AOL is a drag on Time Warner

Harry Potter worked his magic, but continuing struggles at AOL cast a pall over Time Warner Inc.’s third-quarter financial results.

The world’s largest media company’s movie division was one of the bright spots in Wednesday’s quarterly report. Revenue there jumped 33%, boosted by the strong box-office performance of “Harry Potter and the Order of the Phoenix.”

Still, the AOL slowdown remains a big headache for President Jeffrey L. Bewkes, who inherits the chief executive job Jan. 1 from Richard Parsons, who is retiring. Quarterly revenue in the online division sank 38% and operating income fell 23%, as subscription fees plunged and advertising income rose too little to make up for it.

The unit is 15 months into its transition from an Internet-access service to a pure online-advertising vehicle -- an initiative Bewkes kicked off when he became president of Time Warner in 2005. AOL’s advertising growth slowed for the second straight quarter and lagged far behind the industry average.

Overall, Time Warner’s third-quarter profit fell 53% compared with a year-earlier period that was fattened by one-time tax and investment gains. Earnings for the three months that ended Sept. 30 were $1.09 billion, or 29 cents a share, compared with $2.32 billion, or 57 cents a share, a year earlier.

Setting aside one-time items, Time Warner’s earnings of 26 cents a share were in line with the expectations of Wall Street analysts and an improvement over 19 cents a year earlier. Revenue was up 9%, to $11.68 billion from $10.75 billion.

Besides AOL, Time Warner owns the Warner Bros. studios, HBO, Time and People magazines and a fleet of cable TV channels led by CNN, TNT and TBS. It also holds a majority interest in the nation’s second-largest cable TV provider, Time Warner Cable.

In a conference call with analysts and reporters Wednesday morning, Time Warner said it expected full-year double-digit earnings growth in 2008 thanks in part to expected strength in the cable TV channels.

But most of the analysts’ questions focused on AOL, which joined Time Warner in a $99-billion merger in 2001. After posting 40% online ad growth for four quarters in a row, the business hit a bump in this year’s second quarter, when growth slowed to 16%.

Wednesday’s report, showing third-quarter ad growth of only 13%, made it hard to dismiss the springtime slowdown as an aberration. The company said ad growth would continue to decelerate through the first quarter of next year.

Bewkes jokingly thanked the analysts for the unsolicited advice they had offered him lately -- including repeated calls to jettison AOL through a sale or spin-off -- but he said he believed AOL would turn around and belonged in the Time Warner family.

In fact, Time Warner continues to invest in the unit. The company announced Wednesday that it had agreed to acquire Quigo Technologies Inc., a New York-based advertising company that matches ads to the content of websites. Bewkes said that in conjunction with Tacoda Inc., another high-tech ad company purchased this year, AOL would have the best technology in the business for enhancing the profitability of its own web pages and those of its Internet partners.

AOL has snapped up four online advertising companies this year.

Time Warner shares fell 53 cents to $17.80 on a day when the Dow Jones industrial average sank 360 points.

Investors, upset with the conglomerate’s poor stock performance -- zero gain over the last five years -- are clamoring for a broad shake-up, such as selling or spinning off AOL, the venerable Time magazine division and the rest of Time Warner Cable.

Rating agency Standard & Poor’s, citing Bewkes’ statement that all options “are on the table,” Wednesday placed Time Warner on “credit watch with negative implications,” meaning that its bonds could be downgraded. The company said Bewkes’ remarks raised investor expectations for a restructuring, which could result in increased borrowing or shakier security for the $37.1 billion worth of debt already on the company’s books.

Time Warner Cable, which also reported earnings Wednesday, said it had lost 83,000 subscribers in the third quarter, substantially more than analysts had expected. The company said 66,000 of the lost subscribers came in just two cities: Los Angeles and Dallas. It did not break down the losses between those cities.

The company has suffered service problems that sparked a high level of consumer complaints as it worked to upgrade the Los Angeles cable systems it bought from bankrupt Adelphia Communications Corp. Broadband competitors in satellite TV and telephone companies, spotting Time Warner Cable’s vulnerability in Los Angeles and Dallas, have successfully captured customers in those cities.

thomas.mulligan@latimes.com