Time Warner (NYSE:TWX) recently reported its Q3 results. While the operational results were in line with our expectations, the key takeaway from the earnings release was the continued growth in HBO subscription and licensing revenues. However, the company lowered its 2016 EPS guidance from $6 to $5.25 amid increased investments and currency issues.  For Time Warner, HBO remains the key growth driver, in our view. The network will not only benefit from subscription growth but also from HBO Now. While there hasn’t been a major change in our valuation of Time Warner, our updated model reflects continued subscriber declines at Turner networks and a slower growth rate for advertising, primarily due to continued weakness in domestic advertising and currency issues in the international market. Looking at calendar year 2015, we estimate the company’s revenues to be around $29 billion, with EPS of $1.64.
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HBO Is The Key Growth Driver For Time Warner
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 this year received 43 primetime Emmy awards, reflecting the quality of content that the network creates. HBO derives its revenues from subscription, licensing and streaming in the U.S. and international markets. Subscription revenues have been on an uptrend, reflecting growth in subscribers as well as monthly subscription fees. Given the popularity of its programming, HBO has been able to raise prices consistently, and we expect this to continue. We expect the monthly subscription fees to grow from $7 in 2014 to an estimated $10 by the end of our forecast period (towards 2022). This would translate into revenues of over $7.5 billion, and an estimated EBITDA margin of 38% for HBO will translate into EBITDA of around $3 billion, representing more than 20% of the company-wide EBITDA.
However, the contribution will be much higher if we account for its other sources, including licensing, international markets and HBO Now. The growth in subscription revenues will primarily be driven by HBO’s appeal in terms of content. Given that it charges a relatively high fee per subscriber, it is able to afford premium content. Also, despite increasing subscriber fees, HBO has been able to maintain and grow its subscriber base even as the industry is facing headwinds from the rapid growth of digital video platforms, indicating sustained demand for the premium channel. The network saw an opportunity with changing viewing habits, and launched its own over-the-top streaming service – HBO Now. While the company hasn’t disclosed HBO Now subscriber numbers, it expects the product to be a significant contributor to revenues in the coming years.  Given the quality of content that HBO offers, it shouldn’t be difficult for it to find several takers for the service. By the end of Q2, HBO Now had over 1 million paying subscribers on the iOS platform alone.  We currently estimate 5 million HBO Now subscribers by the end of the decade, translating into revenues of around $1 billion.
On the other hand, the Turner networks – following the industry-wide trend – are seeing a decline in subscribers. Given the lower ratings, advertising for most of the networks is flat to negative. Currency issues are further adding to the woes. Based on these factors, we have revised our forecast for Turner Networks slightly downwards, but it hasn’t resulted in a major change to our price estimate.
A Time Warner Deal With Hulu In Its Current Shape Is Unlikely
Digital and streaming platforms have seen viewership growth in the past few years, while television has declined. Currently, there are three major alternative video platforms in the U.S. – Netflix, Hulu and Amazon Prime. Now Hulu is seeking to sell a stake to Time Warner, in a deal which would value the streaming service at $5 billion, according to the Wall Street Journal. Disney, Fox and Comcast jointly own Hulu, and selling a stake to Time Warner would reduce their stakes to 25% each. The deal would help Hulu compete better with Netflix and Amazon Prime, as Time Warner would not only bring in cash but also offer more content than it has currently sold to Hulu.  While Hulu could be far more valuable in the future if it continues to post subscriber growth, Time Warner has been pushing for its own in-house streaming service. Currently, Hulu streams many broadcast shows from ABC, Fox and NBC within days of original airing. This setup doesn’t necessarily align with Time Warner’s, which wants to hold on to the content on its own platforms for much longer before licensing it to others. For instance, HBO would rather promote its programming on HBO Now for months or even years before letting anyone else air it. Otherwise, HBO Now would lose some of its appeal, given that the same content is available with another provider. If Time Warner does take a stake in Hulu, it will have to work out a different agreement on content licensing than what is currently in place with Hulu’s owners. Nevertheless, this is an interesting development and reaffirms that streaming holds a very important place in the future of the media industry.
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