Time Warner Loses Weight

By Ben McClure | June 02, 2009 AAA

AOL must soon fend for itself. The internet company is being spun off by parent Time Warner (NYSE:TWX) before the end of the year. For Time Warner and its shareholders, the transaction couldn't come sooner.
Spinoffs are often a nice way for companies to offload problematic businesses. And for Time Warner, AOL has been a big problem. The internet subsidiary continues to perform abysmally. Dial-up internet access services, which accounted for more than two-thirds of its revenues in 2001, are going the way of the dodo as customers make the move to always-on, broadband internet services. AOL ended 2008 with 6.3 million dial-up subscribers, down from more than 30 million before the merger.

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AOL's Revenues Fell 23%
In the most recent quarter, AOL's advertising revenues fell 23% from the previous year. Keeping up with internet giants Google (Nasdaq:GOOG) and Yahoo! (Nasdaq:YHOO) has demanded plenty of costly and ongoing investments. Much of Time Warner's shrinking revenues and earnings can be attributed to the poor showing of AOL.

When AOL and Time Warner merged back in 2001 at the height of the internet stock bubble, AOL had a market capitalization of more than $163 billion. These days it's probably worth far less. In fact, in 2005 Google bought a 5 percent stake that valued the company at $20 billion. This investment has since been written down, suggesting that AOL was worth about $5.5 billion. (For more, see Impairment Charges: The Good, The Bad And The Ugly.)

AOL Is Probably Worth Less
But even that seems an overly generous valuation. On its own, AOL is probably worth something closer to $3 billion, equivalent to last year's revenues or three times the internet company's annual free cash flow. Time Warner will pocket some cash by spinning out AOL to shareholders, but the take will be far less than what it would have fetched just a year ago.

In any case, with or without AOL, Time Warner looks cheap. It trades on a forward price-to-earnings multiple of 10.5. That compares favorably with Disney (NYSE:DIS) and Viacom (NYSE:VIA), which trade at about 13 times forward earnings. My own sum of the parts analysis gives Time Warner, less AOL, a value of about $28.50 per share, or about 14% higher than the stock's $25 price tag.

Time To Tuck Away Time Warner Shares
By removing the AOL albatross from around its neck, Time Warner can start to get its house in order and restore its earnings growth, especially when the economy starts to turn around. Looking forward to AOL's spinoff this year, investors should think about tucking away some Time Warner shares.

For related reading, see Biggest Merger And Acquisition Disasters.

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