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More signs of progress are likely in 1999, when Time Warner will turn a full-year net profit for the first time in many years, chief financial officer Rich Bressler said in an interview last week. At the same time, TW is expected to generate enough cash to start buying back stock.
Most of the improvement has come from the benefits of the Turner Broadcasting merger, particularly given the strength of cable networks as well as turn-around in the cable system business.
Capital structure overhaul
And while TW chairman Gerald Levin has focused attention on the company's efforts to impose financial discipline across its spectrum of businesses, less noticed has been the effort in the past couple of years to overhaul the company's convoluted capital structure.
A combination of good management and good luck has enabled the company to restructure its bank debt, putting more borrowings into the Time Warner Entertainment partnership and less at the parent company level as well as lengthening the repayment maturities of the debt. The company has redeemed all debt securities convertible into common stock, reducing the potential for dilutive stock issues.
A new credit agreement put in place late last year reduced the total credit lines available to $7.5 billion from $10.3 billion, saving on banking expenses, Bressler said.
At the same time, some of the preferred securities issued over the past three years has been redeemed, at the initiative of both the holders, such as Japanese congloms Itochu and Toshiba, and TW.
Saving on funding costs
Bressler estimated that the media giant had saved "hundreds of millions of dollars" in funding costs as a result of all these steps taken in the past three years.
Redemption of preferred stock held by the two Japanese companies, as well as some of the preferred held by Summit Corp., will alone save $50 million in dividends a year, TW estimated in a recent SEC filing.
Bressler said the single biggest impact on borrowing costs will come from the upcoming redemption of $2.1 billion in preferred shares, which TW said in a recent SEC filing would save $125 million in interest costs a year.
The redemption will be partially funded by a $1 billion bond issue, priced earlier this month at the unusually low coupon of 6.62%. The low rate partly reflected TW's credit upgrade, which allows companies to lower their borrowing costs.
Reversing course
Ironically, however, the preferred stock redemption was a reversal of a deal Time Warner made just 2-1/2 years ago with much fanfare. The media giant sold the preferred, raising only $1.5 billion in April 1996 (the value has increased through accrued dividends), heralding the deal as a major debt-reduction initiative because the shares replaced bank debt and other securities outstanding.
But the shares had a coupon rate of 10.25%, replacing lower-cost debt. Analysts note that interest costs on debt are tax deductible, whereas the interest cost on the preferred shares was not. Lehman Bros. analyst Larry Petrella said it was smart for Time Warner to redeem the shares, but he questioned whether the original securities accomplished anything.
Bressler responded, "You have to put your mind back to where the company was at that point in time." He argued that while the preferred stock had an expensive coupon, the difference between the cost and ordinary debt has widened since 1996.
The shares were redeemed as a result of the decline in interest rates in the past couple of years and the improvement in the company's financial condition, he said.
Wall Street approves
This deal aside, Wall Streeters praise the way the company has overhauled its debt. While absolute amount of debt has only dropped from about $18 billion to near $15 billion (and will rise back to $17 billion as a result of the preferred stock redemption), debt as a ratio of TW's cash flow has plunged to 3:1 from a high of 6.6:1 in 1992.
As Standard & Poors said when it upgraded TW's credit rating earlier this month, "Key credit ratios have continued to improve."
Lehman's Petrella said the perception that Time Warner had "too much debt" was always misplaced but the company had "taken enough action to move the perception to the point where it should have been anyway ... now they have financial flexibility to buy back stock if they want to."
Internal restructuring
Additionally, Time Warner has restructured the way its debt sits internally, shifting more borrowings into the TWE partnership from the parent company. TWE, which is 75% owned by Time Warner but has a separate balance sheet, owns Warner Bros., HBO and many of Time Warner's cable systems.
Last year's new credit agreement capped TWE's debt at $7.5 billion compared with $6 billion for Time Warner.
TWE had previously carried too little debt relative to its cash flow compared with the parent company, Bressler acknowledged. On Sept. 30, the partnership had net debt of $7.3 billion, up from $5.7 billion a year ago, while the parent company had net debt of $8.7 billion, down from $11.2 billion a year ago.
Bressler downplayed the significance of the restructuring, however, arguing that ratings agencies look at the debt in combination. And while loading TWE with more debt helps Time Warner, Bressler said TWE was transferring as much cash to TW as it was able so the debt changes would not make that much of a difference.
