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AOL Plagues Time Warner

By W.D. Crotty
The Motley Fool
November 3, 2004

The five-year chart for Motley Fool Stock Advisor recommendation Time Warner (NYSE: TWX) fails to show the fantastic success of the Lord of the Rings trilogy and the Harry Potter series of films. It is the pall of AOL that has kept this company's stock from rocketing upward.

Overall, third-quarter results were mixed. Revenue increased 5% and net income fell 7.8%. What was impressive was the near tripling of free cash flow to $1.4 billion. Hurting income was a $500 million legal reserve for "pending government investigations" at the AOL unit -- and, since a reserve for shareholder and civil litigation has not been established, you can expect more reserves!

While AOL's revenue increased an anemic 1%, operating income surged 74% (not including the legal reserve) because of a sharp reduction in network expenses. Overshadowing the earnings news is a 646,000 decline in subscribers in the U.S. and 8,000 in Europe -- and no clear way for AOL to steal customers away from cash-rich content providers such as Google (Nasdaq: GOOG), Yahoo! (Nasdaq: YHOO), and Microsoft (Nasdaq: MSFT).

Time Warner's Cable division produced a 10% increase in revenue and operating income because of strong growth in digital video and digital data services.

The Filmed Entertainment unit saw a 1% decline in revenue and a 4% drop in operating income. While the company was No. 1 in the U.S. in home video sales and rentals, the previous year's home video release of The Lord of the Rings: The Two Towers was too much to top.

Networks (Turner, HBO, WB Network) saw revenues climb 8% and operating income increase 13%. TNT was once again the No. 1 ad-supported cable network for delivering adults ages 18-49 and 25-54 during prime time. Publishing revenue increased 3% and operating income climbed 28% on the strength of advertising revenue.

Time Warner's 11.1% operating margins this quarter are below those at competitors Disney (NYSE: DIS), News Corp. (NYSE: NWSWI), and Viacom (NYSE: VIA). Still, the stock trades at a lofty 25 times estimated 2004 earnings because analysts see 15% earnings growth in 2005, a continued reduction in net debt, and strong free cash flow.

If it were not for AOL, Time Warner would be an easy story to tell. But because of AOL and the ongoing government investigations, the outlook is clouded.

 

 

 

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