For Time Warner, a time to break up?

Jeff Bewkes, the media giant's future CEO, faces restive shareholders, a flat stock price, and a key question: Should Time Warner be split up? Fortune's Richard Siklos and Stephanie N. Mehta report.

(Fortune Magazine) -- At Time Warner headquarters in late July, dozens of Manhattan A-listers gathered to hear Senator Barack Obama participate in an off-the-record question-and-answer session led by Time Warner chairman and chief executive Dick Parsons.

Jeffrey Bewkes, Time Warner's president, kicked off the event by introducing his boss as a "savvy businessman and exemplary leader." Bewkes then rattled off some of Parsons' lesser-known civic activities. "It is so clearly his calling," Bewkes deadpanned, "that I've encouraged him to pursue a career in public service."

Jeff Bewkes is expected to take over as CEO of Time Warner when Dick Parsons steps down. He faces some daunting challenges.
Parsons has consistently argued that the company is more valuable together than in pieces.
Headquarters staff doubled to around 700 employees after the AOL merger.
The route to the CEO's office
Before he was Dick Parsons' heir apparent, Jeff Bewkes was best known as the guy who transformed the old Home Box Office from a movie channel into an original-programming powerhouse. Time Warner shareholders may be hoping he can bring similar luster to HBO's parent. Here are a few career highlights.
Served as president, then chairman and CEO, of HBO. Under his watch the network launched shows such as 'Sex and the City,' 'The Sopranos,' and 'Six Feet Under'; earnings grew an average of 20% yearly.
Emerged, along with Don Logan, then CEO of Time Inc. (with Parsons, far left, and Bewkes, far right), as one of the most vocal critics of the Time Warner merger with AOL and later questioned the financial goals set largely by AOL executives.
Promoted to chairman, Time Warner entertainment and networks group. Worked with Parsons and Logan to restore stability to the corporation.
Engineered sale of Warner Music Group for $2.6 billion in cash. Bewkes was criticized for selling it too cheaply, but the group's recent performance suggests he didn't.
Named president and chief operating officer of Time Warner, setting the stage for his ascent to the CEO role.
Pushed AOL to give away e-mail accounts and other services for free, completing AOL's transformation from a subscription model to a free portal. Brought in Randy Falco, a top NBC executive, to run AOL.
Exporting Bollywood
The booming entertainment industry in India is making waves around the world as Bollywood goes global.
The booming online music industry
CNNMoney's Jim Ledbetter and Fortune's Oliver Ryan discuss the rapidly changing online music industry.

Settling into a lounge chair next to Obama, Parsons replied, "He's not kidding about having me take up some other line of work. I don't think he cares if it's public service or whatnot."

The jocular moment underscored the biggest non-secret in the media world: that Parsons is getting ready to wrap up an eventful, nearly six-year stint running the planet's biggest media company, and that Bewkes's era is near. Parsons' contract will expire in May, but several senior people within the company expect him to hand over the CEO reins to Bewkes sooner, perhaps by the time the company's annual top management retreat begins in November in Miami. The betting is that Parsons will stay on as chairman for at least a year.

Street frowns on Time Warner

What is making the transition less smooth than either man hoped, however, is the anvil weighing down Time Warner's stock price. Instead of celebrating Parsons' corporate stewardship, frustrated investors are grumbling that Time Warner (Charts, Fortune 500) (Fortune's parent) is today trading slightly below where it was when he took over in May 2002.

Now, even before Bewkes has the top job, the stock's malaise has some wondering whether the 28-year company veteran, who was anointed as Parsons' likely successor two years ago, can really lead Time Warner's beleaguered shareholders to the promised land (see correction). (Heck, at this point, they'd settle for the stock price going up a few ticks.)

Calls to break up Time Warner have ranged from a chorus to a low rumble but have never gone away. Richard Greenfield of Pali Capital in New York, an analyst known for his provocative views, has questioned Parsons' commitment to the job and is even urging the Time Warner board to expand its search for a new CEO.

It's a safe assumption that Bewkes's ascension is secure. And there's little doubt that the hard-driving former head of the company's Home Box Office unit will attempt to remake the company in his own image: lean, energized, granularly focused on results, unsentimental, and slightly obsessive.

It's far less sure that Time Warner in two years will look much the way it does today, a rambling collective of some of the world's best-known media brands in the film, TV, and magazine businesses; the country's second-biggest cable-TV system; and that Rubik's Cube of big Internet companies, AOL.

Six years after their infamous merger, AOL haunts Time Warner still: Although it is expected to represent only 11% of overall company revenues and 14% of operating earnings this year, Bewkes's early impact as chief executive is likely to be judged largely by how AOL performs in the months ahead.

In upgrading Time Warner stock to a buy recommendation on Sept. 12, Vijay Jayant of Lehman Brothers laid out a scenario, which some investors also believe is brewing, for transforming the company over the next two years.

Specifically, Jayant speculated that Bewkes might completely separate 84%-owned Time Warner Cable from its parent, spin off or sell the publishing business Time Inc. in a tax-free manner, and eventually take AOL public or combine it with one of its portal rivals, Yahoo (Charts, Fortune 500) or MSN. Jayant thinks Time Warner stock should be worth $25 a share, 30% more than what it trades at today.

Parsons has said that there is no proposal to sell, split, or otherwise recombine the company that he and Bewkes and the board have not already looked at.

Content really IS king

Though its stock has been stuck in amber, Time Warner has hardly stood still in the two years since Parsons and Bewkes fended off an assault from corporate raider-turned-activist agitator Carl Icahn. To defuse a threatened proxy fight to replace Time Warner's board, Parsons agreed to buy back $20 billion worth of Time Warner stock and made some fairly dramatic changes at the company, all of which gave its shares a temporary boost, during which Icahn sold most of his stake.

These strategic moves included cutting costs and putting Bewkes clearly in charge of the company's operations after the retirement of co-deputy Don Logan. On Bewkes's watch, the company went ahead with its public listing of the cable business, sold a passel of magazines owned by Time Inc., and most dramatically, redrew the business plan of AOL and then replaced its chairman and CEO.

Elsewhere, Bewkes merged the money-losing WB TV network into a new venture with CBS's UPN, called CW, while ensuring the rest of the company's vast TV and film businesses - including Warner Bros., the Turner cable networks, and HBO - steadily churned out profits.

He has also made it clear that he abhorred forced synergy among Time Warner's divisions but would encourage collaboration where it made sense - like providing the TBS and TNT channels with shows produced by Warner Bros. or launching, a joint venture of Warner Bros. and AOL.

But obviously more is going to be needed. "The stock has been suffering for a long time now," says Logan. "I think there is going to be great pressure on Jeff to go in and analyze the business units with a critical eye."

Parsons' legacy is that he skillfully moved the company beyond the rubble of its merger with AOL, which included settling some fairly daunting legal challenges from shareholders and the Justice Department. Still, many of his employees saw their retirement savings whacked by the post-bubble, post-merger collapse of Time Warner's share price.

And as for recent discontentment, Parsons has brought some of it on himself with two quirky interviews in the New York Times and New York magazine in which he seemed to distance himself from his job.

Through the ups and downs of his tenure, Parsons has consistently argued that Time Warner, which has a market capitalization of $70 billion, is more valuable together than in pieces - particularly since the company has trimmed the portfolio by selling its books and music businesses and the Atlanta Braves, among other things.

And he has made the argument, quite rightly, that media stocks are out of favor with a Wall Street that frets about what the digital world is going to do to these companies' cash flows. In fact, Time Warner produces more cash flow than any of its rivals.

Yet the two standout stocks in the media sector over the past couple of years - News Corp. (Charts, Fortune 500) and Walt Disney Co. (Charts, Fortune 500) - have also shown that it is possible to break away from the herd. Their share prices have significantly outgunned Time Warner's during Parsons' tenure (see chart). Time Warner had revenues of $44 billion last year, while Disney generated $34 billion and News Corp. reported $25 billion.

And whereas Time Warner used to stand as a Goliath among the media conglomerates, the market caps of all three companies are now relatively close. So what does move the dial for News Corp. and Disney? One theory: Both companies made acquisitions - MySpace and Pixar, respectively - that put some digital magic in their stocks. (Of course American Idol and High School Musical don't hurt either.)

Bewkes isn't saying publicly what his moves as CEO would be. A company spokesman said Bewkes would not comment for an article about running Time Warner because it would be speculative. But interviews with people close to him and a look at his track record as an executive offer glimpses at what life at his Time Warner - call it the Republic of Bewkestan - might be like.

"He will certainly look at things with a different eye than I will," Parsons said in an interview last week, "because he's a different person."

Parsons, a Brooklyn-bred lawyer whose career included stints working for the Rockefeller family and turning around New York's Dime Savings Bank, is known for his affability, diplomatic skills, and sociable interests (ranging from late-night Grammy parties to his vineyard in Tuscany).

Bewkes, who grew up in New Jersey and Connecticut, is an alumnus of Deerfield Academy, Yale, and the Stanford Business School. He toyed with becoming a TV reporter and worked briefly in banking before joining HBO as a marketing manager in 1979.

He gained a reputation for his ability to understand numbers, dissect business strategies, and manage creative relationships. He rose to the position of HBO's chief financial officer before becoming its CEO in 1995 - a position he held through what were arguably the network's glory years. In 2002, Parsons became CEO of Time Warner and promoted Bewkes to a position overseeing all the company's film and television businesses.

On paper, Bewkes can seem whitebread and old-school compared with Parsons, a famously laid-back guy who always seems to have music (mostly jazz) playing in his office. They share a directness coupled with a quick sense of humor and mischief.

But where Parsons can appear carefree in the middle of a typhoon, the wire-thin Bewkes, who at 55 is four years Parsons' junior, can seem like a man on a mission who will get around to sleeping or eating next week. He is, associates say, as relentlessly curious about the minutiae of finance or the HBO development slate as he is about adjusting drapes and lighting when he comes into a room. One person who knows both men well says Bewkes can have much sharper elbows than Parsons and can be a tough boss to please.

The first changes will come in the executive suite. A search is already underway for a replacement for longtime CFO Wayne Pace, who is also set to retire and whose name turned up on the front page of the New York Post last year, linked to a woman arrested for running a prostitution ring. (He denied impropriety.)

Bewkes, according to one executive who knows him, is said to want a finance chief who will play an active role in courting Wall Street, since the new CEO is not expected to designate a second-in-command. Rather, the heads of Time Warner's major divisions will continue to report directly to him.

Bewkes's hiring choices have already raised some eyebrows. He and Parsons replaced former AOL head Jonathan Miller with Randy Falco, a veteran NBC Universal executive with no Internet experience, citing the need for someone with operating chops.

In the second quarter, AOL missed its numbers, sending Time Warner stock down 3% in one day, overshadowing the success of the latest Harry Potter movie. And Bewkes recently had to deal with the resignation of Chris Albrecht, his handpicked successor at HBO, after Albrecht was arrested for allegedly assaulting his girlfriend in a Las Vegas parking lot. (Albrecht pleaded no contest to battery and paid a $1,000 fine.) Bewkes elevated that division's second-in-command, Bill Nelson, to the CEO slot while making three longtime executives co-presidents.

Bewkes is also expected to take a hard look at corporate costs. Time Warner endured criticism from Icahn and others for building the $850 million headquarters on Columbus Circle in New York City in the midst of the AOL merger debacle.

But when Parsons took over as CEO in 2002 and led the company away from the brink of financial peril and civil war, he viewed the headquarters as a signal to employees that their company would endure and still stood for something.

Yet corporate staff at headquarters doubled to around 700 employees after the AOL merger - largely with additions in finance and human resources. That may not seem like a lot for a company that has 90,000 employees overall, but Bewkes may want to pare the more than $400 million the company spends on corporate expenses annually.

The bigger question, of course, is whether Bewkes will dismantle the company, as many think he should. "I still believe that the shareholders would best be served if the company were broken up," says Icahn, who still owns about 12 million shares, according to securities filings. He wouldn't comment on whether he plans to buy more.

Under a scenario that has been envisioned by Icahn and others, Time Warner would slim down to a TV and film business anchored by the Warner studio, Turner cable channels, and HBO. And these are the businesses Bewkes knows best. This smaller Time Warner, notes Lehman's Jayant, would be a "simpler, pure-play content/advertising story" for investors.

Yet Bewkes is keenly aware that other splits, notably Viacom (Charts) and CBS (Charts, Fortune 500), have not yielded stellar results. Alan Schwartz, the president of Bear Stearns and a Time Warner advisor, says he doesn't think Bewkes is any more inclined to sell assets than Parsons has been.

Still, the candidates are clear if there is a breakup. Time Warner Cable, which began trading as a separate stock earlier this year, could be spun off completely as soon as next spring. Time Inc., the publishing company, has few clear synergies with the rest of Time Warner.

But Bewkes, two sources familiar with his thinking say, tends to agree with Parsons for now: Time Inc., as the company's original business, is important to the overall corporate psyche. At $5 billion in annual revenue, it also may be too small to move the needle in either direction on corporate performance, although it does produce a tidy $1 billion a year in operating profits.

AOL, on the other hand, does move Time Warner stock, and plenty of analysts and investors think shedding the unit would be best for both the parent and the online division. AOL's less-than-stellar advertising growth of 16% for the second quarter, which triggered that stock drop, was well below analysts' expectations and far less than Time Warner maintains it will produce in the future.

Now management is trumpeting yet another strategic direction for AOL (its fifth such reinvention in six years), stressing the value of its business, which matches advertisers to excess inventory on thousands of websites, including the portal - sort of doing for online display ads what Google does for Internet classified ads.

AOL moving to New York

Alas, AOL always seems to be emulating other web players. When it began pushing itself as an Internet portal more than two years ago, Dick Parsons famously said at a board meeting, "You mean there's a Yahoo inside AOL?"

But now tech executives and investors question whether Time Warner has the resources and know-how to compete with the likes of Google (Charts, Fortune 500), Yahoo, and Microsoft (Charts, Fortune 500), which recently spent $6 billion to acquire aQuantive, a company that competes with

One informed Time Warner investor expressed anger that the company had spent up to $25 billion over the past three years buying back its own stock rather than using some of that money to bolster AOL with substantial acquisitions.

Some analysts and former AOL executives think AOL might be better off as part of a bigger Internet player or as a spinoff that has its own currency with which to do deals. (That hasn't worked out so well for Time Warner Cable, whose shares are down about 10% since it became a separately traded stock.)

John McKinley, a senior AOL executive who left the company last year, recently posted an article online suggesting that the best option for AOL is to spin off Advertising. com, which he values at about $10 billion. The rest of the company could be folded into Time Warner or sold off separately.

Of course, selling AOL too soon or too cheaply would be a stark admission of management failure. If Bewkes chooses to hang on to AOL, he may have to face the uncomfortable prospect of reintegrating it with the company's other media assets.

Jeff Marshall, digital managing director for ad buyer Starcom USA, says he and his peers in the ad world are constantly asking Time Warner's divisions to offer marketers a simple way to buy ads across a variety of Time Warner's digital properties. "The more we push cross-platform proposals, the more they are going to have to organize themselves to deliver what we're asking for," says Marshall.

Parsons is among those who are confident that Bewkes will figure it all out. He says he recently bought some Time Warner stock. "I'm probably going to go out and buy some more," he says, "because I think it's trading at a ridiculously low price."

Correction: An earlier version of this story erroneously stated that Jeffrey Bewkes, Time Warner's president, joined the company 18 years ago. He joined 28 years ago. Top of page

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.