It's About Time Warner

My question was prompted by the latest proposed incarnation of Time Warner's (TWX) AOL, which by my count is its fifth. First there was dial-up access AOL; then there was dial-up plus premium content; then there was dial-up or high-speed plus premium content; then all the above plus free content. Now paid access will be all but abandoned in favor of an advertising-driven revenue model, and content will be free.

I've been an advocate of Time Warner stock for several years, a stance that has earned me nothing so far and has cost me thousands of dollars in out-of-the-money expired options. (My last call options, which expire in January 2007 at a strike price of $20, seem well on their way to a similar oblivion.) When I first addressed the question of the value of Time Warner, I suggested that AOL could be deemed worthless and the company should still be valued at more than $17 a share, which is pretty much where the stock has been stuck ever since. It recently traded around $16.50.

You'd think I would be chastened by now, but I still maintain that Time Warner is undervalued, albeit in ways that I couldn't have anticipated back then. Time Warner's "old" media properties — Time Inc., HBO, Warner Brothers — have suffered along with others in those media industries as the Internet has siphoned off advertising dollars and threatens to take an ever greater share. "Content" providers, like the Hollywood studios, have fallen out of investor favor, though Time Warner has fared worse than most. I agree that the future of these businesses is cloudier than it was a few years ago, though I still believe strong content will always find a market and that investors have overreacted. But let's concede those assets aren't worth what they once were.

Time Warner has also suffered from Wall Street's aversion to cable, which accounts for a quarter of Time Warner's revenues and a third of its profits. Under this scenario, cable companies are being squeezed by dominant content providers, like Walt Disney's (DIS) ever more costly ESPN, and phone companies, which are poised to offer television along with high-speed Internet and phone service. Verizon Communications (VZ), in particular, is aggressively building a fiber-optic system that promises state-of-the-art digital delivery, though it's still in its infancy.

Finally there's AOL. If the latest proposed incarnation sounds a little desperate, it's no wonder. None of the others, each highly touted at the time, seems to have worked. Never mind that AOL still ranks as the third biggest portal (after Yahoo (YHOO) and Microsoft's (MSFT) MSN) and that Google (GOOG) put up $1 billion for a 5% stake, which suggests AOL is worth something, even if not the $20 billion the Google stake implies. In the rampantly pessimistic view of Time Warner, every single one of its businesses is dying.

But let's look again at Time Warner's cable assets. Are they really so bad? I know it's perilous to generalize from personal experience, but I recently moved all of my at-home communication and entertainment services to Time Warner cable: high-speed Internet access, VoIP phone service and digital cable TV — everything except cellphone service. The impetus for this wholesale changeover was my Samsung high-definition television, which looked worse with regular cable than my old non-digital TV. When Time Warner offered me a package as part of the upgrade to digital, I took it. So far it's been great — both for me and for Time Warner. I'm spending far more with the cable company than ever before, especially for movies on demand.

My trips to the movie theater have plunged and it'll be the rare DVD I'll want to buy now that I can rent recent films with a click of the remote for just $3.99. I figure I'm actually saving quite a bit of money by spending more with Time Warner. Meanwhile, cable revenues are surging, which makes Time Warner's purchase of Adelphia (in partnership with Comcast (CMCSA)) look like a good deal.

True, the phone company may soon offer the same or better services, but Verizon hasn't come calling yet. In any event, why bet on just one horse? I also own shares in Verizon and AT&T (T), and see no reason not to own cable and phone stocks. The war between cable and phone giants seems far from resolved, and may never be, which suggests to me there's more potential in Time Warner Cable than investors currently recognize. Comcast, by comparison, has been regaining investor favor, and is up nearly 25% this year (vs. a more than 4% decline in Time Warner's stock). I hope Time Warner delays any public offering of its cable assets (something dissident shareholder Carl Icahn was clamoring for) until it's confident it can realize full value.

I'm not going to be so foolhardy as to put a precise dollar value on Time Warner, except to say it should be north of $20 a share. When it will get there is anybody's guess. Even if I'm right, it may take years of solid earnings before the market comes around. So no more options for me. I'll just buy the stock, wait patiently, and continue to enjoy movies on demand.