Fitch Affirms Time Warner's IDR at 'BBB+'; Outlook Stable
KEY RATING DRIVERS
--Time Warner's consistent financial policy and capital allocation strategy continues to revolve around investing in its businesses to strengthen its product portfolio, maintaining a strong balance sheet (net leverage target of around 2.75x) and returning excess capital to its shareholders. Fitch does not anticipate any change to Time Warner's financial policy, namely its net leverage target of around 2.75x or its capital allocation strategy. Shareholder returns that exceed free cash flow (FCF - defined as cash flow from operations less capital expenditures and dividends) generation are incorporated into the current ratings to the extent that leverage remains below Fitch's 3.5x total leverage threshold.
--The stability, recurring revenue, and FCF generation of the cable networks businesses (Turner and Home Box Office) underpin Time Warner's ratings. Time Warner's operating profile benefits from the stability, recurring dual-stream revenue profile, high operating margin and FCF generation characteristics attributable to its cable networks businesses. Fitch expects these businesses will continue to generate a significant amount of Time Warner's earnings and cash flow.
--Fitch's ratings incorporate the strong competitive position of Time Warner's film and television studios at Warner Bros. The size and scale of Warner Bros.' television studio enables the company to capitalize on strong demand for television content while providing meaningful diversification of revenue sources. Fitch notes that as Warner Bros.' gaming business grows it also adds to the diversification.
--Time Warner is well positioned to address the secular threats and opportunities presented by emerging alternative distribution platforms and continued audience fragmentation across the media and entertainment landscape.
Time Warner's operating profile benefits from the stability, recurring dual-stream revenue profile, high operating margin and FCF generation characteristics attributable to its cable networks businesses. A key operating strategy within its cable networks businesses will be to continue to leverage increased investment in original and sports programming to continue driving healthy domestic affiliate fee revenue growth.
Fitch's ratings incorporate the strong competitive position of Time Warner's film and television studios at Warner Bros. Their size and scale enable Time Warner to capitalize on strong demand for television content while providing meaningful diversification of revenue sources. Warner Bros.' strategic priorities include expanding its leadership in TV production beyond broadcast, focusing on global franchises to grow its theatrical business and improving margins through cost reduction efforts. Embedded in the strategy is more collaboration with Turner networks in scripted and kids programming. Fitch is cognizant of the inherent volatility of hit-driven content in the film and television production businesses and acknowledges that growth of Warner Bros.' gaming business adds diversification and stability to the business. Fitch also acknowledges Time Warner's risk mitigation processes (film co-financing arrangements, etc.) and strong track record of consistently generating desirable content.
Fitch remains convinced that Time Warner is well positioned to address the threats and opportunities present in the evolving media landscape, including the growing prominence of alternative distribution platforms and audience fragmentation within the context of a stagnant multichannel video subscriber base, providing sufficient flexibility within the current ratings to accommodate the company's leverage target and capital allocation strategy. Fitch also believes demand for high-quality content remains strong across all major end-markets (broadcast networks, cable networks and subscription video on demand) and that large, well-capitalized content providers, such as Time Warner, will remain crucial to the industry.
Fitch recognizes the ongoing secular shifts within the pay television industry, including changing media consumption patterns, a growing preference for time-shifted viewing and intensifying competition from emerging distribution platforms, that continue to drive audience fragmentation and mute multichannel video subscription growth as subscribers migrate away from the traditional pay television ecosystem. These factors, along with the potential shift to the skinny bundles video service offerings from cable MSOs, have the capacity to hamper anticipated affiliate fee revenue growth over the longer term. Fitch expects that multi-channel video subscribers will continue to decline during the rating horizon at an annual rate ranging between 1.5% and 2%.
Turner has successfully renewed affiliation agreements with the majority of leading multichannel video programming distributors, which removes a significant portion of the risk related to expected affiliation fee increases during the rating horizon. In addition, Turner networks have been included in emerging OTT platforms, providing further evidence of demand for its content across distribution platforms, and which, to the extent the new platforms are successful, can help mitigate modest subscriber declines in the traditional multichannel ecosystem and continues to pursue new opportunities outside of the traditional ecosystem to take advantage of the shift of consumption patterns and help drive incremental growth. Fitch expects Time Warner to have mid-single-digit top-line growth, expanding margins and high FCF conversion over the next several years, driven by domestic affiliate fee growth and international expansion.
Leverage and Financial Policy
Time Warner's financial structure and strategy remain consistent. The company continues to manage its leverage to a net leverage target of around 2.75x, which remains within the context of Fitch's 3.5x total leverage threshold for the current rating. Shareholder returns that exceed FCF generation are incorporated into current ratings to the extent that leverage remains below Fitch's 3.5x total leverage threshold, which remains unchanged. In Fitch's opinion the positive operating momentum coupled with predictable, recurring FCF generated by Time Warner's strong portfolio of businesses is leverageable, providing a sound basis to accommodate the company's net leverage target within the context of the current 'BBB+' rating.
Total debt outstanding as of June 30, 2016 was approximately $24.5 billion, reflecting a 2.8% increase relative to year-end 2015. Consolidated leverage was 3.0x (calculated on a gross basis excluding restructuring and programming impairments) and 2.7x (calculated on a net debt basis) as of the LTM ended June 30, 2016.
Time Warner's capital allocation strategy remains consistent and is centered on investing in its businesses to strengthen its product portfolio, maintaining a strong balance sheet and returning excess capital to its shareholders. Fitch believes the ratings provide sufficient capacity to accommodate the company's capital allocation policy and that shareholder returns will be managed within the context of the company's net leverage target of around 2.75x. Fitch acknowledges that Time Warner's share repurchases and dividend payments represent a significant use of cash; however, Fitch believes the company would reduce the level of share repurchases should the operating environment materially change in order to maintain flexibility.
Time Warner returned approximately $4.4 billion of capital to its shareholders through the LTM period ended June 30, 2016, representing 124% of FCF before dividends.
Fitch's key assumptions within the agency's rating case include:
--Fitch assumes that Turner cable networks businesses' revenues continue to grow by mid-single digits, driven by higher affiliate fees and stable advertising revenues.
--HBO revenues grow in the mid-single digits driven in large part by an acceleration of subscription revenue growth.
--The film and television studios grow by low - to mid-single digits during the forecasted periods. This segment benefits from continued demand for television content, international expansion, and digital delivery, offset by ongoing declines in DVDs.
--Stable operating margins due to positive operating leverage of its businesses and higher margin profile of digital versus physical delivery are offset somewhat by higher overall investment in programming and production.
--Increased programming and production investment in the businesses.
--Fitch assumes that shareholder returns continue so the company can manage to its net leverage target of around 2.75x.
Fitch does not contemplate additional positive rating actions over the current ratings horizon. However, positive rating action would likely coincide with Time Warner adopting a more conservative financial policy provided Time Warner continues to demonstrate that its operating profile is sustainable amid ongoing competitive pressures, changing media consumption patterns and evolving technology platforms.
Negative rating actions are more likely to coincide with discretionary actions of Time Warner's management including, but not limited to, the company adopting a more aggressive financial strategy or event-driven merger and acquisition activity that drives leverage beyond Fitch's 3.5x threshold in the absence of a creditable de-leveraging plan. Negative rating actions could also result should Fitch begin to observe a weakening of Time Warner's ability to produce desired film and television content or secure programming on its cable networks that consistently delivers viewing audience ratings, leading to lower subscription or advertising revenues. Further, a weakening of its competitive position due to its failure to adapt to emerging distribution platforms could prompt Fitch to take negative rating actions.
Time Warner generated approximately $2.4 billion of FCF (defined as cash flow from operations less capital expenditures and dividends) from continuing operations during the LTM ended June 30, 2016, a 4.5% increase relative to the FCF generated during the year ended Dec. 31, 2015. Fitch expects that the higher investment in programming, production and capital expenditures will translate into strong FCF generation during the ratings horizon. Fitch believes that the strong FCF profile will be led by the revenue, operating margin and low capital requirement characteristics of the company's Turner and Home Box Office businesses. The FCF generation affords the company significant financial flexibility.
Time Warner's liquidity is strong and supported by $2.5 billion of cash on hand as of June 30, 2016, $5 billion in credit facilities (all of which was available as of June 30, 2016), and expected FCF generation. Time Warner's revolver commitments mature on Dec. 18, 2020. These facilities provide liquidity back-up for Time Warner's $5 billion commercial paper (CP) program. There was no CP outstanding as of June 30, 2016. Time Warner's debt maturity profile is well laddered and within Fitch's FCF expectations. Scheduled maturities include $500 million during 2017, $600 million during 2018 and $650 million during 2019. Fitch expects the company to refinance this debt with either new long-term debt and/or issuance of CP.
FULL LIST OF RATING ACTIONS
Fitch affirms Time Warner's ratings as follows:
Time Warner Inc.
--Long-Term IDR at 'BBB+';
--Short-Term IDR at 'F2';
--Senior unsecured revolving credit facility at 'BBB+';
--Senior unsecured notes and debentures at 'BBB+';
--Commercial Paper at 'F2'.
Time Warner International Finance Limited
--Long-Term IDR at 'BBB+';
--Short-Term IDR at 'F2';
--Commercial Paper at 'F2'.
The Rating Outlook is Stable.