In a note to clients last month, Pali Research media and cable analyst Richard Greenfield upgraded shares of Time Warner Inc. to "buy" based, in part, on his opinion that the time has come for the media conglomerate to unwind its complex corporate structure and fully spin off its major operating units, most notably Time Warner Cable. We spoke to him about the pros and cons of such a move.

Why should Time Warner Cable break away completely from TWX (Time Warner Inc.)?

Richard Greenfield: The cable business is changing rapidly. It’s not just a video business anymore; it’s a multi-platform, multiproduct environment. You’re looking at joint ventures with Sprint for wireless, and so you’re talking about wireless phones and wireless devices. [Consider] how consumer behavior is changing and what types of businesses and what types of opportunities Time Warner Cable should be aggressively going after, [for example,] if they wanted to do national cable networks on their own. Despite being a separate public company, national cable networks appear to be the world of TWX. Building an Internet portal the way Comcast is trying to do — whether it’s through build, buy or both — that seems very much the world of AOL [which is part of TWX].

So a total spin-off would spur growth for the cable unit?

Greenfield: I definitely think Time Warner Cable could flourish as a fully separated entity from TWX. I think the synergies are little to none. It’s not like TWX has been aggressively launching cable networks. Name the last cable network Time Warner launched leveraging Time Warner Cable. Plus, it’s hard to look at TWC as a fully independent company when 85% of it is owned by Time Warner.

Any downside to a split?

Greenfield: To the extent that shifting day-and-date movies on demand is a significant driver of their business, not being vertically integrated could make those types of negotiations more difficult. Now it seems like it’s being done for the greater good of Time Warner Inc., regardless of what it means for the film studio.

Meanwhile, you lowered earnings estimates for TWC and TWX.

Greenfield: Insignificantly, though. The larger point is that we think there’s a dramatic restructuring needed of TWX. You’re looking at TWC, which has rebounded in recent weeks, up 15%. TWX continues to trickle down day after day, under-performing the sector and the market. And I think management and the board have had long enough to address the situation. Now is the time when they must take action.

Pali Research Forecast: Time Warner Cable

Rating: Neutral

52-Week Price Range: $35.93-$44.00 Market Cap.: $39.3 billion

5-Yr. Est. EBITDA CAGR: 13.1%

2006 ACTUAL 2007 ESTIMATE 2008 ESTIMATE
Source: Pali Research Estimates and Company Documents, 7/16/07. EBITDA = earnings before interest, taxes, depreciation & amortization. CAGR = compound annual growth rate.
Revenue $14.8 billion $16.6 billion $18.8 billion
EBITDA $5.2 billion $5.9 billion $6.8 billion

Rob Garretson is a business and technology writer based in Gaithersburg, Md.

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