Time Warner finally showing promise

By Robert Walberg

Shareholders of Time Warner are used to being in the shadows, as the company has struggled to make its merger with America Online work.

Over the past three years Time Warner's (TWX, news, msgs) stock has risen by a mere 23.5%, versus gains of 56% for Walt Disney (DIS, news, msgs), 27% for News Corp. (NWS, news, msgs) and 34% for the Standard & Poor's 500 Index ($INX). This week its latest earnings report was overshadowed by News' $5 billion bid for publishing giant Dow Jones (DJ, news, msgs).

But if the little-noticed earnings report is any indication, Time Warner may finally be starting to catch up.

Despite an 18% year-over-year drop in net income, there was a lot to like in Time Warner's report. Excluding one-time gains, earnings of 22 cents per share topped last year's number and the consensus estimate by 2 cents, or 10%. After delivering weaker-than-expected results the previous two quarters, exceeding expectations is a positive first step.

Rising earnings and ratings

Now there's hope that it can do so consistently because management upped its guidance for 2007 by 5 cents, to $1.05. Wall Street had been anticipating only 99 cents. Consequently, investors can expect adjustments to earnings estimates by analysts over the next few days, with several of those changes likely to include ratings upgrades. Nothing gets a stock moving like the combination of rising earnings and bullish ratings.

What's driving the improved performance at Time Warner? First, the company has seen a rebound in its cable unit with a jump in subscriptions that boosted revenue 61% to $3.9 billion. Recent acquisitions also have given the cable business a boost. Considering that only 44% of customers have subscribed to two or more primary services and a mere 12% have signed up for the triple play (video, high-speed data and voice), there's plenty of room for growth.

Another area of surprising growth came from former albatross AOL. Though its move away from subscriptions negatively impacted the group's total sales, the 40% surge in ad revenue suggests that the strategy is working. Given the site's popularity, there's room to squeeze out more ad revenue, and comparisons will begin to be more favorable later in the year.

• Video: Time Warner's earnings

Finally, the company's movie business held its own during a difficult comparison period. Bolstered by the surprising strength of "Happy Feet" and by the critical success of "The Departed" and "Blood Diamond," revenue slipped by a mere 1% -- better than expected. With "Harry Potter and the Order of the Phoenix" and "Ocean's 13" due for release this summer, the film unit should enjoy considerable growth.

Meanwhile, as long as the economy holds up, advertising growth should help the struggling publishing and television units at least keep pace with last year's results.

Though Time Warner's management team hasn't turned heads with major acquisitions like News Corp.'s purchase of MySpace and Disney's deal for Pixar, it deserves applause for streamlining operations and getting the core businesses back on track. The turnaround has taken time, and a few bumps along the way are likely, but Time Warner is a stock worth owning once again.

Bolstered by the improved earnings picture, look for the stock to test its 52-week high of $23.15 in short order, with penetration setting up a long-term run at $25.50. At 21 times next year's estimated earnings that might seem pricey, but compared with what News just bid for Dow Jones (39 times current-year earnings), it's downright cheap.

At the time of publication, Robert Walberg did not own or control shares of any company mentioned in this article.