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Time Warner's Quarter Could Puzzle

However, third-quarter earnings numbers may not be indicative of actual performance.

Editor's Note: This column by Steve Birenberg is a special bonus for



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Time Warner


will likely report a messy third quarter tomorrow due to the closing of the Adelphia acquisition on July 31.

There is also potential volatility related to the new strategy at AOL and the lousy performance of the company's summer film slate. As a result, headline numbers might not be indicative of the how the company actually performed in the quarter. With that caveat, consensus estimates call for revenue of $11.1 billion, EBITDA of $2.8 billion and EPS of 20 cents.

TWX shares have performed well lately, rising 25% since mid-August. Investors have responded to strong performance across the cable industry, indications that the new strategy for AOL is off to a good start and there is stronger-than-expected advertising growth in the cable network industry through the summer and early fall.

Additionally, investors appear to be expecting awful results from the film business and are looking ahead to 2007, when comparisons will be easy and the film slate looks strong with sequels to key franchises like

Harry Potter

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Ocean's Eleven

set to hit theaters.

With the shares performing so well lately, it is possible that the shares will pull back on anything less than a clean beat with strong guidance. Both of those things are possible, as we just saw great results from



, and cable is Time Warner's largest division. I believe upside is limited to the low $20s, so I wouldn't chase the shares here, although the bias still seems upward.

The real action in analyzing the quarter will be at the segment level. For AOL, revenue is projected to decline about 6% as subscriber losses accelerate to over 2 million. Most of the subs that are dropping their paid subscriptions are still using the AOL Web site, so advertising growth will be robust, maybe as high as 40%. But that won't be enough to overcome the sharp drop in subscription revenue. EBITDA will outperform revenue as the company drives network and marketing savings that are crucial to sustaining profitability in the new free model.

It is really hard to get a read on cable growth due to the Adelphia deal and simultaneous swaps with Comcast. It looks to me like revenue and EBITDA growth on a pro forma basis are expected at 13%-15%. Basic subscribers are expected to grow by around 30,000, with high-speed-data subgrowth of about 280,000. Overall ARPU will continue to rise as more customers take the triple play.

Filmed Entertainment results also could be quite volatile. All of the company's major releases during the quarter were flops relative to expectations. Depending on how high the marketing expenditures were for the films, EBITDA could quite easily surprise significantly to the downside. On the flip side, timing issues could allow

Superman Returns

to contribute positively to the quarter even though the film is at best break-even over its life. The focus here will be on 2007.

Cable Networks continue to experience slower growth, with revenue and EBITDA growth likely to come in around 7% and 9%, respectively. I have been concerned about slowing growth in this segment, which used to comfortably kick out double-digit gains. A firmer-than-expected scatter market for cable networks over the last few months may provide some upside this quarter.

Publishing is looking at a flat quarter on revenue and EBITDA as the magazine industry continues to struggle against the secular challenge from the Internet. TWX is divesting titles to focus on its largest periodicals, so investors likely will give any unexpected weakness in this division a pass. Additionally, this is TWX's smallest division, accounting for only about 10% of revenue and EBITDA.

On the balance sheet, debt levels should be way up following Adelphia and the large share-buyback program. I am looking forward to resetting my balance sheet spreadsheet along with the changes coming as pro forma data for the company's many acquisitions and divestitures are provided.

At time of publication, Birenberg held no positions, 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. Prior to forming Northlake, Birenberg was a principal, director of research and portfolio manager at Gofen and Glossberg, LLC. Prior to that, he was a trust investment officer at Star Bank in Cincinnati, Ohio. Birenberg has managed portfolios and researched stocks for more than 22 years. He earned his bachelor's degree from Miami University, Ohio. From 1987 through 1992, Steve taught at the CFA preparatory program the Study Seminar for Financial Analysts in Windsor, Ontario. Birenberg appreciates your feedback and invites you to send it to