For all the talk about culture clashes, maybe America Online and Time Warner had more in common than people knew.
That's essentially what one analyst concludes following
AOL Time Warner's
forecast last week of weaker-than-expected results at its cable television systems in 2003.
To be sure, some aspects of Time Warner Cable's performance reported last Wednesday were indeed encouraging, and the cable unit's problems may pale in comparison to difficulties faced by AOL Time Warner's online and music businesses. But the surprising and alarming drop at Time Warner's cable systems doesn't reflect industrywide difficulties, observers say, as much as it suggests that Time Warner Cable has been more aggressive than most industry peers in recognizing certain kinds of revenue.
Saying that the company's cable division "got caught ... in a long-term misrepresentation of advertising," Sanford Bernstein analyst Tom Wolzien calls the cable division's practice "a parallel to what happened at AOL (though certainly not as egregious)." The AOL division is the subject of an inquiry by the Justice Department and the
Securities and Exchange Commission
over past revenue-recognition practices.
Without making the AOL parallel, analysts Jessica Reif of Merrill Lynch and Niraj Gupta of Salomon Smith Barney similarly concluded that the cable operation's projected 2003 disappointment stems from its approach toward accounting for certain fees it collects from programmers -- an approach not shared by most other cable operators.
The central issue at the cable operations is certain payments that AOL Time Warner and other cable operators receive from programmers. While the cable operators generally pay fees to programmers for their content, programmers with channels debuting on systems typically pay cable operators money to promote those channels during their launch.
AOL Time Warner calls the transaction "advertising purchased by programming vendors to promote their channels."
Wolzien, however, looks at it differently, using a grocery store metaphor. The payments from programmers are "slotting fees," he says -- "in reality ... a payment for carriage that lasts for several years."
In her report, Merrill's Cohen writes that most major cable operators --
-- conservatively amortize these payments over the multiyear life of the relevant programming contract and classify them as reductions in programming costs.
But AOL Time Warner and
recognize the payments as lump-sum revenue items, says Cohen.
While this practice has boosted the AOL Time Warner's cable revenue in the past, a dropoff in new launch fees in 2003 will cause more suffering at AOL Time Warner than elsewhere. While Time Warner Cable's vendor advertising revenue is expected to drop from $230 million in 2002 to $50 million in 2003, writes Cohen, "We firmly believe that AOL's vendor advertising problem will not be faced by Comcast, Cox, Cablevision and Mediacom."
Similarly, Gupta says that, except for Charter, he doesn't expect to see among the cable operators he covers any material variance in EBITDA growth in 2003 and 2004 because of declining launch support payments.
Cohen has neutral ratings on AOL Time Warner, Cablevision and Mediacom, buy ratings on Cox and Comcast, and an "under review" rating on Charter. Her firm has received money for investment banking services in the past 12 months from AOL, Cablevision, Charter, Comcast and Cox. Wolzien has a market perform rating on AOL. Gupta has an outperform rating on Comcast and Cablevision, an in-line rating on Mediacom, and underperform ratings on AOL Time Warner and Charter. His firm has received investment banking compensation from Cablevision and Comcast in the past twelve months.
The past year has been a nightmare for AOL Time Warner shareholders, and much of the blame has been laid at the feet of the America Online executives who took charge after the 2001 merger creating the media giant. Many of them, including Bob Pittman and Steve Case, have since stepped aside amid probe-induced snickers about what critics called America Online's aggressive business and accounting practices. But the analysts' remarks suggest that businesses on both sides of the aisle were straining to reach financial targets.
For investors, the upshot is that AOL Time Warner's cable operations will report 2003 earnings before interest, taxes, depreciation and amortization -- a common bottom-line yardstick for media companies -- lower than expected by most of Wall Street.
Along with the multimedia conglomerate's decision to take a $45.5 billion writedown, continued online advertising problems and increased pension expense, the ebitda disappointment is one of the several reasons that AOL Time Warner's stock has been hit over the past few days.
In fact, the cable ebitda shortfall is one of the handful of reasons that AOL Time Warner cited for its forecast of "essentially flat" 2003 EBITDA compared to 2002, instead of the 3%-plus growth analysts had been expecting.
AOL Time Warner's stock fell 34 cents Friday to close at $11.66. The stock is down more than 16% from its Wednesday close before release of its fourth-quarter 2002 results.