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Time Warner Spins Its Wheels

Clearing up litigation fails to impress growth-hungry shareholders.
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Time Warner


pledged to move forward Wednesday, but investors didn't seem to be persuaded.

The New York media conglomerate agreed to pay $2.4 billion to settle class-action suits alleging bubble-era accounting misdeeds at America Online. The move could clear the way for big divestitures along the lines of those planned at rivals such as


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Clear Channel

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, media stalwarts whose shares, like Time Warner's, have been losing ground in recent years. Wall Street has been looking forward for some years to a sale or spinoff of the huge Time Warner Cable unit.

But any sense of relief over the litigation settlement was overshadowed by lingering questions about the company's growth prospects. Time Warner's movie business posted a soft quarter that executives emphasized was highlighted by tough year-ago comparisons, and the struggling AOL division continues to cough up subscribers and revenue.

So what could have been a pivotal moment in CEO Dick Parsons' efforts to remake the media titan was lost as Wall Street was left to wonder what Time Warner will do to restart its flagging growth engine. Time Warner shares dropped 2%.

Goldman Sachs, which rates the stock neutral, said in a note that the latest quarter marked the fourth straight one of weak growth. Goldman says AOL trends are deteriorating faster than expected and its valuation of cable won't increase, given in-line results and a rich valuation. The firm says faster cable growth or a decision to spin out AOL could boost the stock. Goldman does or seeks to do business with the company.

Kathy Styponias of Prudential, which rates the stock neutral weight, noted Wednesday morning that Time Warner remains exposed to a possible advertising slowdown.

"Approximately 17% of Time Warner's revenues are derived from advertising-related businesses," writes Styponias. "Should a recovery in ad spending falter or be less robust than expected, it could have an adverse impact on the company's profitability."

The company's profitability was certainly impacted Wednesday by the $3 billion litigation reserve Time Warner set up to cover the AOL accounting suit settlement. Time Warner posted a $321 million second-quarter loss and missed Wall Street's pro forma earnings and revenue estimates.

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"Our performance this quarter, which faced very difficult prior-year comparisons, keeps us on track to achieve our full-year objectives," Parsons said. "Importantly, we generated industry-leading free cash flow of $2 billion through the first half of the year, demonstrating the vitality of our businesses."

Expected revenue declines at the company's movie and AOL segments were offset almost entirely by growth at the cable, networks and publishing segments, Time Warner said. The company said adjusted operating income before depreciation and amortization declined 3% to $2.6 billion, reflecting tough comparisons in the movie business. The company reported an operating loss of $1.2 billion, reversing year-ago operating income of $1.8 billion.

On a Wednesday morning conference call with analysts, Parsons touted Time Warner Cable's new products and services. While rivals talk about what they'll soon offer, "Time Warner Cable is already there," he said. "We have first mover advantage."

Parsons noted that the division added 200,000 net high-speed data subscribers in the latest quarter, giving it more confidence in the strategic rationale for the Adelphia acquisition. Time Warner agreed this summer to join with cable rival


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in acquiring the assets of the bankrupt cable operator.

Where AOL is concerned, Parsons pointed to the Internet transmission of July's Live 8 benefit concerts as proof that the remodeled service is more than just an information source.

But Styponias says, "We believe dial-up subscriber growth continues to slow and AOL risks seeing an accelerating outflow of subscribers if they are unable to effectively market AOL broadband at a reasonable price to their existing subscriber base. Delays in the recovery of the online advertising market could continue to undermine the growth prospects for the division." (The analyst, a team member or a household member has a financial interest in the company.)

The company said that AOL domestic user numbers are growing, and that while ad revenue is up, it is not at the level of other industry leaders. Indeed, second-quarter AOL revenue slid 4% to $2.1 billion, reflecting a $99 million rise in advertising revenue, offset by a $168 million drop in subscription revenues.

As of June 30, the AOL service had 20.8 million U.S. members, down 917,000 from the prior quarter and down 2.6 million from the year-ago quarter. In Europe, the AOL service had 6.2 million members, a decrease of 99,000 from the previous quarter and a decline of 80,000 from last year's quarter.

One media analyst noted that the market was reacting to the soft quarter and pointed out that the company's share-buyback plan was on target and a positive. Parsons and other executives were clear that the company remained on target for year-end numbers.

One area where the company might be taking too much heat is on the filmed entertainment side. The TV network and Turner broadcasting are doing well, and the next two quarters look encouraging for the studio despite broad softness at the box office.

Jeff Bewkes, chairman of Time Warner's entertainment and networks group, emphasized that the company has a string of hits at the box office right now, including

Wedding Crashers


Charlie and the Chocolate Factory


If the upcoming release of

The Dukes of Hazzard

pleases audiences, the company could have four consecutive weeks with the No. 1 film at the box office. And in case investors had forgotten, the latest

Harry Potter

installment will arrive for this holiday season.

Still, Wednesday's market action makes it clear that investors are looking for much, much more.