Why Time Warner's CEO loves cable
Its IPO filing shows that Time Warner Cable is extremely profitable for its parent.
By Stephanie Mehta, Fortune senior writer

NEW YORK (Fortune) -- No wonder Time Warner CEO Dick Parsons likes the cable business so much.

Time Warner's cable unit this week filed long-awaited papers outlining its plans to sell shares to the public, and the document confirmed what many investors already knew: Cable has disproportionately contributed to the media conglomerate's profitability and revenue growth.

While the IPO filing offered little new information about the cable company's strategy or its growth projections, it revealed that Time Warner Cable is extremely profitable for its parent: Its 2005 net income was almost $1.3 billion. Time Warner (also the parent of Fortune and CNNMoney.com) typically doesn't break out the profits for each of its units when it reports its earnings, though it does provide a metric of its own making, "OIBDA," operating income before depreciation and amortization for each of its movie, network, publishing, AOL and cable divisions.

OIBDA is an OK measure of the company's financial health, but we happen to like a good, old-fashioned, generally accepted accounting metric like net income. And Time Warner Cable had plenty of it: Cable accounted for 43 percent of Time Warner's 2005 profits, even though it represented only 22 percent of revenue. And while the parent company's net income fell in 2005, the cable unit's profit jumped 72 percent, due largely to a big drop in the income-tax provision assigned to cable. Excluding taxes and discontinued operations, income still grew 18 percent.

The numbers laid out in the filing underscore a big change in the financial health of the cable sector. It wasn't that long ago that cable companies didn't show profits or free cash flow due to capital spending for upgrades to their systems. Now, however, companies like Comcast (Charts), Cablevision (Charts) -- and Time Warner Cable -- are delivering bottom-line results.

Time Warner has wanted to create a separate stock for its cable unit for some time now. The idea is that the cable unit would have its own currency with which to make acquisitions, but also, to "unlock" the value of the cable business. Until recently, Time Warner (Charts) stock has been a woeful underperformer, with shares today trading at roughly where they were at the end of 2004. (In the last three months, Time Warner shares are up about 20 percent.)

CEO Parsons has long believed the stock price didn't reflect the performance of the cable unit (though, to be sure, cable stock had been out of favor until about six months ago). A partial spin-out of the cable business, he has said, would help investors better assess the value of the unit.

The cable IPO had been complicated by several factors, including the recent purchase by Time Warner and Comcast of systems owned by bankrupt Adelphia Communications. In fact, the shares offered to the public actually are held by Adelphia, which ended up with a stake in Time Warner Cable as part of that transaction.

So far, Time Warner Cable looks like a solid investment, with financial performance that's pretty consistent with that of Comcast, the No. 1 cable operator in the country. (Comcast, for example, saw its cable revenue grow 9.5 percent in 2005; Time Warner Cable's revenue climbed 12 percent.)

The question for investors is whether the company will continue to deliver growth, especially now that it is absorbing Adelphia assets, which will require substantial investment to upgrade. But most analysts view the Adelphia systems as a growth opportunity for Time Warner Cable: By sprucing up that network, Time Warner will have a chance to sell subscribers a "triple play" package of high-speed data, telephone and digital cable services, which will increase revenue and help retain those customers.

Meanwhile, Time Warner will remain firmly in control of the cable unit. After the IPO, the parent company will still own 84 percent of Time Warner Cable, and control 90 percent of the voting shares. That means cable will continue to contribute to Time Warner's bottom line. With some of Time Warner's other businesses facing challenges, including a big business-model change at AOL and downsizing of the magazine business, that just gives Dick Parsons another reason to like cable.

Three cable stocks to buy: Charter Communications (Charts); Liberty Global (Charts); Comcast Top of page