Fitch Rates Time Warner's Bond Offering 'BBB+'

CHICAGO--()--Fitch Ratings has assigned a 'BBB+' rating to the proposed issuance of benchmark sized 10-year senior unsecured notes by Time Warner Inc. Net proceeds will be used for general corporate purposes, including debt reduction. Fitch currently rates Time Warner Long-Term 'BBB+' Issuer Default Rating (IDR) with a Stable Outlook. The company has approximately $24.5 billion of debt outstanding as of Sept. 30, 2016.

The issuance and the concurrent commencement of cash tender offers to purchase certain outstanding debt securities is consistent with Time Warner's financial policy. Under the merger agreement, Time Warner has ceased stock repurchases, which permits Time Warner's excess cash generation to be used to reduce debt. Fitch views the company's announced cash tender offers for debt securities as a positive for Time Warner's overall credit profile as the transaction should result in overall debt reduction during the course of 2017. 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 Sept. 30, 2016.

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. This is the same guarantee structure as Time Warner's 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 (net leverage target of around 2.75x) and returning excess capital to its shareholders. While share repurchases have been discontinued, the company continues to pay its quarterly dividend, both in line with the terms and conditions of the pending acquisition by AT&T. Fitch does not anticipate any change to Time Warner's financial policy, namely its net leverage target of around 2.75x or a change in its dividend policy.

--The stability, recurring revenue, and free cash flow (FCF, defined as cash flow from operations less capital expenditures and dividends) 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. As Warner Bros.' videogames 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 networks, 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.' videogames 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 believes Time Warner is still 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

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. 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 Sept. 30, 2016 was approximately $24.5 billion, reflecting a 3% 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 Sept. 30, 2016.

KEY ASSUMPTIONS

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 sales of 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 the company will not repurchase shares while the AT&T transaction remains pending. The company will continue to pay its quarterly dividend at the current rate.

RATING SENSITIVITIES

Fitch does not contemplate additional positive rating actions over the current rating horizon. However, 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. 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.

LIQUIDITY

Time Warner generated approximately $2.7 billion of FCF (defined as cash flow from operations less capital expenditures and dividends) from continuing operations during the LTM ended Sept. 30, 2016, a 19% 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 $2.3 billion of cash on hand as of Sept. 30, 2016, $5 billion in credit facilities (all of which was available as of Sept. 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 Sept. 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 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.

Date of Relevant Rating Committee: Sept. 20, 2016

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--No material adjustments have been made that have not been disclosed in public filings of this issuer.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage - Effective from 17 August 2015 to 27 September 2016 (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

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Fitch Ratings, Inc.
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or
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+1-212-908-0649
or
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or
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Contacts

Fitch Ratings
Primary Analyst
David Peterson
Senior Director
+1-312-368-3177
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Rachael Shanker
Associate Director
+1-212-908-0649
or
Committee Chairperson
Jack Kranefuss
Senior Director
+1-212-908-0791
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com