Time Warner preps for change

NEW YORK (CNNMoney.com) -- There were no major surprises in the third-quarter earnings report of Time Warner, the world's largest media conglomerate.

But the results, coming just two days after the company announced chairman and chief executive officer Richard Parsons would be resigning as CEO on Jan. 1 and that current president and chief operating officer Jeffrey Bewkes would succeed him, highlight the challenges ahead facing Bewkes.

Jeffrey Bewkes, who will become CEO of Time Warner on January 1, has some tough decisions to make about the future of Time Warner Cable and AOL.

Shares of Time Warner and its publicly traded Time Warner Cable unit have not performed well in 2007.

Time Warner, the parent company of CNNMoney.com, reported results from two key business units - its majority-owned Time Warner Cable division and AOL Internet unit - that appear to have disappointed analysts.

"The two key areas for the company - AOL and Time Warner Cable - were a little bit weak," said Robin Diedrich, an analyst with Edward Jones. Time Warner Cable accounts for about a third of Time Warner's overall sales and operating profits, while AOL accounts for roughly 10 percent of Time Warner's revenue and nearly 15 percent of operating profits.

Many analysts have speculated that Bewkes may be open to spinning off or selling AOL since it has been a drag on Time Warner's overall profits.

"AOL has been a question mark for some time, and with Bewkes taking charge there will be more calls from investors to do something with AOL. The idea of selling it may be revisited," said Diedrich. "AOL is the most pressing concern right now."

Wall Street has also suggested that Bewkes may be interested in spinning off more of Time Warner Cable to the public. Time Warner owns 84 percent of Time Warner Cable.

But Craig Moffett, an analyst with Sanford C. Bernstein, wrote in a research note Wednesday that selling more shares of Time Warner Cable might not be the best idea right now, considering how poorly shares of Time Warner Cable and Comcast have done lately.

"Undoubtedly, Bewkes will consider significant changes. But a spin-off would seem ill-timed given all-time low valuations and sentiment," Moffett wrote. "The market appears to have too little appetite to digest even the cable equity available today."

During a conference call with analysts to discuss Time Warner's results, Bewkes was asked about how he thought Time Warner would look at the end of 2008. He said that he would not "telegraph" potential changes but would explain actions as they happen.

Bewkes also said that he was not ruling out making sizable purchases. So investors should not be just expecting Time Warner to sell assets.

"We are looking at anything that can improve our strategic advantage over competitors. That will be true for acquisitions or divestitures," he said.

His comments were made in response to an analyst's question about whether Time Warner would be interested in buying GE's (Charts, Fortune 500) NBC Universal or cable networks owned by newspaper publisher E.W. Scripps (Charts) if they were up for sale. But Bewkes did not comment on specific acquisition targets.

Shares of Time Warner (Charts, Fortune 500) fell 3 percent in trading on the New York Stock Exchange Wednesday.

The stock has lagged the performance of media rivals Walt Disney (Charts, Fortune 500), News Corp. (Charts, Fortune 500) and Viacom (Charts, Fortune 500) this year, largely due to the issues facing Time Warner Cable and AOL.

Time Warner Cable reported sales of $4 billion and earnings of 25 cents per share. Analysts were expecting revenue of $4.06 billion and a profit of 27 cents a share.

Spencer Wang, an analyst with Bear Stearns, wrote in a research note published after Time Warner reported its results that Time Warner Cable (Charts) added more high-speed Internet access and digital phone subscribers than he was expecting but that the company lost more basic cable subscribers from newly acquired cable systems than he had forecast.

Time Warner Cable and Comcast (Charts) jointly purchased the assets of bankrupt cable provider Adelphia earlier this year and Time Warner Cable has had some integration problems with these new systems. In addition, some analysts and investors feel that cable companies are facing increased competition from phone companies AT&T (Charts, Fortune 500) and Verizon (Charts, Fortune 500), which now offer video service.

During a conference call to discuss Time Warner Cable's results, Time Warner Cable chief executive officer Glenn Britt conceded that the company has faced problems dealing with new customers, particularly in Dallas and Los Angeles.

But he added that the company was working hard to gain customer confidence and that he expected the Dallas and Los Angeles systems to contribute to Time Warner's growth in 2008.

At AOL, revenues and adjusted operating income before depreciation and amortization, or adjusted OIBDA, a key measure of profitability in the media business, both fell as the unit continues to shift away from a subscription-based model for Internet access and email in order to capitalize more on the lucrative online advertising market.

But online advertising growth at AOL grew by just 13 percent in the quarter, below what many on Wall Street were expecting.

AOL's online ad growth increased 40 percent in the year's first quarter, leading some analysts to proclaim that AOL's turnaround strategy was on track. Those hopes dimmed when AOL posted online ad growth of only 16 percent in the second quarter.

During the conference call to discuss Time Warner's results, Parsons admitted that the online ad growth figures may be "a little bit of a disappointment" compared to Wall Street's expectations.

Parsons said sales tied to display ads - banners, video and other graphical ads - rose just 6 percent on the AOL network in the quarter, compared to 15 percent growth in the second quarter. But he added that search advertising bounced back in the third quarter, rising 15 percent from a year ago, compared to 6 percent growth in the second quarter.

Chief Financial Officer Wayne Pace, who is retiring at the end of the year and will be replaced by Time Warner Cable CFO John Martin, added that overall advertising growth at AOL would be lower in the fourth quarter than it was in the third quarter.

Nonetheless, Time Warner is pleased with the progress at AOL, Parsons said, adding that he expects AOL to post an increase in adjusted OIBDA for 2007. Through the first three quarters of the year, AOL's adjusted OIBDA was 1.4 percent lower than the first nine months of 2006.

Bewkes also noted that there were some "bright spots" at AOL, pointing to the 21 percent revenue growth at Advertising.com, an online ad network that AOL purchased in 2004.

And AOL continues to bulk up its online advertising business. The company announced separately Wednesday that it was acquiring Quigo, which specializes in supplying online publishers contextual-based sponsored links and competes against Google (Charts, Fortune 500) and Yahoo! (Charts, Fortune 500). Quigo is the fourth online advertising company that AOL has acquired this year.

Time Warner - which also owns cable networks CNN and TBS, the Warner Bros. and New Line Cinema movie studios and the Time Inc. publishing unit - reported results from its traditional media businesses that were largely in line with expectations, however.

The company reported strong revenue and profit increases from its film studio thanks to the blockbuster box office performance of "Harry Potter and the Order of the Phoenix" as well as solid DVD sales of "300." Revenue increased 33 percent in the studio division while adjusted OIBDA surged 71 percent.

Time Warner's networks unit also posted a decent gain in revenue and profits due to healthy demand for cable advertising. Bear Stearns' Wang noted that excluding the impact of the closing of the WB, a broadcast network that merged with CBS (Charts, Fortune 500)-owned UPN last year to form the CW, network advertising increased 10 percent from a year ago.

And even though the publishing business posted no change in revenue, operating profits were up 13 percent.

Bewkes started his Time Warner career at cable network HBO and moved into a position that put him in charge of all of Time Warner's cable networks and studios before being promoted to president and COO of all of Time Warner in 2005. So his background with the more traditional media assets definitely is viewed as a plus at a time of intense change in the media business.

"This company will have to change fast. The world is going digital. The world is going mobile," Bewkes said at the conclusion of Time Warner's conference call.

The reporter of this story owns shares of Time Warner through his company's 401(k) plan.