Monday, May 30, 2005

How to Save a Sinking Ship

Long suffering Time Warner may finally be pulling itself up from market whipping boy and pre-market bust joke back to a stable firm. Ever since the “visionaries” of the mega-merger between AOL and Time Warner, Steve Case and Jerry Levin, raised their hands in victory and promised to build the most valuable company in the world, Dick Parsons, the current CEO of Time Warner, has led the company from being known as the “worst merger in business history” back to a prominent player in the cable and media industry. Since then, Parsons has accomplished most all of what he promised when coming into the company as Chairman and CEO in 2002- he has reduced corporate debt by half, stabilized America Online, settled two federal investigations, and is now set to take control of Adelphia’s cable assets. Due to all of Parson’s success, Time Warner has been reaping the fruits of success, posting a profit of $3.3 billion on revenues of $42 billion… but will the company be achieve similar success long term while winning back the hearts and minds of a skeptical market?

Before jumping into the analysis of Parson and team’s strategies for long-term success, a quick walk through the company’s operating units would be valuable at this juncture. The following data was provided by Standard & Poors. AOL, the global leader in online services, had about 31.6 million subscribers worldwide, while the Film entertainment business unit, mainly Warner Bros., consists of both film and television properties. According to Deutsche Bank equity analysts, the AOL business unit, together with the film unit, was both bright spots in Q1 of this year. Another large business unit of Time Warner, the Cable segment, is the second largest U.S. cable operator, serving about 10.9 million subscribers. It offers high speed data and other interactive digital services. Analysts were also encouraged by the cable business unit’s solid results, meeting their estimates. Although Time Warner has additional business units within its control, these are the three primary foci for future growth of Time Warner.

Although equity analysts are coming around on the short term prospects of the stock, investors still seem confused. As stated in the article in Fortune Magazine titled, “Will Wall Street Ever Trust Time Warner,” the author believes that growth investors like the prospects of cable and AOL, but find the publishing and broadcasting businesses a major drag- and would rather put their money in pure plays such as Comcast and Yahoo. Value investors, on the other hand, are averse to the risks in the cable and online properties. Finally, investors who believe in the value of content would put their money in Disney even though Time Warner owns some of the most valuable entertainment and media properties.

Based on the Fortune article references above, Parsons understands that the past failures to capitalize on synergies and complementarities between the diversified business units (the core of the value proposal from the AOL and Time Warner merger) is the key source of confusion with investors which has caused the company to trade at the same value as over a year ago and nine times 2005 earnings (below other diversified media companies). At the same time, though, we believe that Parsons has the correct strategies in mind to drive strong earnings from all business units with the backup plan to spin off those business units that under perform, which should begin to re-build investor confidence.

At the business unit level, he and his management team have refocused the underperforming business units into more profitable units. For example, in the AOL business line, while subscriptions continue to drop over time, Parsons and team have taken a page out of the Yahoo business model and plan to release a free portal with content and other value added features with the sole purpose of capturing a larger piece of the online advertising market. Analysts have taken this as a very favorable strategy, and this is one of the key points driving the bullish outlook of the company. With the same desire to strengthen the cable business line, Parsons also made a strong investment by purchasing the cable lines from Adelphia’s cable properties, providing Time Warner’s networks with access to approximately three million cable viewers. The deal also calls for the company to create a separate cable stock that would have its own equity, although Time Warner would still have controlling interest. This is a very positive move for Time Warner since it will allow them to make moves in the cable and wireless area without further confusing shareholders and market investors. Both of these moves to strengthen two of their core business units, if successful, should allow Parsons to begin to capitalize on synergies and complementaries between the business units.

A primary step before doing this, however, is for Parsons to focus his energies to truly break down the fiefdoms between the various business units, a key factor in driving synergies between the business units. The architects of the original AOL and Time Warner deal had the correct idea in mind, but they clearly did not consider the internal culture clash that was to come that would torpedo the success of the deal. However, thanks to Parsons, the focus from the top down is to focus on Human Resources to promote information sharing and harmony between the units.

If Parsons is truly successful in building the AOL and cable businesses into consistently profitable business lines while building strong lines of communication between all business lines within the enterprise, only then will the company begin to capitalize on the synergies and complementarities that they have only been able to speak about in the past without any tangible success. If Time Warner is successful, the company will own a suite of complementary products and services that will saturate the market producing significant barriers to entry to other diversified media companies. This is a tantalizing vision for the business units, the management team and shareholders alike. On the flip side, the backup plan to spin off the AOL and cable units depending on success or failure of these initiatives will provide some solace and clarity to investors that AOL’s chairman and CEO still has the shareholder’s best interest in mind. Based on Parson’s success to-date turning around one of the biggest corporate disasters in history, even the most risk averse investor should think twice when deciding on whether or not to pass on investing in Time Warner and its chairman.

-- Bryant Houston, Sachin Kelkar, Riahna Phillips


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