NEW YORK (CNN/Money) -
AOL Time Warner and AT&T are still trying to decide how to unravel a complicated partnership. But an initial public offering of the joint venture, known as Time Warner Entertainment (TWE), has been ruled out for AOL and AT&T.
AT&T owns a 27 percent stake in Time Warner Entertainment, a joint venture that includes a majority of AOL's cable assets, the Warner Brothers movie division and the HBO and WB networks. AOL Time Warner, the parent company of CNN/Money, owns the remainder of TWE.
This is no small matter: Time Warner Entertainment makes up a major portion of AOL Time Warner's business, accounting for 41 percent of overall revenue in the first quarter and more than half of earnings before interest, taxes, depreciation and amortization (EBITDA). The rest of AOL Time Warner's business comes from other network and film assets, music, publishing and the AOL online division.
For AT&T and its cable merger partner Comcast, a sale of the stake in TWE would help raise sorely needed cash to pay down debt. Comcast is assuming $20 billion of AT&T's debt once the merger is completed at the end of the year.
The two companies have been seeking a way to end the relationship for nearly two years. But in the immortal words of Neil Sedaka, "breaking up is hard to do." AOL and AT&T hired Banc of America Securities in June to decide the valuation of that stake and an opinion was expected on Monday. But AOL and AT&T have asked Banc of America to not give an opinion for the time being.
If Banc of America Securities gave its valuation opinion Monday, AOL would have had 15 days to decide whether to register to sell AT&T's stake in TWE to the public or to buy AT&T's stake outright. AT&T would have had to respond to AOL's offer within 20 days. AOL and AT&T said they plan to seek other ways to end the relationship.
A cable spin-off is possible
Since AOL has a big debt load of its own, it is unlikely that it would buy out AT&T's stake in TWE. "You have two cash-strapped companies trying to come to terms on this transaction," says Dan DeMonica, portfolio manager with National City Investment Management Company, subadvisor for the Armada family of mutual funds.
Time Warner Entertainment
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|41 percent of AOL's revenue
|50.5 percent of AOL's EBITDA
|Majority of AOL's cable assets (including Road Runner high speed Internet access service)
|Warner Bros. movie studio
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A partial spin-off of TWE, which no longer seems like an option, would have further complicated AOL's Byzantine corporate structure. And since taking over as AOL Time Warner CEO, Dick Parsons has maintained that simplifying AOL's structure is a priority.
Time Warner Entertainment owns just two of AOL's many networks. CNN, TBS, TNT, The Cartoon Network and several other networks are not part of TWE. A separate stock for TWE would also make it confusing to evaluate AOL's overall movie business. New Line Cinema, for example, is not part of TWE and that unit is responsible for the distribution of the movies in the "Lord of the Rings" trilogy as well as the recent blockbuster, "Austin Powers in Goldmember."
A spin-off of just the cable unit now appears to be the most likely course of action, and would be more advantageous to AOL. That's because the majority of AOL's cable business is already a part of TWE. TWE's cable revenue and EBITDA accounted for nearly ninety percent of AOL's overall cable revenue and EBITDA in the first quarter. So it would be relatively easy for AOL to lump the rest of its cable assets with those already a part of TWE.
AOL would need to either buy AT&T's stake in the film and networks divisions before proceeding with a public offering or agree to grant AT&T a higher percentage of the cable spin-off.
Also, it's highly questionable that AT&T (or Comcast for that matter) would just want shares of a pure-play cable company because it would probably be difficult to get a good price for them in this market environment.
Cable stocks have been among the market's poorer performers this year due to the bankruptcy of cable company Adelphia, concerns about their highly leveraged balance sheets, competition from satellite TV providers and overall investor distrust of corporate accounting. Wall Street relies mainly on EBITDA, the profitability metric that WorldCom was alleged to have fraudulently inflated, to value cable companies.
Comcast and Cox Communications are down more than 40 percent this year while two smaller cable companies, Cablevision and Charter Communications, have each lost nearly 85 percent of their value. To that end, AT&T is said to be asking for at least $1 billion in cash from AOL in addition to a stake in the cable unit, according to a report in the New York Times on Monday.
How this will eventually resolve itself is still up in the air. AT&T certainly needs the cash and AOL clearly would benefit from a simpler corporate structure. DeMonica thinks that AT&T's balance sheet woes are more serious than AOL's so AOL might have the upper hand in negotiating terms of a deal.