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Investors: Don't judge this magazine by its cover

Time Warner Inc. may be looking forward to life without magazines. Should shareholders feel the same?

That's a question that Time Warner investors will face on Monday, after the media company completes the spinoff of its publishing division, whose titles include Sports Illustrated, People and Time. Once investors get shares in the new company, called Time Inc., they can simply sell and be rid of exposure to the magazine industry.

The temptation to dump the stock is obvious. The print industry has been in decline for several years as consumers and advertisers move over to digital media alternatives. Time Inc. has told investors it expects revenue excluding acquisitions to decline by 3 percent to 5 percent in 2014, with adjusted operating income falling 1 percent to 7 percent. It's hard to predict when the business will turn as consumers spend more and more time online, particularly on mobile devices.

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Sports Illustrated Swimsuit Edition from 2013 featuring model Kate Upton on the cover.
Adam Jeffery | CNBC
Sports Illustrated Swimsuit Edition from 2013 featuring model Kate Upton on the cover.

But betting against print media isn't a slam dunk. Just consider Rupert Murdoch's News Corp, which houses a number of struggling newspapers. About a year ago, News Corp. hived off its film and television assets into a separate company now called 21st Century Fox. Since the separation, News Corp. has risen a respectable 10 percent even as its newspaper assets remained under pressure.

Another big print media company that has shined in the face of industry headwinds is Germany's Axel Springer. Its stock has risen more than 40 percent since the start of 2013, even as some investors were eager to sell short. Axel Springer makes about half its profits from print media, where circulations have been in steady decline. And as marketing firm ZenithOptimedia points out, advertisers in Germany spend far more on print than in other countries, suggesting there's plenty of room to move to areas like television.

The key to Axel Springer's success: In July 2013, the company shocked investors by selling some of its best-known newspapers and magazines for a healthy valuation multiple. That gave Axel over $1 billion, allowing it to focus on its strongest brands and ramp up its digital operations. Axel shares continued to march higher: The stock has risen to a multiple of 20 times forward earnings from 15 times last July.

Indeed, a big risk for those betting against Time Inc. is that all, or part, of the company is sold. In early 2013, Time Warner engaged in talks with Meredith Corp. about selling some big Time Inc. titles to its rival, whose magazines include Family Circle and Betters Homes and Gardens.

While those discussions fell apart, a deal could arguably make more sense after Time Inc. becomes an independent company. Given that many of the Time Inc. titles have been around for decades, the company's tax liability on them is likely very high. But investment bankers say Meredith could revisit a deal, likely several months after the spin or more, without triggering any taxes for Time Warner.

A merger between two magazine companies makes a lot of sense on paper. Given the ample opportunity to slash costs, Meredith could pay a sizable take-out premium for Time Inc. and still generate a healthy increase in earnings in the process, according to Citigroup analyst Jason Bazinet. Meredith didn't respond to a request for comment from CNBC while both Time Warner and Time Inc. declined to comment.

Even without a deal in the near term, Time has very strong cash flow that will probably provide support, particularly in an environment when many investors have shunned high-growth companies that generate little earnings. Based on Time Inc.'s indicative trading range in the gray market, the stock will have a free-cash-flow yield of more than 10 percent, based on Morgan Stanley's estimates.

And investors should probably give Time Inc. a chance manage the business better as an independent entity. As a very small part of Time Warner, accounting for less than 10 percent of operating profit, it was probably a distraction but not worth the full attention of management from the parent company.

What's more, Time titles probably have strong brand value that can translate to digital revenue over time. Sports Illustrated's SI.com, for instance, drew 19.2 million unique visitors in April, up from 15.5 million a year earlier, according to comScore.

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Time Warner also has a respectable track record when it comes to past spinoffs. Since Time Warner Cable was separated in March 2009, investors who kept those shares have seen an incredible 507 percent total return, including dividends, according to FactSet. Over the same period, Time Warner Inc. has returned 361 percent.

Even AOL Inc., which was considered doomed by many, has generated a 78 percent total return since its spinoff in December 2009. Over that time, Time Warner has risen 169 percent.

Granted, Time Inc. arguably has greater challenges than other publicly traded print companies. News Corp., for instance, probably owes some of its success to valuable television assets in Australia while Meredith also owns lucrative TV stations.

But Time Inc. is looking downright cheap based on the latest gray market price of $23. That's equivalent to an enterprise value, adjusted for net debt, of about 6.7 times last year's earnings before interest, taxes, depreciation and amortization. Meredith, meanwhile, trades at nearly 10 times ebitda. At that price, bets against Time are a risky gamble.

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—By CNBC's John Jannarone

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