Cable Operators

Time Warner's Crucial Moment

8/26/2005 8:00 PM Eastern

Time Warner Cable CEO Glenn Britt says 2005 has been a pivotal year for the nation’s second largest MSO. But he quickly concedes “it seems to me that just about every year is pivotal in some way or another.”

Perhaps. But consider the following changes:

  • In the last nine months, Time Warner has shuffled or replaced the bulk of its top executives.

  • The MSO has reorganized its operating structure into six regions.

  • It won a controversial and decisive lawsuit allowing it to jettison AMC after the network dramatically changed its format.

  • The company is in the middle of completing its acquisition of Adelphia Communications Corp. in a deal with Comcast Corp. that will give Time Warner a total of more than 13 million customers.

  • The MSO will become a publicly traded company following the close of the Adelphia deal. Details of the public offer could change, though. While 85% of Time Warner stock will continue to be owned by parent Time Warner Inc., financier Carl Icahn is pushing for a larger float.

Time Warner Cable At a Glance
As of March 31, 2005
Source: Time Warner Cable
Basic customers: 10.9 M
Digital customers: 5.1M
Digital penetration: 46%
High-speed data customers: 4.3M
High-speed data penetration: 22%
DVR customers: 1.1M
DVR penetration: 22%
Digital phone customers: 614,000
Phone penetration: 4%
Revenue: $2.4B
Cash flow: $900M
Operating income: $495M

All the while, the company has managed to sign on a record number of digital-phone customers, grow its digital subscriber base, introduce new products at a steady pace and post strong quarterly financial numbers.

Pivotal and rocky, indeed.

Many analysts are generally pleased, yet somewhat cautious, with what they see at Time Warner despite the turmoil over the last several months. The company’s quarterly results have repeatedly been a beacon of light in a sea of uncertainty at Time Warner Inc. The unit accounts for almost a quarter of the parent’s operating profit.

Merrill Lynch analyst Jessica Reif Cohen downgraded Time Warner Inc.’s stock following the company’s second-quarter results released Aug. 3, but praised Time Warner Cable’s numbers.

The cable division’s earnings before interest, tax and depreciation and amortization (EBITDA) was a tad lower than expected — up 10% vs. the 11% Cohen had predicted. But the “underlying operating trends were extremely strong (the one real bright spot for the quarter),” she wrote in an Aug. 3 memo to investors, noting that average revenue per unit was 10% above expectations.

Fulcrum Global Partners analyst Richard Greenfield has long been bearish on the idea of Time Warner Inc. spinning out a portion of its cable unit to the public. He reiterated his disdain for the public float of shares again Aug. 19 in a note to investors.

Greenfield doesn’t think the small float will entice investors and believes the stock will trade at a discount as a result. Greenfield also predicts the Time Warner security will have little appeal as an acquisition currency. For instance, he says if Cablevision Systems Corp. ever does sell its cable systems to Time Warner, as has been predicted for years by analysts and industry watchers, the Dolan family, which controls Cablevision’s stock, “is likely to want Time Warner Inc. stock under the current structure versus Time Warner stock,” Greenfield wrote.

“Unless there are severe tax consequences that we are not aware of, we believe deconsolidation of Time Warner Cable, in some form, will increase the value of Time Warner,” Greenfield continued. “While AOL [Inc.] remains the key swing factor in terms of value creation over the next 12-24 months, a 'smarter’ corporate structure toward Time Warner Cable would help drive Time Warner Inc. toward our price target.”

What’s more, Greenfield is vexed over the company’s acquisition of Adelphia.

In a note to investors dated Aug. 4, Greenfield expressed his concern that the new management team is untested when it comes to smoothly integrating the assets of another systems company. He wrote: “Time Warner has not acquired a major cable system in quite some time. In addition, given the significant changes in management at Time Warner Cable, we are not completely comfortable with management’s ability to execute.”

Greenfield is not alone in wanting the deal stopped or at least closely monitored. A number of entities, including DirecTV Inc., Mid-Atlantic Sports Network, Media Access Project, have asked the Federal Communications Commission to place certain restrictions on the deal.

They want protection so that Time Warner and Comcast can’t take undo advantage of the extra clout they’ll have by absorbing Adelphia’s assets.

Several analysts believe the FCC will greenlight the deal, and Britt dismisses the critics, especially DirecTV, which is worried that the cable operators will buy exclusive programming it won’t be able to offer to its own customers.

“There is already an existing set of rules on exclusivity,” Britt says. “The rules say we shouldn’t be able to buy exclusive programming, but DirecTV has been granted the most exclusive sports programming available today with its [pro football “NFL Sunday Ticket”] deal. We believe the rules should apply to everyone, regardless of who you are.”

THE NEW TEAM

Despite the criticisms, most analysts are more focused on Time Warner’s new management team, product sales and the prospect of more uncertainty following Icahn’s decision to get involved in Time Warner Inc. decisions.

Some industry observers have expressed surprise at the new appointments, which include the elevation of Landel Hobbs from chief financial officer to chief operating officer, as well as the appointment of John Martin as CFO; Rob Marcus as senior vice president in charge of mergers and acquisitions, programming and human relations; and Sam Howe as chief marketing officer.

The MSO made headlines earlier this year when it began a nationwide search for a new team following the departure of executives Tom Baxter, John Billock and Chuck Ellis. In the end, all the positions were filled by insiders.

“The COO position was the only position we looked for on a national basis,” Britt says. “We wanted to do a thorough job of searching for the right person. In the end, Landel was the best candidate.”

He adds: “We had already worked well together, and that was critical. He’s well known on Wall Street and understands the operational aspects of the business. And we weren’t really looking for a CFO, but when we made Landel COO, we realized John Martin would be perfect for the job.”

As for the other appointments, Britt says “we have always tried to build our company from within before looking outside. It worked out well for us all around this time.”

All of the new executives are familiar enough with their jobs and the company to hit the ground running. Hobbs had been CFO at Time Warner Cable since 2001.

“As a finance person, I have always strived to understand the business first,” Hobbs says. “The numbers always flow from there. Of course there will be a bit of a learning curve for me [as COO], but this is a good fit for everyone. This sector is very metrics oriented. I’m a business person first and a financial guy second.”

Howe had been Time Warner’s senior vice president of marketing for voice services before the promotion to CMO in June.

A 22-year cable industry veteran, Howe’s track record at selling digital phone service — the MSO added 242,000 new phone customers in the second quarter, far exceeding Wall Street estimates — should translate well into overseeing the marketing across all of the MSO’s product lines, Britt says.

Martin has worked at corporate mother ship Time Warner Inc. for 12 years, with a short stint as a media analyst for ABN AMRO Securities LLC between 2000 and 2002. Under Martin’s leadership, Time Warner Inc. was awarded the top spot in Institutional Investor magazine’s most recent ranking of investor-relations programs. The magazine also named Martin Institutional Investor’s 2001 All America Research team “Next Generation” analyst for the cable TV industry.

Marcus is also intimately familiar with the inner workings at Time Warner Cable, having served as senior vice president of mergers and acquisitions for Time Warner Inc. He has been actively involved in the Adelphia deal and has overseen programming deals at the parent company. He expects to remain active in mergers and acquisitions at the cable unit, too.

PRODUCT INVESTMENTS

For one thing, Time Warner Cable will have more flexibility to acquire assets when it goes public next year, he says.

Furthermore, to remain on the cutting edge of offering new products and technology, Time Warner executives figure they’ll need to invest in companies creating those products. Britt and Hobbs say the MSO will keep its eye out for operating assets, but won’t buy a system or company simply to bulk up its numbers.

It’s a fairly good bet that Time Warner won’t into the wireless business through an acquisition. Britt told attendees of Reuters Telecommunications, Cable and Satellite Summit in New York last month that while he’d consider making an investment in an existing wireless company — either as a standalone investment or through a joint venture with other MSOs — he doesn’t see Time Warner buying a wireless company as a wholly owned property.

“I should never say we’d never buy something, or we would buy somebody, but it seems unlikely,” Britt said, according to a Reuters report.

When Time Warner Cable’s stock becomes available to the public, which is expected sometime during the first half of 2006, Britt will have a certain comfort level, knowing he’ll be working with a financial team he already knows and trusts. The appointments of Hobbs, Martin and Marcus will likely pose no surprises for either him or Wall Street.

“Obviously, the management changes are significant, but our strategy hasn’t changed,” Britt says. “We have a plan, and that hasn’t changed with all the other things going on here.”

THE 'TO DO’ LIST

That strategy is three-pronged. “We need to make sure we continue to innovate,” Britt says. “We also need to be smarter with our marketing. That doesn’t mean spending more. But it does mean developing better merchandising skills and using sophisticated back-office management and database marketing.”

He adds, “Lastly, we must improve our customer care. We actually know what to do to make customers happy. So why don’t we do it? A lot of it is looking at our processes. We are embarking on a never-ending project to really change the way we care for our customers.”

The reorganization of the company should help, Hobbs says. Time Warner is coalescing its 31 divisions into six distinct regions. And the marketing department will move from product silos to a more comprehensive brand architecture and campaign creation.

Howe has also formed a marketing counsel with regional vice presidents to coordinate marketing efforts across the entire company.

“By reorganizing our structure and creating these regions, our guys will be closer to the systems and to customers,” Howe says. “We want operating officers closer to the beat. Cable will always be a local business. But the regions give us clout to compete with the national guys.”

The regions may also be reporting in to a new national nerve center. It’s been rumored for months that Time Warner Cable will move its current Stamford, Conn., headquarters to a new location. And conjecture is that should this happen, the new base will be in Charlotte, N.C., where several back office functions have been positioned in the last two years. But Britt says there are no plans to totally relocate at this point in time.

Some programmers have expressed some concern the new operational structure will make it more difficult to work with Time Warner Cable, which already gives its divisions a certain amount of autonomy in carriage decisions. But Starz Encore Group LLC executives say the regional realignment and new management isn’t worrisome.

“Time Warner Cable has been performing well for us,” says Starz Encore vice president Tom Southwick. “We are even working on expanding our relationship right now, so we are pleased with what’s going on there. As for the reorganization, we have regional people who regularly go into the field, so it won’t affect our current relationship.”

Time Warner Cable has always been willing to take programmers and broadcasters to task for what its executives characterize as egregious demands or negotiations. The company found itself entangled in a legal battle with Rainbow Media Holdings earlier this year when it claimed its contract with AMC was voided when the network dramatically changed it format.

Britt says Time Warner tried to negotiate with Rainbow, but in the end the programmer filed suit against the MSO for breach of contract. But a judge ruled Time Warner had the right to drop AMC. The imbroglio shocked industry players because while skirmishes over programming-content changes are far from rare, few fights have ever escalated to that level.

“It was a matter of principle and was very important to us,” Britt says. “We have spent years establishing our rights as First Amendment speakers. We’ve had a number of disputes over the years, and they have usually been resolved amicably. Cablevision decided to take us to court and fight.”

It’s unclear what the long-term ramifications of the fight will have, but it served as a reminder that Time Warner isn’t afraid of going to the mat. Time Warner Cable and Cablevision are working on a new AMC carriage deal. No resolution was in sight at press time.

To be sure, there are plenty of challenges ahead and more pivotal events will surely occur on Britt’s watch. The Adelphia deal isn’t completed yet; it’s unclear what Icahn’s pressure on Time Warner will change; tussles with programmers are inevitable; and competition continues to intensify on several fronts. But Britt believes his biggest challenge will be to continue organizing Time Warner in way that enables the company to deliver a continuing stream of products over a single platform.

“It’s wonderful opportunity,” Britt says. “But we need to make sure we’re organized and ready for anything and everything.”

March