A tale of two giants

Apr 28, 2003  •  Post A Comment

The back-to-back quarterly earnings calls of AOL Time Warner and Viacom-in addition to delivering better-than-expected results-offered an interesting and unexpected contrast in how the media giants are growing, leveraging their resources and meeting challenges.

In cost cutting, growing advertising and subscription revenues and mining existing resources for profit, AOL Time Warner seems to be taking a page from Viacom’s tradition-bound management book, although the ongoing, unprecedented regulatory probes of its accounting practices and the free fall of its online unit set the company apart from its media peers.

Even as AOL Time Warner races against time to reduce its nearly $30 billion gross debt, revitalize its America Online unit, mine its stellar cable and film units and emerge from federal investigations, it has managed to deliver its first bit of good financial news in a year: a swing to profitability in the first quarter with $396 million in net income, or 9 cents a share, compared with a year-earlier loss of $54.2 billion, or $12.25 a share.

Never mind that first-quarter 2002 results were grossly inflated by a $54.2 billion goodwill accounting charge, or that AOL Time Warner management has admittedly set its financial bar low enough to meet or exceed stated targets. New disclosure regulations (on restating restructuring costs) also work in the company’s favor, though even without those adjustments, the company would have reported a better-than-expected 9 percent hike in cash flow last quarter.

That said, the company’s first-quarter results moderately exceeded analyst estimates, with $2 billion in earnings before interest, taxes, depreciation and amortization, up 14 percent from a year earlier, on a 6 percent rise in revenues to $10 billion, driven by the cable networks and filmed entertainment.

Some of the most important first-quarter improvements came from its beleaguered AOL unit, where heavy-duty cost cutting resulted in better-than-expected $404 million in earnings despite accelerating narrowband subscriber losses.

AOL’s overall cash flow fell 3 percent on a 4 percent fall in revenue. However, Bernstein Research analyst Tom Wolzien cautioned, “The hope is seen in the cost cutting of AOL, but the uncertainty comes from a complete lack of understanding what will need to be spent to acquire or develop programming to hold high-speed users.” Such troublesome issues prompted Mr. Wolzien and other analysts to maintain a more cautious position on the stock.

5 percent ad revenue drop

While trying to help its AOL unit make the leap to broadband and establish more conventional advertising revenues, AOL Time Warner suffered a 5 percent drop in total ad revenues last quarter, even as its WB network posted ad gains of 27 percent and the Turner cable networks grew ad revenues by 8 percent.

In the end, there was no risk in the company sticking by its vague 2003 guidance: that revenues will rise by mid-single digits as cash flow grows by low- to mid-single digits.

While its first-quarter gains are a far cry from reversing its financial fortunes, AOL Time Warner is demonstrating strength on several important fronts. It continues to generate about $1 billion in quarterly free cash flow and is selling enough assets (including a 50 percent stake in Court TV, its Atlanta sports teams and its Warner Music manufacturing operations) to achieve serious debt reduction.

AOL Time Warner CEO Richard Parsons said during the April 23 earnings call that the company can achieve $4 billion in asset sales to reduce debt by late 2004, even without the public spin off of its Time Warner Cable, whose first-quarter earnings rose 6 percent to $691 million on a 9 percent rise in revenue to $1.8 billion. Good thing, too, since company officials also confirmed the initial public offering of the cable operations-which are valued at $34 billion and could raise an estimated $7 billion in proceeds-is delayed while the Securities and Exchange Commission continues to probe AOL accounting.

To make the point, Mr. Parsons said a recent $2.1 billion payment to Comcast Corp. to dissolve the troubled Time Warner Entertainment partnership was virtually offset by free cash flow and asset sales, which most recently included sale of its 50 percent stake in Comedy Central to Viacom for $1.2 billion cash-a deal analysts praised for the leverage it adds to Viacom’s low $10 billion debt load.

Viacom, which is expected to buy other cable networks, TV and radio stations or other core assets using its extraordinary $3 billion in annual free cash flow, also delivered better-than-expected first-quarter results this week. It is eyeing Vivendi Universal Entertainment’s Sci-Fi Channel and USA Networks, AOL Time Warner’s CNN and more TV stations.

In the first quarter of this year, when no one was sure the United States still wasn’t in a recession or that advertising was really “back,” Viacom said it grew its overall earnings 12 percent to $1.2 billion, or about $24 million ahead of many analyst estimates. Its revenues rose 7 percent to $6.05 billion, half of that rooted in ad revenues which were up 6 percent overall. It reported net profit of $443 million, or 25 cents per share, compared with a loss of $1.1 billion, or 63 cents per share a year earlier.

While Viacom represents one of the few major media mergers that has worked, posting record earnings since its May 2000 union, it also has its own troubleshooting to do. Its radio division, the most basic of its traditional media assets, posted flat $275 million in earnings on 3 percent growth in revenues to $822 million.

Like AOL Time Warner, Viacom was boosted in the first quarter by a 19 percent rise in cash flow on just a 3 percent revenue growth at its cable networks, and a 13 percent cash-flow boost to its television network and stations on a mere 4 percent rise in revenues.

Viacom’s CBS is prepared to play its strong hand in next month’s upfront, seeking 15 percent to 20 percent price increases at 80 percent inventory sellout, Mr. Karmazin said, reiterating estimates he made in February. Achieving those goals would make CBS a principal beneficiary of what could approach a record $9 billion prime-time network upfront. “Better buy often and buy fast and get your order in,” he advised advertisers, who have paid as much as 30 percent to 40 percent scatter market premiums to CBS.

By wrapping Comedy Central into its cable networks stable, Viacom will be able to “drive revenue enhancements and cost savings,” which sources say could initially total more than $7 million annually, Merrill Lynch’s Jessica Reif Cohen said.

With those growth prospects, Viacom is sticking by its guidance for full-year 2003 earnings growth of 9 percent to more than $6 billion. The message: There is plenty of reliable growth to mine in traditional media assets-something even AOL Time Warner embraced in its investor call.

For instance, AOL Time Warner clearly is working diligently behind the scenes to generate new revenue streams from existing resources with plans to syndicate more existing and new HBO programming in the future, according to Jeff Bewkes, entertainment and networks group chairman.

Time Warner Cable-which is way ahead of its peers in digital subscriber, high-speed data and high-definition and personal video recorder deployment-is set up for its content-driven corporate parent to make the most of those low-cost, high-return new tech platforms. It is going after video-on-demand services, which have been fully deployed across its systems.

But, Mr. Wolzien cautions that AOL Time Warner could get into trouble acquiring or developing content for its high-speed online service, estimating it could cost up to $800 million a year within five years, and curbing AOL earnings growth to 7 percent, or about half what it could be by then.

But for AOL Time Warner, the financial liabilities tend to be more dire, even in the face of improved quarterly results. “If it weren’t for the SEC investigations and a bevy of shareholder lawsuits, AOL Time Warner would not be categorized as a troubled company, but one in early
stages of recovery,” Mr. Wolzien said.

But AOL Time Warner made it clear this week that the prolonged probes will take a heavier toll on its balance sheet, prompting Standard & Poor’s to maintain a “negative credit watch” on the company due to growing concern about “ongoing controversy” involving AOL advertising transactions. “These issues have assumed at least as much importance in our review as near-term balance sheet debt to earnings and leverage, including all debtlike items,” S&P said in a statement issued after AOL’s earnings call. That means it is going to take a whole lot more than a few assets sales and one upbeat quarter earnings report to make AOL a bonafide turnaround story.