be managed by Time Warner Cable, which announced that Jeffrey King is replacing William Gordon as president of the service.

The restructuring was the option that AT&T chose to meet the regulatory conditions of its acquisition of Media One.


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