Our Revised Price Estimate Of $91 For Time Warner

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TWX
Time Warner

We have revised our price target for Time Warner (NYSE:TWX) stock from $83 to $91, which reflects a change of around 10%. The current valuation reflects our revised estimates of DVD & Electronic Sales and HBO’s penetration in the U.S. We believe that the DVD and Electronic sales will continue to see some pressure in the coming years amid the rise of alternative video platforms and it is unlikely that a growth in digital sales will be able to offset the declines in DVD sales in the near term. However, we believe that the licensing business will continue to see strong growth led by growth in the digital platforms. We remain bullish on HBO as the demand for its programming continues to remain high and the network is now focused on increasing its penetration among U.S. pay-TV households.

See our complete analysis for Time Warner

TV Shows And Movie DVD & Electronic Sales Will Continue To Decline

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Warner Brothers’ DVD & Electronic Sales have declined in the past primarily due to a decline in DVD sales as a result of cannibalization by Internet video companies and movie rentals. Movie DVDs & Electronic sales have declined from $3.16 billion in 2008 to $1.78 billion in 2014. [1] We expect this downtrend to continue in the coming years, albeit at a slower pace. We now estimate the segment revenues to be around $1.50 billion by the end of our forecast period. A similar trend can be seen in the TV Shows DVD sales, which have come down from $772 million in 2011 to $543 million in 2014. We expect these revenues to come down to around $380 million by the end of our forecast period.

Time Warner and other media companies are now focusing on developing additional electronic revenue streams to offset DVD declines. This includes licensing older content to online rental companies such as Netflix (NASDAQ:NFLX), Hulu and Amazon’s (NASDAQ:AMZN) Amazon Prime. Looking at licensing revenues, it has been on a strong uptrend in the recent past. TV Show Licensing revenues have grown at an average annual rate of 10% in the past five years and we expect this uptrend to continue, albeit at a slower pace. Overall, we estimate Warner Bros.’ movie business (this excludes its TV Shows) will generate revenues of around $5.30 billion in 2015. An estimated EBITDA margin of around 16% will translate into EBITDA of $860 million, representing over 10% of the company-wide EBITDA.

Expect HBO To Further Expand Its Subscriber Base

HBO is a premium pay-TV network that primarily provides recently released movies and original programming, including popular series such as True Blood and Game of Thrones. Given the demand for its content, it charges a high fee per subscriber and therefore has low penetration compared to regular cable networks. HBO’s penetration among U.S. pay-TV households has increased from 38% in 2010 to 43% in 2014. However, this is far less than Time Warner’s other cable networks such as TNT and TBS, where the penetration is around 90%. Other than U.S. subscriptions, HBO earns money via subscriptions in international markets, licensing of its content to cable networks and selling its original programming via digital platforms, DVDs and Blu-Rays.

HBO has been focused on expanding its subscriber base in the U.S. and it has increased from less than 40 million in 2011 to 46 million in 2014. [1] The network has recently announced its much hyped over-the-top streaming service, HBO Now, to be launched on Apple devices starting in April;   the service will be priced at $15 per month. In order to compete with HBO’s standalone service, some of the pay-TV operators have reduced HBO’s subscription prices to the end customers. For instance, Verizon (NYSE:VZ) has extended its $9.99 HBO promotion from six months to 12 months. Time Warner Cable (NYSE:TWC) discounted HBO from $15.95 to $9.99 for online orders. Cox Communications is also offering HBO for $10 a month for the first six months. [2]

Given these trends, pay-TV operators may share the cut with HBO and it may impact the subscription pricing.  But at the same time it will help the network grow its subscriber base, as the price drop has been as high as 35% in some of the cases. It must be noted that there is a massive demand for HBO’s content, evident from the fact that Game of Thrones was the most pirated TV show in 2014 with episodes downloaded via torrent networks about whopping 48 million times last year. [3] With reduced pricing from pay-TV operators, many of the households, which have not yet subscribed to HBO may opt for it now. Accordingly, we expect HBO’s penetration among U.S. pay-TV households to be over 55%, translating into more than 60 million subscribers by the end of our forecast period. An estimated subscription fees of around $9.35 will translate into domestic subscription revenues of close to $7 billion and an estimated EBITDA margin of 39% will translate into EBITDA of over $2.70 billion, representing more than 20% of the company-wide EBITDA. Furthermore, if we account for HBO’s international revenues, the contribution will be more than 30%.

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Notes:
  1. Time Warner’s SEC Filings [] []
  2. Pay-TV operators lower HBO price ahead of a la carte launch, Fierce Cable, January 30, 2015 []
  3. Top 10 Pirated TV Shows of 2014: ‘Game of Thrones,’ ‘Walking Dead’ Lead List, Variety, Jan 2, 2015 []