It's Time for Time Warner

This is the third in my new series of columns I'm calling "Why You Should Own..." The first column in the series covered Dreamworks Animation (DWA - commentary - Cramer's Take). The second column covered Discovery Communications (DISCA - commentary - Cramer's Take). Today, I will discuss why you should own Time Warner (TWX - commentary - Cramer's Take).

Time Warner is one of the world's leading entertainment companies. The company owns AOL, 84% of Time Warner Cable (TWC - commentary - Cramer's Take), Warner Brothers, HBO and a leading stable of cable networks including TNT, TBS and CNN. Time Warner also still owns its iconic magazine titles including Time, People and Sports Illustrated.

In early 2009, Time Warner will split off TWC, leaving TWX as a pure-play content company. Presently, TWC produces approximately half of EBITDA. After the split, the new TWX will get more than half its EBITDA from Cable Networks, with AOL and Filmed Entertainment (movie and TV production) generating another 20% each. The balance will be from magazine publishing. New TWX will have about $29 billion in sales and $6.4 billion in EBITDA. Debt will be $9 billion to $10 billion, less than 2 times EBITDA, leaving TWX with the best balance sheet in major media. Free cash flow will likely be $2 billion to $3 billion.

Adjusted for the TWC split, TWX is trading at less than 5 times 2009 EBITDA and about 7 times EPS. I am assuming that EBITDA will fall by 12% in 2009. This is below consensus, which is falling.

Short-Term Catalysts

Valuation-based ideas have not worked as the market crashed, but TWX is really cheap. In this case, cheap will matter because the split from TWC provides a catalyst to recognizing the value. TWC shares have outperformed TWX shares, making TWX shares cheaper post-split. Once the split is finalized, investors will look at New Time Warner and see a mix of assets that have low capital intensity and produce high free cash flow. The company will have a remarkably good balance sheet, making a material dividend or share buyback or an accretive acquisition a positive outcome.

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At time of publication, Birenberg was long TWX in personal and client accounts, although holdings can change at any time.

Steven Birenberg is president and chief investment officer of Northlake Capital Management, LLC. Northlake specializes in managing equity portfolios using a combination of exchange-traded funds and special situation stocks. Birenberg appreciates your feedback; click here to send him an email.