AOL TW could turn to spinoff

Apr 29, 2002  •  Post A Comment

AOL Time Warner’s damage-control plan in the wake of its sobering first-quarter earnings report could include a public spinoff of its cable systems, though a widely speculated spinoff of its even more distressed AOL online unit is less likely.
That is the word from high-level company and industry insiders following last week’s report, which was marked by the biggest-ever $54 billion corporate write-down (reflecting the merged company’s lost value) and another lowering of the bar on its 2002 profit and revenues.
AOL Time Warner management declined comment on the prospects for a public spinoff of its cable systems or its AOL unit, or the prospects of selling a minority stake in its troubled Time Warner Entertainment, a partnership with AT&T and Advance/Newhouse that comprises most of its cable systems, HBO and Warner Bros.
However, company insiders confirm management has revived discussions about selling a minority stake in a newly formed entity that would come to include all of Time Warner Cable’s 13 million cable subscribers and could be valued at more than $50 billion.
Such a move would aid in the unraveling of the troubled TWE partnership and would likely be endorsed by Wall Street, where confidence in and support for AOL Time Warner has been waning. It also would create a deal currency that could be used in the acquisition of additional cable operators and systems by the country’s second-largest cable company. AOL Time Warner would remain the majority owner of such a cable entity, sources said.
A cable spinoff also could serve as a takeover defense, since AOL Time Warner becomes a potential takeover target as its stock dips below $20 a share. It fell to a new low of $18.61 per share last week in reaction to all the news.
As for a potential AOL spinoff, one high-level executive, who asked not to be identified, fired back, “Absolutely not.” However, sources close to the company said there have been discussions about such an option, which is not considered likely only 16 months into the merger.
Analysts said such a move would not make financial sense given AOL’s relative weakness, “But stranger things have happened!” one leading cable analyst quipped. AOL Time Warner stock is trading at about one-third of what it was at the time the merger was announced, when it reflected only the value of the Time Warner assets.
AOL spinoff speculation in recent weeks has been fueled in part by disgruntled company employees who have seen the value of their stock options plummet.
The fact that AOL Time Warner has lowered its expectations several times-to only about one-third of what they were when the companies merged in January 2000-is why there wasn’t more bloodletting on Wall Street last week in response to the company’s 3 percent rise in first-quarter earnings before interest, taxes, depreciation and amortization to $2 billion on a 4 percent rise in revenues to $9.8 billion and $1.1 billion in free cash flow after nonrecurring items. Revenues were dragged down by a 13 percent decline in advertising and commerce at AOL, which comprises only 19 percent of the corporate parent’s overall revenues.
A slew of analysts lowered their ratings on the stock, and most analysts once again lowered their earnings and revenue targets for the next several years. But leading Lehman Bros. analyst Holly Becker said in a report to clients there still is more bad news to come at AOL Time Warner. Company officials conceded last week that second-quarter results are not likely to be much better than the first quarter, even though ad spending should increase during the second half of the year and its more traditional Time Warner businesses are posting solid growth.
Underscoring the seriousness of its situation, the company lowered its target for 2002 earnings to between 5 percent and 9 percent on a mere 5 percent rise in revenues. It is a far cry from January, when the company projected 8 percent to 12 percent growth in 2002 earnings, down considerably from the 19 percent earnings growth projected at the time the companies merged.
Publicly spinning off its cable systems, a possibility first reported in the Wall Street Journal, would go a long way in winning support on Wall Street, even though outgoing CEO Gerald Levin has passionately fought against such a move. There was speculation at the time Mr. Levin abruptly announced his retirement that the controversial move somehow played a role in his decision to leave the company he helped to merge. New CEO Richard Parsons and other company executives have said it could benefit from simplifying its financial structure.
Mr. Parsons himself is leading the revived discussions with Comcast President and CEO Brian Roberts and AT&T Chairman Michael Armstrong.
Comcast Corp. has indicated its preference to sell AT&T’s 25 percent stake in TWE when it acquires AT&T Broadband later this year. AT&T already has registered to sell all or part of its stake on the open market.
The Newhouse partners have indicated their interest in withdrawing their cable systems from the partnership, accounting for about 2 million of the cable subscribers in TWE.
Either move would diminish Time Warner Cable’s second-place standing among cable operators and its efforts to roll out its AOL broadband service to subscribers served by other cable operators. Like most other cable operators, Time Warner Cable has suffered a slowdown in new digital subscribers.
Without a spinoff, AOL Time Warner runs the risk of having to pay more than $10 billion to buy out Comcast-AT&T and Newhouse’s positions in TWE, which would add to AOL TW’s already troublesome $28 billion debt.