HBO And Warner Bros. Will Drive Time Warner’s Future Growth

Time Warner’s (NYSE:TWX) recent Q2 results reaffirm our expectation and warrant no material change in valuation. We believe that, in the short to medium term, Time Warner’s stock will primarily be driven by two factors — HBO and Warner Bros.’ movies and TV licensing. However, unfavorable currency effects will likely be a drag on earnings. HBO’s unparalleled content will continue to aid its subscription growth in the coming years while the new streaming service will widen its subscriber reach. Warner Bros.’ movies and TV licensing will aid Time Warner’s overall growth. We currently estimate revenues of about $29 billion for Time Warner in 2015 with EPS of $4.58, which is somewhat lower than the market consensus of $4.67, compiled by Thomson Reuters. We currently have a $95 price estimate for Time Warner, which we will soon update to reflect the June quarter earnings.

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Higher Subscription Revenues At HBO Will Drive Future Growth

We estimate that HBO accounts for more than 35% of Time Warner’s value. The network’s programming has seen massive demand, especially in the last few years with hits such as Game of Thrones. HBO received 126 Emmy nominations this year, reflecting the quality of content that the network creates. Recently, the network’s president, Michael Lombardo, stated that Game of Thrones will run for 8 seasons and the network may also make a prequel to the hit series. ^[1] While there is no advertising associated with HBO, it charges a high monthly subscription fees of more than $7 per subscriber, according to our estimates. Given the popularity of its programming, HBO has been able to raise the prices consistently in the past and we expect it to continue this trajectory. We estimate the subscription fees to grow from $7.10 in 2014 to an estimated $9.00 by 2020. This will translate into revenues of close to $6.50 billion and an estimated EBITDA margin of 40% for HBO will translate into EBITDA of $2.50 billion, representing 20% of the company-wide EBITDA (see – HBO’s Original Programming Will Drive Time Warner’s Future Growth).

Currently U.S. subscriptions account for 70% of the segment revenues while international operations and content deals, among others, make up the rest. Earlier in Q2, the network launched its over-the-top standalone streaming service, HBO Now, for Apple devices and has recently extended its distribution to Verizon, Amazon and Google. The company’s management stated that it was the top grossing entertainment app on iTunes for May and June. ^[2] While the company didn’t given any subscriber numbers, they have been targeting the 10 million broadband-only subscribers and 70 million homes that haven’t subscribed to the network. We currently estimate 5 million HBO Now subscribers by the end of our forecast period and its impact on revenues is included in HBO International, Content & Other Revenues in our model.

Warner Bros. Movies And TV Licensing Will See Solid Growth In Coming Years

Time Warner’s studio operations are widely diversified with TV production, movies, electronic sales, video games and licensing. However, we flag TV Show Production & Licensing as a separate driver in our model. Looking at box-office, Warner Bros. has a solid star cast for its lineup in the coming months, including Johnny Depp in Black Mass, Hugh Jackman in Pan, Antonio Banderas in The 33 and Sylvester Stallone in Creed. The studio will release its much-hyped DC movie, Batman v. Superman: Dawn of Justice, around Easter 2016. These movies should do well at the box-office and aid overall revenue growth for Time Warner. However, given the strength in dollar, currency will surely impact the studio’s performance in the near term.

Looking at the television product, we expect strong growth in the coming years primarily due to licensing of its popular shows. Warner Bros. is licensing its content to various international markets and in the U.S. to different platforms including Hulu and Netflix. In Q2 2015, revenues grew 23%, reflecting the benefits from syndication of The Big Bang Theory and the licensing of Seinfeld and Friends. ^[2] With a vast content library at its disposal and increasing distribution avenues on digital front, Warner Bros. can look forward to solid growth in licensing revenues. We currently estimate TV Licensing revenues will grow from $5 billion in 2014 to over $8 billion by the end of our forecast period. An estimated EBITDA margin of 21% will translate into EBITDA of $1.85 billion, representing 15% of the company-wide EBITDA. The contribution will be much higher at around 25%, if we account for entire studio operations (see – Even With Ratings Pressure, There Is An Upside Potential To Time Warner If This Event Is Triggered).

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1. ‘Game of Thrones’ Eyes 8 Seasons, HBO ‘Open’ to Prequel Series, Variety, July 30, 2015 [↩]
2. Time Warner (TWX) Jeffrey L. Bewkes on Q2 2015 Results – Earnings Call Transcript, Seeking Alpha, Aug 5, 2015 [↩] [↩]