TW does about-face

US West talks, debt reduction plans shelved

NEW YORK — Time Warner Inc. is reversing course on two of its biggest strategic priorities of the past three years, revealing Wednesday it has abandoned attempts to restructure its Time Warner Entertainment partnership and no longer will pursue significant reduction in its debt.

TWE, which includes Warner Bros., HBO and most of Time Warner’s cable systems, will continue to be owned 25.5% by telco US West and 74.5% by Time Warner. TW chairman Gerald Levin said Wednesday he met with US West Media Group CEO Chuck Lillis last week and the two agreed to end two and a half years of negotiations on breaking up TWE.

“We have mutually agreed that there is no current need or requirement to restructure,” Levin told reporters at a briefing on Time Warner’s second-quarter earnings result, noting that the two sides had not been able to agree about how much the TWE assets were worth in a proposed restructuring.

A US West spokeswoman declined comment, reiterating the telco’s long-standing view that it was happy with the partnership as it was.

Levin also told reporters, “We don’t think the debt perception of Time Warner is valid,” adding that as a ratio of Time Warner’s enormous cash flow (earnings before interest, taxes, depreciation and amortization) the company was “on the way to a solid investment-grade” credit rating. Time Warner has about $17 billion of debt, but its annual cash flow is about $5 billion.

These two revelations, made Wednesday in separate briefings to Wall Street analysts and reporters, come as Time Warner is enjoying a rally on the stock market that has taken it to levels never seen since it was created in 1990 from the merger of Time Inc. and Warner Communications.

The rally partly reflects the company’s booming business performance, highlighted in Wednesday’s second-quarter earnings result (see separate story) that pushed Time Warner’s stock price up $4.25, to close at $49.62. Every division except Warner Music is performing strongly, with the “highest double-digit growth since the creation of Time Warner,” Levin said.

Wall Street analysts said Wednesday’s positive investor reaction showed just how much the Wall Street environment has changed for Time Warner in the past six months. For most of the past few years, pressure to unload cable, reduce debt and simplify the corporate structure by restructuring TWE kept the stock price stagnant.

Different story

Several analysts said Time Warner’s stock price would have dropped several dollars if Levin had made Wednesday’s announcement six months ago. But in recent months the cable sector has come back into favor, initially because sat TV operators ran into problems, but more recently because of Microsoft Corp.’s $1 billion investment in Comcast Corp.

At the same time, the cable business has been improving, benefiting Time Warner as much as any cabler because its cable systems are among the best-performing of any in the industry. Time Warner’s stock price has jumped 35% since Jan. 1.

All this is thought to have stiffened Levin’s resolve not to sell TW’s cable systems to US West at too cheap a price. His attitude was reinforced by some big institutional shareholders, aware of how cable was coming back into favor.

Ironically enough, the market rally first began last fall, when Levin and Turner went on a road show to meet institutional investors ahead of shareholder meetings to vote on the merger of Time Warner and Turner Broadcasting System. At those meetings, Levin promised to “lighten up on cable,” and Turner talked about the company’s need to slash its debt.

Levin told reporters Wednesday he still plans to fulfill that promise to Wall Street to lighten up on cable, by pruning its massive group of cable systems in some joint ventures with existing operators, but these deals are expected to be tiny compared with the cable divestments that could have resulted from a breakup of TWE.

And he promised to reduce debt enough to improve Time Warner’s credit rating, but analysts expect that means debt will be cut by only $1 billion-$2 billion. Standard & Poor’s Register of Corps., one of the main credit rating agencies, declined to specify how much debt Time Warner would need to cut to qualify for a rating upgrade.

Simplification, long one of the corporate objectives behind the TWE restructuring, is on the back burner, Levin said. Time Warner’s financial performance “is so strong we don’t attach the same value to that” as the company did in February 1995 when Levin announced plans to simplify the company’s corporate structure to make it easier for investors to understand.

Time Warner is getting a lot of new support from investors because it lately has adopted a financial discipline long lacking, analysts say. Not only has Levin been promising to show returns on capital higher than the broader stock market, by increasing earnings and eventually buying back stock, but he revealed Wednesday that the company had reorganized its internal financial reporting.

Now each of the businesses has its own balance sheet, with separate debt ratios. Time Warner cable is treated even more distinctly, as a self-financing entity with a higher debt ratio than other businesses, he said.

“Jerry was very clear and specific about the financial goals and financial management and it was very shareholder-oriented,” Merrill Lynch analyst Jessica Reif said.

At the same time, most analysts agree with Levin that Time Warner’s debt is not high compared with other entertainment companies such as Viacom Inc. or Tele-Communications Inc. “The debt is manageable,” Reif said.

“He doesn’t need to restructure from a financial standpoint. He did it from a shareholder receptivity standpoint,” said Lehman Bros. analyst Larry Petrella, who noted that the question was whether investor attitudes on cable may shift again at some point in the future.

In the meantime, Levin promised that Time Warner Cable and US West, which itself owns major cable operator Continental Cablevision, would work together more closely on developing cable products such as Internet access and telephony. The two companies together have 19 million subscribers, easily more than any other cable operator. “And we share the same philosophy about cable (and have) the same views about telephony and the Internet and marketing and basic cable,” Levin said.

Keeping partnership easier

TWE also has begun paying out cash to Time Warner, which makes keeping the partnership easier. Tax restrictions flowing from its formation five years ago have lapsed and it recently paid out $500 million to Time Warner, and Levin said they would pay out $2 billion more in the near future.

Petrella said the company was due to pay out between $2.25 billion and $2.5 billion in the next two years to Time Warner, primarily cash that has been sitting in the partnership since US West bought in five years ago.

Wednesday’s meetings with analysts and reporters were Levin’s first public appearances as Time Warner chairman since the murder of his son Jonathan last month, and he said he deliberately brought all TW division heads to the analyst meeting for support.

In a short, emotional speech, he told both groups he was “deeply appreciative of the expressions of support and sorrow” flowing in from the business community, noting that he had felt “almost a hero worship” for his son.

Levin added that his son’s death had made him “even more committed” to reinforcing Time Warner’s values in areas such as journalism, human dignity and freedom.

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