Subscription Fees Growth At Cable Networks Boosts Time Warner’s Q4 Earnings

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Time Warner

Time Warner (NYSE:TWX) recently reported its Q4 2014 earnings, which came out largely on expected lines. While the revenues declined 1% to $7.5 billion, earnings fell 17% to $0.84 per share due to higher costs. The adjusted earnings were $0.98 per share after excluding the programming charges at Turner and restructuring and severance charges. While HBO and Turner saw steady growth during the quarter, Warner Bros. revenues were down 5% due to lower home entertainment revenues. The operating income at Warner Bros. was also down 32% due to higher restructuring and severance charges. [1] Both, HBO and Turner networks benefited from higher subscription revenues. The company has given a guidance of $4.60 to $4.70 earnings per share for 2015. [2] This is slightly higher than our current earnings estimate of $4.56 per share. We will soon revise our $83 price estimate for Time Warner to incorporate the recent quarterly earnings.

We continue to believe that Time Warner will see healthy growth in the near term as well as in the long run driven by its cable networks. HBO continues to expand internationally with double-digit growth. In the U.S., HBO added close to 3 million subscribers in 2014, highest in over 30 years. This can be attributed to its immensely popular programming including, Game of Thrones and True Detective. While the viewership at Turner networks declined in 2014, TBS is seeing improved ratings lately for some of it’s programming such as Ground Floor, which is averaging 3.1 million viewers per episode currently.

See our complete analysis for Time Warner

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Continued Subscription Growth At HBO

HBO saw a revenues growth of 6% to $1.30 billion during the December quarter. This can be attributed to a 5% subscription revenue growth and 14% jump in content revenues. However, operating income declined 5% $394 million due to higher programming and distribution costs. A similar trend was seen in the pervious quarter as well. However, looking at 2014, the segment operating income grew 7% to $1.80 billion. While we expect the growth in subscription revenue to continue in the coming years, rising programming costs remain a concern. The company’s management stated that HBO is focused on limiting its non-programming expenses and, excluding the international consolidations, SG&A grew only 1% for 2014. [2]

We believe that HBO’s subscription revenue growth will be driven by higher rates as well as higher contributions from international markets. HBO is able to increase its prices periodically given the high demand for its original programming. Despite increasing subscriber fees, HBO has been able to maintain and grow its subscriber base, indicating sustained demand for this premium channel. We estimate the monthly subscription fees for HBO in the U.S. to be around $7.50 in 2015 and around $9 towards the end of our forecast period. This will translate into revenues of close to $5 billion for U.S. operations and an estimated EBITDA margin of 40% will translate into EBITDA of around $2 billion, representing close to 20% of the company wide EBITDA by the end of our forecast period. The contribution will be more than 25% if we take into account HBO’s international operations as well.

Steady Growth At Turner Networks

Turner networks saw a revenue growth of 2% to $2.60 billion during the December quarter. This was led by a 5% subscription revenue growth and 3% jump in content revenues. However, advertising revenues declined 1% primarily due to lower ratings during the quarter. The segment operating income grew 5% to $921 million due to 1% decline in programming costs. [1]

While we believe that Turner networks will continue to see subscription growth in the near term, advertising income may remain lower due to a decline in viewership at some of the popular networks. For instance, TNT and TBS viewership in 2014 was down 4% and 10% respectively. [3] On the other hand, subscription revenues will continue to grow, largely driven by the rising 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.

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Notes:
  1. Time Warner’s SEC Filings [] []
  2. Time Warner’s (TWX) CEO Jeff Bewkes on Q4 2014 Results — Earnings Call Transcript, Seeking Alpha, Feb 11, 2015 [] []
  3. ESPN no. 1 in cable ratings for 2014, Boston Herald, Jan 3, 2015 []