Tuning to the Right Channel

 | Aug 15, 2013 | 1:30 PM EDT  | Comments
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A Form 4 filed with the Securities and Exchange Commission has disclosed that Paul Wachter, a member of the board of directors at Time Warner (TWX), directly purchased 3,000 shares of the stock on Aug. 9 at an average price of $64.33 per share.

This brings Wachter's total direct holdings of Time Warner to a little over 9,000 shares, with another 3,000 shares held by a family trust. As such this is a significant percentage increase in Wachter's holdings and therefore to his company-specific risk related to Time Warner.

Economic theory suggests that insiders should prefer to diversify their wealth unless they are particularly confident in the company, Insider purchases can serve as a signal that a stock may be worth closer consideration.

The media and entertainment company generates about half its revenue from its networks, which include cable channels such as TNT and CNN as well as subscription channels HBO and Cinemax. Most of the rest of Time Warner's business comes from the production of films and television shows.

The network's business grew its revenue by 7% in the second quarter vs. a year earlier, and margins improved considerably -- even if we add back a large impairment charge to the prior year period. With growth occurring in the film and TV entertainment segment as well, total revenue grew by 10% resulting in significant improvement in operating and net income. Time Warner earned $1.60 per share in the first half of 2013, and bought back $1.5 billion worth of its stock.

With markets being optimistic about media and entertainment companies in general, Time Warner is valued at 17x its trailing earnings. With little need for capital expenditures relative to the company's cash flow from operations, we'd expect share repurchases to continue in the future (though potentially to a lesser degree). Wall Street analysts seem to be expecting only moderate increases in earnings per share next year, with a forward price-to-earnings ratio of 15. This would seem to indicate little growth in profits.

There are a number of possible developments that could be positive for Time Warner. First, the company plans to spin out much of its publishing business next year as Time Inc. Spinouts can result in management being better able to focus on core operations now that this business is independently traded. Of course, Time's own management may be more capable of improving the magazine business as well.

We've also seen that the current business is doing quite well and it's possible that growth could continue in the future for the company as well as in media and entertainment as a whole.

The closest peer for Time Warner is probably Disney (DIS), although that company also has theme park assets and ABC in addition to its cable networks and entertainment production businesses. The stock is valued at a slight premium to Time Warner with a trailing price-to-earnings ratio of 19. That is possibly due to these other businesses, to its more powerful entertainment brand and to the fact that ESPN is a more attractive asset than Time Warner's TV networks.

Disney's earnings increased by 7% in the first half of 2013, compared to the same period in the previous year. Good results in the company's other segments were offset by poor performance in the studio entertainment business.

Neither of these media and entertainment stocks is a pure value play. The same could be said for other large industry players as well. Recent reports, however, have shown decent growth on the bottom line and the cable business certainly throws off a good deal of cash.

The fact that an insider is buying Time Warner should serve as an indicator to take a closer look at that name and to related companies to try to get a better understanding of how sustainable the recent levels of earnings growth might be. Continued double-digit growth rates in earnings for the next few years could qualify these stocks for "growth at a reasonable price" status.

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