HBO Spin-Off Would Be a Mistake for TWX

On Friday (1/8/16), rumors surfaced that Time Warner, Inc. (TWX) activist shareholder Corvex Management is looking to force the separation of HBO through either a spin-off or outright sale. Having worked at HBO and on the BD team that launched HBO NOW, I thought I would give my two cents on these speculations.

Setting the Scene

At first glance, an HBO spin-off makes a lot of strategic sense.

• TWX is currently trading substantially below FOX’s $85 per share bid in 2014, secular headwinds pose a significant challenge for broadcast businesses such as Turner, and the 3 different business models present within TWX create conflicting divisional interests.
• Furthermore, from an outsider’s point of view, HBO is the crown jewel. A publicly-traded version of HBO could potentially be even more of a leader and far more innovative than what is permitted by its current ownership structure. With such a strong brand and management team, the company could foreseeably pivot to become more like Netflix.

However, that is also the issue — HBO is not built to be like Netflix… in any way, shape, or form.

To believe that an HBO spin-off is actually beneficial, one would need to believe a couple things:

1. One is that HBO is undervalued as a part of TWX, which is a fair assessment to the extent you believe HBO would do some things significantly differently as a public company and does not sufficiently benefit from its TWX relationship.
2. Two is that TWX can maintain its position as a top media company without its strongest asset. Side note: Time, Inc. was clearly not core to TWX, so its spin-off was a completely different — and logical — story.

Spin-Off Benefits

Here are a few spin-off advantages that may or may not materialize:

• From a financial / strategic perspective, HBO could technically build out HBO NOW as more of a direct Netflix competitor, including creating the necessary technology in-house and running it without 3rd party providers.
• In parallel, HBO could also alter its distribution strategy to be digitally-focused, acquiring and creating a more robust digital content library (though one may question what this does to brand dilution and content quality). In other words, HBO NOW would not necessarily be at parity with HBO GO.
• HBO may also become more open to acquisitions and investments, though it has traditionally been more focused on organic growth.
• From a creative perspective, it is unclear to me how much would actually change (or need to change) post-spin.
• TWX no longer has conflicting premium cable vs. broadcast network business models under its umbrella.

Key Challenges

The vast majority of the problems with the spin-off argument lies in the strategic vision for HBO. Is HBO better off as another Netflix-type service? And if so, can HBO successfully transform its business to directly compete with Netflix, Hulu, Amazon Prime Instant Video, and the slew of other SVOD services already on the market? The answer is most likely no.

• There is already a large overlap between Netflix, Hulu, and Amazon Prime Instant Video content — the value of HBO today is in the quality of its original content and selection of top films. If HBO goes ahead and splits its efforts between building out a large SVOD library (incl. non-HBO series) and continuing to produce top original programming, it may start to lose its competitive edge and brand differentiation. Netflix has already successfully dominated this space and is well-equipped to continue its international expansion plans.
• Execution must also be (close to) flawless, including from a technological, programming, distribution, marketing, and even customer management perspective. This requires substantial investments across all operating areas and a complete change in focus to achieve. And obviously, this all takes time — not an easy feat, particularly during a time when media & tech are evolving so rapidly.
• Now, this is all predicated on the idea that eventually the majority of households will probably cut the cord and simply buy broadband (plus the content that they desire). If, in fact, this is not what you believe, the argument is still that HBO is unlikely to achieve significant growth (over historic levels) on a purely linear basis — certainly, not a sufficient enough amount to merit a large valuation increase.
• Post-spin, HBO also becomes an obvious takeover target. In this scenario, the company probably becomes even more attractive to buyers like Fox, which already owns the top competitors to TWX’s Turner and Warner Bros. segments anyways.
• On the flip side, TWX also becomes an easier M&A target, though likely far less attractive than HBO. Rich Greenfield actually mentioned a more interesting alternative — simply selling Turner. This makes significantly more sense given the synergies that HBO + Warner Bros. have vs. Turner + Warner Bros.

If activists are intent on pressuring TWX to change, an HBO spin-off should probably be at the bottom of that list.