Time Warner Benefits From The Subscription Growth At Turner And HBO In Q3

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Time Warner

Time Warner (NYSE:TWX) recently reported its Q3 2014 earnings. While the revenues grew 3%, earnings declined 12% to $1.11 per share due to higher costs and severance for layoffs. [1] The adjusted earnings were $0.97 per share after excluding the benefits on tax matters, programming charge at Turner, and restructuring and severance charges. [2] While all of Time Warner’s segments, including HBO, Turner and Warner, saw growth in revenues, operating income declined due to higher costs.

Looking at the carriage deal with Dish Network (NASDAQ:DISH), the company stated that Dish dropped some of its networks as Time Warner did not move an expiration date towards end of the year. The company said that Dish dispute will have some impact on the fourth quarter earnings. [2] It must be noted that the current carriage contract for TNT and TBS with Dish will expire in November and if the same is not extended, the impact would be worse for both Dish and Time Warner in the near term, primarily due to the fact that unlike CNN or Cartoon Network, TNT and TBS command much higher ratings and carry some of the popular sports programming, including NBA. It will be interesting to see how this story develops over the next few weeks and if Dish decides to drop TNT and TBS as well.

We estimate revenues of around $29.24 billion for Time Warner in 2014, with EPS of $4.13, which is in line with the market consensus of $3.87-$4.40, compiled by Thomson Reuters. We currently have a $80 price estimate for Time Warner, which we will soon update to incorporate the recent quarterly earnings.

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See our complete analysis for Time Warner

Continued Subscription Growth At HBO

HBO accounts for 30% of Time Warner’s stock value, according to our estimates. The segment revenues for the September quarter increased 10% to $1.30 billion, led by growth in subscription revenues. Higher contractual rates and subscriber growth led to a 10% growth in subscription revenues to $1.16 billion. However, operating income declined 24% to $380 million due to higher programming and other direct costs. [1]

We expect HBO subscription revenues to continue to grow strongly in the coming years given the high demand for its original programming including True Detective and Game of Thrones. This will drive the subscription growth in domestic and international markets, both in the near term and in the long run. Accordingly, we estimate the monthly subscription fees in the U.S. to be north of $7 by end of the year and around $10 towards the end of our forecast period. HBO recently announced that it will launch an over the top service in 2015. The streaming service will primarily target the cord-nevers and broadband-only subscribers. There are around 5 million such homes in the U.S. Moreover, there are around 70 million homes, which are not subscribed to HBO as part of their television package. [2] HBO thus plans to increase its penetration and viewership on different video platforms.

Higher Costs Weigh Over Turner Networks’ Quarterly Performance

We estimate that the Turner Networks contribute around 50% to Time Warner’s stock value. Turner networks include TNT, TBS, CNN, truTV, Cartoon Network and Adult Swim. The segment revenues increased 5% to $2.45 billion, driven by a 10% growth in subscription revenues. However, advertising revenues were down 2% to $993 million due to lower income from international markets. The segment operating income was down 67% to $337 million due to 84% jump in programming costs. [1] This can be attributed to Turner’s decision to stop airing certain programming and it took a $343 million programming charge in the third quarter. [2]

While we believe that Turner networks will continue to see subscription growth in the near term, advertising income may be lower due to a decline in viewership at some of the popular networks. For instance, TNT was down 11% in viewership for the third quarter. [3] Subscription growth will largely be driven by higher programming costs, which to a large extent are passed on to the pay-TV operators and eventually to subscribers. We believe that this trend will continue in the coming years and accordingly estimate subscription revenues for TNT and TBS to be around $2.20 billion by end of the year and over $3 billion by the end of our forecast period.

A Muted Quarter At Warner Bros.

Warner Bros. contributes around 6% to Time Warner’s stock value, according to our estimates. The studio currently ranks No. 3 in terms of market share (15.3%) at the U.S. box office with grossing of over $1.30 billion. [4] Looking at the third quarter, studio revenues were up 3% to $2.78 billion. However, the revenue growth was primarily on the television front and theatrical revenues declined 10%. [1] This can be attributed to the subdued performance of the movies released in the quarter as compared to the prior year period, which benefited from the success of Pacific Rim, The Conjuring and We Are The Millers. The segment operating income declined 23% to $237 million due to higher restructuring and severance costs. The company in its earnings call stated that the studio will incur additional restructuring charges of around $100 million in the fourth quarter. [2] We believe that the studio will see a better Q4 and also Q1 2015 driven by its November release of Interstellar, which is expected to perform well at the box-office globally. Moreover, the studio will release the last sequel in Hobbit series in December, benefit of which will be seen in the first quarter of 2015.

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Notes:
  1. Time Warner’s SEC Filings [] [] [] []
  2. Time Warner’s (TWX) CEO Kevin Tsujihara on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, Nov 5, 2014 [] [] [] [] []
  3. Fox News Scores First Basic Cable Viewership Win in Third Quarter of 2014, The Wrap, Sep 30, 2014 []
  4. Box Office By Studio, Box Office Mojo, As of Nov 6, 2014 []