After the deal’s done, TW still faces snags

Time Warner’s $8 billion buyout of Turner Broadcasting System hadn’t happened by late last week, but already TW chairman Gerald Levin’s fans and critics alike were buzzing about his next step: How will he clear the hurdles facing the world’s biggest media company once the TBS acquisition is wrapped up?

“People are spending more time around here speculating on what (Levin’s) second act will be than they are doing their jobs,” says a senior Time Warner exec. “If Jerry has any idea what that second act is, he’s keeping it close to the vest.”

As of Sept. 15, people close to the talks said all of the major elements of the deal had been resolved. But there were still many details to address before the boards of Time Warner, TBS and Tele-Communications Inc. would approve the sale. A formal announcement wasn’t expected until Sept. 19 at the earliest.

When Levin and TBS chairman Ted Turner do finally meet the press, Levin will undoubtedly be keen to talk about the potential synergies generated by the combination.

No one questions the opportunities, which include exploiting the WB film and animation library to enhance the value of TBS properties such as the Cartoon Network and TNT overseas; achieving cost savings at the cable networks; and tying Time Inc.’s news brands with CNN and its new business channel.

And no one questions that Time Warner’s earnings growth will be boosted by the addition of TBS’ fast-growing cable networks. Time Warner shareholders are more interested, however, in whether profits grow fast enough to offset the high cost of the deal.

Still, Levin needs to restructure Time Warner Entertainment and simplify the corporate structure, reduce the company’s debt, quell management infighting and operate in the presence of Seagram Co. as a major and potentially hostile shareholder.

While some of these problems will be alleviated by the TBS acquisition – Seagram’s stake will be diluted and debt ratios will improve slightly – others will be aggravated.

Instead of just Seagram as a hard-driving shareholder, Levin will have to contend with cable giant TCI and Ted Turner. Even Time Warner insiders concede that TCI chief exec John Malone and Turner will give Levin more impetus to focus on the stock price.

The deal has also given some of Time Warner’s corporate chieftains reason to resume internal warfare. Sorting out the reporting structure will be one of the biggest tasks for Levin to tackle in coming weeks.

Meanwhile, how the deal affects the crucial restructuring of Time Warner Entertainment is unclear. While Levin persuaded TWE’s two Japanese investors, Itochu and Toshiba, to swap their interest in the partnership for stock in Time Warner Inc., more complicated negotiations with TWE’s 25% shareholder US West have stalled.

While the TWE assets are now a smaller part of a bigger pie, some Time Warner shareholders are worried that Levin’s vision for simplifying Time Warner’s corporate structure has disappeared in the midst of trying to buy TBS.

“Early in the year there seemed to be a clear direction as to where they were going with respect to the cable systems and the asset sales and debt paydown. Now the Street doesn’t have that clarity,” says Tim Pettee, an analyst with money manager Alliance Capital, a big TW shareholder.

‘PlanB’

Pettee strongly supports the TBS acquisition. “In a nutshell, the strategic thrust of the deal makes sense. It’s a great group of assets, but there has to be some compromise,” he says, adding that Levin better have a “Plan B” for speeding up asset sales and paying down debt. “Otherwise, the dilution is really tough to swallow.”

Levin’s future hangs on whether Time Warner’s shareholders can happily digest the dilution. If Time Warner’s stock price does not perform better in the future, Levin will have to deal not only with existing shareholders but with power players like Malone of TCI, which will emerge from the deal with a 8% stake.

To some analysts, the dilution will be hard to overcome despite the strength of potential synergies. Schroder Wertheim analyst David Londoner says in a recent report that the synergies “are real. There is little question in our mind that the companies are an excellent fit and combined they constitute an entity that should grow more rapidly. Our sole reservation about the arrangement is over price. In our view, the amount paid will dilute the per-share values and cash flows of Time Warner in a meaningful way, one that will not be overcome by the above synergies.”

In plain English, that means the poor performance of Time Warner’s stock is unlikely to improve anytime soon. But there are plenty of people who disagree, including some of Time Warner’s big institutional shareholders and Wall Street.

Price ‘justified’

“It’s one of the most significant strategic moves in the media business over the last five years,” says Michael Garin, senior managing director of Furman Selz. “The strategic and financial benefits clearly justify the price.”

While attention so far has focused on possible synergies between CNN and Time Warner’s magazine group, one Time Warner exec says the real benefits will come in other areas – such as enhancing the global brand of TNT and the Cartoon Network.

John Dempsey in New York and Anita Busch in Hollywood contributed to this report.

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