Credit analyst considers AOL Time Warner bonds too rich still

By Ronda Fears

Nashville, April 9 - AOL Time Warner Inc. bonds are still trading too rich, said Gimme Credit director of research Carol Levenson in a report Wednesday. Moreover, she said the media giant's only hope of improving its credit quality lies in asset sales, rather than the current path of debt-financed acquisitions.

"In 2001, AOL bought Time Warner for $150 billion in stock. Two years later, the stock of the combined companies isn't worth enough for AOL Time Warner (Baa1/BBB+) to use it as currency to pay the $800 million the company had committed to buy the rest of AOL Europe from Vivendi," Levenson said in the report.

"Yesterday, in what the CEO termed 'the right decision for our shareholders,' AOL said it will use borrowed cash to make this payment instead of stock, thus continuing to delay its promised debt reduction."

The AOL Europe acquisition has now cost the company some $8.3 billion in cash and debt, while contributing negative EBITDA in 2002 of $150 million, she added.

Other uses of cash have popped up subsequent to year-end, too.

According to AOL's recently filed 10-K report, in January the company used cash to purchase an additional stake in The WB Network for $128 million, make a pension contribution of $257 million and redeem putable convertible bonds for $384 million.

Offsetting a total of $1.6 billion in cash used were gross proceeds of $800 million from the sale of GM Hughes stock.

All tallied, Levenson said AOL Time Warner's net debt remains unchanged.

Another significant item is the possibility that the SEC could require AOL to restate another $400 million in advertising revenues because of a disagreement about the accounting treatment of a deal with Bertelsmann AG.

"We learned from previous advertising restatements that they can have a meaningful impact on results, as the EBITDA margin is extremely high, nearly 60% in the case of the previous restatement," Levenson said.

"Granted, the company has already conditioned the market to expect substantially lower advertising revenue from its AOL unit this year. But it's worth noting the disputed Bertelsmann payments comprised 20% of the unit's ad revenue last year.

"Moreover, AOL's five most significant advertisers (including Bertelsmann) accounted for 35% of last year's ad revenue, further illustrating the riskiness of this EBITDA stream."

Also, the analyst noted that the SEC is investigating a range of other transactions and further restatements are possible.

In a section of the 10-K referred to as "Contractual and Other Obligations," the analyst noted that AOL lists a whopping $30 billion in "firm commitments" with $8 billion due this year, including the $2.1 billion owed to Comcast. Over half of these commitments are agreements to purchase cable programming and movie production deals, she added.

Under "Contingent Commitments," guarantees and letters of credit there is another $5 billion, while securitization facilities represent another $2 billion.

"Thus, while AOL lists a mere $27 billion in long-term debt on its balance sheet, the total of all its commitments (including debt) is a staggering $64 billion," Levenson said.

"We understand there's a big difference between debt and these other obligations, but we're grateful for this disclosure and the perspective it gives on a company's financial flexibility.

"AOL's only hope for credit quality improvement is asset sales, and we continue to consider its bonds overpriced."

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