What Is Time Warner Worth? The 2006 Icahn Break-Up Model Revisited

Lazard Freres delivered Carl Icahn a break-up analysis of Time Warner (NYSE:TWX) in late January 2005. Icahn had bought five million shares in the media company and he wanted the board to sell the company’s cable and publishing units. Either move, he reasoned, would decrease Time Warner’s heavy debt load.

Icahn is long gone, but the Lazard evaluation survived. The 343 page analysis used several valuation methods to determine what each of the major parts of Time Warner would be worth if the firm was broken into pieces. In the summary of its findings it said that AOL was worth between $17.5 billion and $21 billion, Time Warner Cable was worth between $41.6 billion and $46.4 billion, the Time, Inc magazine operations were valued at $12.5 to $14 billion, and the cable network business at $54.5 billion to$60 billion. Networks included properties such as HBO, CNN, TBS, TNT, and the large studio business which is primarily Warner Bros.

Lazard’s analysis gave the entire company a valuation of $129 billion to $145 billion on a “sum or the parts” overview. Time Warner’s debt was $31 billion, so the “equity” value of the entertainment firm was $101 billion to $116 billion. The value per share was between $23 and $27.

Shares in what is called the “new Time Warner “trade for $30 today, which gives the company a market capitalization of $35 billion. A comparison of today’s number and the early 2006 figure provided by Lazard shows how much the value of some of the properties have fallen but also the benefit of the company’s restructuring efforts over the last two years. Time Warner Cable (NYSE:TWC) has been spun-off into a separate company with a market cap of $14 billion. Time Warner has $7 billion in cash and $15 billion in long-term debt. In early 2006, it had $5.5 billion in cash and $30.5 billion in debt. The new publicly traded Time Warner Cable has $22.6 billion in debt and $500 million in cash. There have been small purchases and sales of assets by Time Warner which have also changed its P&L.

It is overly simple, but the combined market cap of the two public companies is $50 billion and together they have $45 billion in debt and about $6 billion in cash. The DJIA is off 12% since Lazard did its analysis. If Time Warner’s shares had fallen by the same amount, the company, if it was still intact, would be worth about $90 billion.

The valuation of the cable company as it stands today has to be left on its own because that is determined by the public markets. That leaves the content, magazines, and AOL. Lazard used a number of methods to evaluate these. OBITDA and operating earnings calculations are probably the most transparent of these. It is impossible to decide whether the figures that they used for their multiples in 2005 would apply now, four years later. But, they probably would not. The effects of the economy should bring them down, and so should the assault of the internet on all three of these parts of the parent company. The multiples have been dropped 20% for the purposes of this valuation, which takes them down to 8 times to 12 times OBITDA for the three divisions with the magazines on the lower end of that scale and content businesses, especially the cable networks, on the higher end.

The other critical assumption is that revenue at the three segments of Time Warner will up by 5% in the second half compared to the first and that operating margins will go up by 10%. Part of this is due to improvements in the economy, and part due to the fact that many of these operations have improved revenue during the holidays.
Based on these numbers, the content operations (film and networks) are worth $48 billion now. This is down about 17% from 2005, but OBITDA and operating profits have also fallen.

AOL’s value is now $6 billion. Industry analysts have said AOL is worth less than this and several put its value  now at $4 billion. This is due in part to looking at discounted cash flow and a drop in the internet company’s ISP revenue. It is open to question whether the margins at AOL can be improved by increasing ad sales and cutting cuts. The Lazard analysis put AOL’s value at $20 billion in 2005, so the sharp drop in ISP revenue and the effect of the current recession on internet advertising has cut the price that the operation would get by 70%

The Time Inc. publishing operation would be worth about $3.5 billion, down from about $13 billion in the Lazard analysis.  Some small parts of Time, Inc. have been sold over the last four years and it has started and bought some other modest-sized businesses, but the most substantial consideration for the valuation is clearly the massive drop in advertising revenue in the print publications which has not been replaced in any meaningful way by sales from Time, Inc.’s internet properties. Lazard valued the publishing operations at about $13 billion in 2005. Time, Inc.’s brands are so widely regarded that a buyer might pay a premium on the $3.5 billion valuation, but it is not likely that a higher amount could be justified based on any reasonable ROI calculation.

The sum of these parts before corporate overhead is taken into account is $57.5 billion. This cannot be directly compared to the media value of $112 billion that Lazard gave Time Warner on a break-up valuation. The cable properties were given a value of $44 billion then. They have not only been spun out; Time Warner Cable also paid out a special dividend of $10.9 billion most of which went to its former parent.

That leaves the issue of what Time Warner is worth today. It has a lower net debt load (long-term debt less cash) and the value of its primary content business have held up well particularly given the effects of the internet and recession.  Time Warner is probably worth about $46 billion, or about $38 a share, after overhead costs have been taken out. Collins Steward recently raised it price target on TWX to $33.50. And Goldman Sachs recently upgraded the stock from Neutral to Buy and the media conglomerate to its Conviction Buy List and set a $33.50 6-month price target on the shares, up from $25.50. There are probably more positive brokerage calls on Time Warner as it spins off AOL.

Time Warner’s market cap has been sharply eroded by AOL and Time Inc., but has been substantially helped by its restructuring and balance sheet improvements. It is no longer a five-legged stool. Its cable and studio business that has, as its primary challenge, dealing with the world of content on the internet.

Douglas A. McIntyre