Fitch Rates Time Warner's Notes Issuance 'BBB '
The issuance is consistent with Fitch's expectation that Time Warner will increase its debt over the ratings horizon to meet its net leverage target of 2.75x. Shareholder returns that exceed free cash flow (FCF) generation are incorporated into current ratings to the extent that leverage remains below Fitch's 3.5x total leverage threshold, which remains unchanged. Consolidated leverage, pro forma for the capital market activity executed during June 2015, was 3.1x (calculated on a gross basis excluding restructuring and programming impairments) and 2.6x (calculated on a net debt basis) as of the LTM ended March 31, 2015.
The notes will be issued by Time Warner Inc. under the indenture dated March 11, 2010. They will be guaranteed by Time Warner's wholly owned subsidiary Historic TW Inc., a holding company that owns Home Box Office, Inc. (HBO), Turner Broadcasting System, Inc. (TBS), and Warner Bros. Entertainment Inc. (Warner Bros.). In addition, HBO and TBS will guarantee Historic TW Inc.'s guarantee of the notes and the debentures. This is the same guarantee structure as other notes and debentures issued after November 2006.
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 (2.75x net leverage target) and returning excess capital to its shareholders. Fitch does not anticipate any change to Time Warner's financial policy, namely its 2.75x net leverage target or its capital allocation strategy. Shareholder returns that exceed 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 the company'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.
--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.
Overall, Fitch's ratings on Time Warner reflect strong and consistent FCF, solid credit protection measures, sound liquidity, leading scale and market positions in core businesses, and strong content brands. In addition, Time Warner's lower exposure to cyclical advertising revenues relative to its peer group, and lack of exposure to the hyper-cyclical local advertising markets, provides incremental support to the 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. A key operating strategy within its cable networks businesses will be to continue to leverage increased investment in original and sports programming to accelerate domestic affiliate fee revenue growth.
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 potential cable industry consolidation, have the capacity to hamper anticipated affiliate fee revenue growth over the longer term. Fitch believes that Time Warner has successfully secured 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, to the extent the new platforms are successful can help mitigate modest subscriber declines in the traditional multichannel ecosystem. Fitch expects 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.
The company plans to increase its investment in original programming across all of its cable networks, which should improve viewership, strengthen network brands, and translate into higher affiliate fees and stable advertising revenues. Turner has its sports rights portfolio under long-term contracts with the new NBA deal in place and starting during the 2016/2017 season. Sports rights are expected to represent a growing portion of Turner's overall programing budget. From Fitch's perspective the investment in sports programming is critical to securing affiliate rate increases and advertising revenue growth. In addition, Time Warner's investment in original programming across domestic networks is expected to grow. Overall, Turner expects to double the number of original programming hours on TNT and TBS between 2014 and 2020. The company will seek to diversify its programming with more distinctive and younger skewing programs.
HBO added approximately 2.8 million subscribers during 2014, ending the year with 46 million domestic subscribers. Central to HBO's growth plans is to leverage its continuing investment in original programming to increase domestic penetration of HBO's service, convert non-revenue-generating subscribers and address a growing market of potential subscribers outside the multichannel video service universe. Fitch believes the launch of a streaming OTT service is in step with HBO's operating objectives to maintain content and programming leadership, and invest in technology to improve customer experience and service capabilities while increasing domestic subscriber penetration and capitalizing on revenue growth opportunities. Key to HBO's operating profile is securing affiliate agreement renewals on favorable terms that can translate into an acceleration of subscription revenue growth over the ratings horizon.
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. 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, cable networks, and subscription video on demand) and that large, well-capitalized content providers, such as Time Warner, will remain crucial to the industry.
Outside of a material change to its financial strategy or event-driven merger and acquisition activity, ratings concerns center on Time Warner's ability to balance escalating programming expense and production costs with the requirement to consistently deliver programming that drives incremental share of viewing audience while maintaining or expanding operating margins.
Leverage and Financial Policy
Time Warner's financial structure and strategy remain relatively consistent. 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.
Fitch anticipates that Time Warner will increase debt over the ratings horizon to meet its net leverage target of 2.75x. 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.
Total debt outstanding as of March 31, 2015 was approximately \\$22.5 billion, which is in line with total debt outstanding as of Dec. 31, 2014 and an 11% increase relative to March 31, 2014. Consolidated leverage, pro forma for the capital market activity executed during June 2015, was 3.1x (calculated on a gross basis excluding restructuring and programming impairments) and 2.6x (calculated on a net debt basis) as of the LTM ended March 31, 2015.
SHAREHOLDER RETURNS
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. Shareholder returns that exceed FCF generation are incorporated into the current ratings to the extent that leverage remains below Fitch's 3.5x total leverage threshold. Fitch acknowledges that Time Warner's share repurchase authorization and dividend payment represents a significant use of cash; however, we believe the company would reduce the level of share repurchases should the operating environment materially change, in order to maximize flexibility.
Time Warner returned over \\$6.6 billion of capital to its shareholders during 2014 representing 206% of FCF before dividends. Shareholder returns benefited during 2014 from the company's decision to increase its net debt leverage target from 2.5x to 2.75x and the cash generated from the sale of space in the Time Warner Center office building (\\$1.3 billion). Fitch expects that 2015 total shareholder returns will be lower than in 2014 and will be managed within the context of the company's 2.75x net leverage target.
FCF and Liquidity
Time Warner generated approximately \\$1.4 billion of FCF (defined as cash flow from operations less capital expenditures and dividends) from continuing operations during the LTM ended March 31, 2015. This follows the generation of approximately \\$2.1 billion of FCF from continuing operations during the year ended Dec. 31, 2014. Fitch expects TWX's FCF generation during 2015 will be suppressed by severance payments related to 2014 restructuring actions, and higher working capital use related to large syndication sales and to a lesser extent by higher cash taxes and interest payments. Fitch expects that the higher investment in programming, production and capital expenditures will translate into strong FCF generation during the ratings horizon. Fitch believes 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 \\$2.26 billion of cash on hand as of March 31, 2015, \\$5 billion in credit facilities (all of which was available as of March 31, 2015), and expected FCF generation. Time Warner's revolver commitments mature on Dec. 18, 2019. These facilities provide liquidity back-up for Time Warner's \\$5 billion commercial paper (CP) program. There was no CP outstanding as of March 31, 2015. Time Warner's debt maturity profile is well laddered and within Fitch's FCF expectations. Scheduled maturities include \\$463 million during 2016, and \\$500 million during 2017. Fitch expects the company to refinance this debt with either new long-term debt or issuance of CP.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case include:
--The model assumes that the Turner cable networks businesses' revenues continue to grow at a mid-single-digits pace, driven by higher affiliate fees and stable advertising revenues.
--HBO revenues are expected to grow mid-single digits driven in large part by affiliate rate increases (as opposed to subscriber growth). Fitch expects HBO's operating margin will benefit from cost restructuring efforts taken during 2014 and the operating leverage present within the business.
--The film and television studios are anticipated to grow at 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 delivery versus physical are offset somewhat by higher overall investment in programming and production.
-- Increased programming and production investment in the businesses.
--The base case assumes that shareholder returns continue so the company can manage to its 2.75x net leverage target.
RATING SENSITIVITIES
Fitch does not contemplate additional positive rating actions over the current ratings horizon. That notwithstanding, positive rating action would likely coincide with Time Warner adopting a more conservative financial policy provided it 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. Additionally, negative rating actions could 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 fee 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.
FULL LIST OF RATINGS
Fitch currently rates Time Warner as follows:
Time Warner Inc.
--Long-term IDR 'BBB+';
--Short-term IDR 'F2';
--Senior unsecured revolving credit facility 'BBB+';
--Senior unsecured notes and debentures 'BBB+';
--Commercial paper 'F2'.
Time Warner International Finance Limited
--Long-term IDR 'BBB+';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
The Rating Outlook is Stable.
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