Cutting Cord to HBO Could Be Costly for Time Warner

A spinoff of HBO may be tantalizing to some Time Warner  (TWX) shareholders. Freed of its corporate bounds, and valued on comps to Netflix  (NFLX) , the home of Game of Thrones and The Sopranos could be worth $30 billion or more.

Chief Executive Jeff Bewkes has focused the New York media group around film, television and video properties, which may not auger for a breakup of HBO from properties such as Warner Bros and Turner Broadcasting. Some analysts have questioned how true the comparisons to Netflix ring. Time Warner declined to comment on the possibility of a deal.

Moody's Investors Service analyst Neil Begley said Time Warner's balance sheet contains a substantial impediment to a divestiture, namely indentures on billions of dollars in bonds that would require the company to obtain bondholder consent for a spin or risk litigation.

"It wouldn't an easy task or a painless task to spin off HBO," Begley said.

It wouldn't be cheap either. About $8 billion in debt has guarantees that prevent HBO from getting rid of substantially all of its assets. Unlike other indentures, these notes do not have provisions that would release the guarantees if the securities were repaid or made whole. In some cases, the company cannot call the debt.

"They could demand a lot of money [where bonds are not callable and therefore without make-whole provisions], which would be the likely case," Begley said, regarding holders of the notes. "If [bondholders] owned a lot of other bonds and they wanted to protect themselves further up the chain," he added, "they could just say no."

Theoretically, Time Warner could fold all of HBO into one of its corporate structures holding other assets. Then, if Time Warner spun off HBO's assets but left other operations within the structure, it would not be divesting all of the entity's assets.

However, Begley said that when Time Warner spun off AOL in 2009, the company gave bondholders guarantees from HBO as a concession.

"To get consents from bondholders to allow them to do that, effectively giving up that guarantee from the AOL assets, they had to give them something else in return," he said. "There might have been a fee and they gave them a new guarantee that didn't exist before from HBO to the intermediate holding company which in turn guarantees the ultimate parent."

Since HBO has started its over-the-top video service, providing content over the Internet rather than through a set-top box, the comparisons to Netflix are tempting.

But Barclays Capital analyst Kannan Venkateshwar noted in a recent report that Netflix is a retail business, while HBO is still primarily wholesale and sells content through cable TV operators or companies such as Apple (AAPL) .

The web of guarantees complicating an HBO divestiture is not typical for an investment-grade company, Begley said. The guarantees reflect its history of deals, from the merger of Time and Warner Communications to the purchase of Turner and the combination with AOL.

"It's unusual because there are all of these guarantees from different entities, which at one time had their own debt when acquired, and are underneath the parent," Begley said. Time Warner now has its debt at an intermediate holding company, but has guarantees from the various operating companies.

While Time Warner's guarantees may look complicated, Begley said, the intent is to simplify the credit structure. "If you have multiple layers of senior unsecured debt stemming from legacy acquisitions, and you want to have an investment grade simplified structure, you put guarantees in place to essentially make them all pari passu," Begley said, meaning that all the holders would be on an equal footing. 

"If you don't, you have debt at operating companies that makes the debt at holding companies subordinate," he added. "Usually the newest debt would be at the parent, which would in that case be the subordinated debt. That would be not be attractive when you're trying to issue new debt, so it would be highly irregular."

The guarantees certainly do not render a spin of HBO any simpler. In fact, a larger deal might be an easier outcome.

"If someone tried to buy out the whole company and lever it up or do a leveraged recap there is no protection there against that except for a weak high yield debt market, which would be a huge challenge right now," Begley said.

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