HBO’s Original Programming Will Drive Time Warner’s Future Growth

Time Warner’s (NYSE:TWX) HBO network has seen phenomenal growth in the past few years led by the success of its original programming. It is a premium network and generates revenues primarily from subscription fees collected from pay-TV service providers. The subscription fee has been rising given the demand for some of its popular television series such as Game of Thrones. HBO competes with other premium networks such as CBS’ (NYSE:CBS) Showtime and has recently launched its standalone over-the-top streaming service, primarily targeting the broadband-only subscribers in the U.S. We believe that the network’s unparalleled content will continue to aid its subscription growth in the coming years. Moreover, the new streaming service will widen its subscriber reach and aid Time Warner’s overall growth. On that note, we discuss below the trends in HBO and our estimates and forecasts.

We estimate revenues of about $29 billion for Time Warner in 2015 with EPS of $4.58, which is slightly lower than the market consensus of $4.67, compiled by Thomson Reuters. We currently have an $95 price estimate for Time Warner, which is more than 5% ahead of the current market price of $88 per share.

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HBO Benefits From The Success of Its Original Programming

We estimate that HBO accounts for more than 35% of Time Warner’s value. The network’s programming is distributed in more than 60 countries across the globe. HBO U.S. had 46 million subscribers while the worldwide subscriber base was around 92 million as of December 2014. ^[1] The network charges high monthly subscription fees, and therefore has low penetration in the U.S., compared to regular cable networks. As of December 2014, HBO reached about 43% of the U.S. pay-TV households and charged a monthly subscription fee of over $7 per month, according to our estimates. This compares with TNT’s penetration of 90% and an estimated monthly subscription fees of around $1.30. HBO’s domestic subscription revenues have grown from $2.70 billion in 2008 to $3.80 billion in 2014. The network’s international, content and other revenues also grew from $1.15 billion to $1.60 billion during the same period. There are no advertisements on HBO, making it relatively less risky than ad supported cable networks, since ad revenues tend to be volatile during economic downturns. HBO is a more discretionary product given the higher fee per subscriber.

We expect HBO penetration to increase to over 55% by the end of our forecast period. However, any significant growth is unlikely due to rising demand for alternative video platforms, which provide cheaper options to watch movies and TV series. HBO itself has recently launched its standalone over-the-top streaming service (see – Time Warner: How Will HBO Now Impact The Network’s Performance In The Coming Years?). Looking at the monthly subscription fees, it should see continued growth in the coming years and be north of $9 by the end of our forecast period. This will translate into domestic annual subscription revenues of close to $7 billion and an estimated EBITDA margin of 40% will translate into EBITDA of over $2.80 billion, representing 22% of the company-wide EBITDA. The contribution will a little under 35% if we account for the network’s international, content and other revenues.

The growth in penetration and subscription fees will largely be driven by higher contractual rates and HBO’s content appeal. Contracts between content companies and pay-TV service providers include prescribed yearly increments for subscription fees. These contracts are long-term, spanning across several years. Moreover, HBO is unparalleled in terms of its movie content and original programming. Given that it charges a very high fee per subscriber, it is able to afford such premium content. Despite increasing subscriber fees, HBO has been able to maintain and grow its subscriber base, indicating sustained demand for this premium channel and its content.

HBO has backed several original drama and comedy series, many of which have won awards and received critical acclaim, including Game of Thrones and True Blood.  In recent years, HBO has largely benefited from the success of Game of Thrones, which has broken all viewership records and stands as the most watched television series for HBO. The fifth-season finale drew the show’s largest audience ever with an average 8.11 million viewers, up 14% from season 4 finale. Game of Thrones has become cable’s second most popular program after AMC’s The Walking Dead. ((‘Game of Thrones’ Finale Sets Ratings Record, Variety, June 16, 2015)) The network’s original programming has also helped it secure an exceptionally active international fan base. The network generates strong demand due to significant investment in its content. This is the reason why the network has been able to grow its domestic subscriber base to over 40 million, despite charging the highest subscription fee in the industry. Continued investment in programming will ensure high demand for its content, which in turn will aid the subscription fee growth in the coming years (also see – What Can Move Time Warner’s Stock Higher?).

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1. Time Warner’s SEC Filings [↩]