On the surface, it looked like just another awesome megadeal. There were the top executives up on stage, palling around like local-TV anchors--and assuring everyone that this would be a merger of equals, a careful blending of two companies, two cultures. But make no mistake: America Online is the acquirer. The trading symbol for the new company, tellingly, is AOL.
Given the realities of the New Economy, it could hardly be otherwise. By now, the pattern is clear: The digital will prevail over the analog, new media will grow faster than old, and the leaders of the Net economy will become the 21st century Establishment. If the ascendance of the Net economy were not clear already, the Jan. 10 announcement of America Online Inc.'s $183 billion deal to purchase Time Warner--the biggest deal ever--should be taken as proof positive. AOL has just one-fifth the revenue and 15% of the workforce of Time Warner, itself the combination of publishing and entertainment empires that have been fixtures in America culture since the 1920s. But with a New Economy stock that investors valued at nearly twice that of the Old Economy icon, AOL had the resources to be the buyer, not the bought. "The deal shows the torch has passed," says Bruce Leichtman, director of media and entertainment strategies at research firm Yankee Group.
Now, New Economy titans Stephen M. Case and Robert W. Pittman will team up with Old Economy strategist Gerald M. Levin--CEO until 2003--to assemble a new kind of conglomerate whose very existence will likely change the contours of
information and entertainment media--digital and otherwise. Case, who will be chairman of AOL Time Warner, is making a huge bet that by melding the Time Warner colossus with his Internet empire, he will create a hybrid with unmatched advantages as the long-anticipated convergence of entertainment, information, communications, and online services comes about in the next few years.
It is a bid to define the future. By assembling more assets and audiences and advertisers for the new digital marketplace than anyone has previously even thought of, Case and AOL President Pittman see a chance to move so far ahead that others won't catch up for years--the way Alfred P. Sloan audaciously engineered the creation of General Motors Corp. in the 1920s--producing the corporation that dominated the U.S. in the Auto Age. "This should provide encouragement for other combinations that wouldn't have been thought possible," Time Warner Chairman Levin told BUSINESS WEEK on Jan. 11.
COSTLY BET. But deal handicappers are scratching their heads, trying to figure out how to come close to this combo. "There just isn't another AOL out there," says Robert "Dob" Bennett, president of Liberty Media Corp., which owns a 9% nonvoting stake in Time Warner. "This was a landmark deal, and I don't know if it can be duplicated."
It is also an immensely costly move: To secure this strategic stronghold, AOL proposed to pay a 71% premium over what Time Warner was valued at in the market. In the following days, however, AOL's high-flying stock was quickly devalued as investors focused on how tying up with Time Warner may produce a company with rates of return usually associated with the Old Economy. Pittman, who will start out as co-chief operating officer with Time Warner President Richard D. Parsons, says the market is wrong in thinking that AOL will come to resemble Time Warner rather than vice versa. Time Warner has "traditional businesses with big brands, long consumer relationships, strong cash flow," he argues. "All you need to do is put a catalyst to it, and in a short period, you can alter the growth rate. The growth rate will be like an Internet company, but built on businesses that have already built their brands."
Still, there is a fundamental risk to AOL that goes beyond stock valuation. Although the acquirer, it could become the captive of the sprawling Time Warner empire, which has 82,000 employees and a distinctly Old Economy management culture that could rob 15-year-old AOL of the flexibility, speed, and entrepreneurial drive that are crucial in the New Economy.
That's the big picture. For now, however, you can think of the combination in simpler terms: pipes and content. With its cable systems serving 20% of the country, Time Warner gives AOL a clearer path into broadband than it had with its previous plans to rely solely on upgrades in local telephone lines and satellite TV. The speedy new links--available across Time Warner systems by next year--not only will make existing Web fare far more appealing but will also make practical all sorts of new things, including AOL TV, a service to deliver the Web to TV sets that the company is rolling out this June. "We're now at the cusp of a fundamental new Internet experience, enabled by broadband access," says Case. "It's [about] a whole range of experiences, including a more engaging multimedia experience on a whole range of devices, of which TV is increasingly prominent."
KING CONTENT. And when all that bandwidth and all those gizmos are hooked up, AOL Time Warner will have the world's greatest trove of content with which to attract the largest audience, the most subscribers, and the most ads and e-commerce. From In Style magazine to Turner Classics' movie vault to CNN to the latest Kid Rock CD, Time Warner has something for everybody. Nobody knows that better than Levin, who has spent hundreds of millions in efforts to leverage those assets in cyberspace--and had budgeted as much as $500 million for 2000. But many projects, such as the Pathfinder Web portal, went nowhere. And Time Warner's Old Economy balance sheet and shareholders would not permit the years of losses required to fund a massive online effort--the way pure Internet companies such as AOL can.
In the end, that helped convince Levin and his eclectic management team--including Vice-Chairman Ted Turner-- that it was worth giving up corporate control to secure their company's berth in the New Economy. "It's damn hard," says Parsons. "We could work for a decade and maybe still not get up to a level that would be competitive."
AOL also gains things that it needed but could not get on its own: access to broadband distribution and more compelling content. The company, which dialed back its own efforts to develop new content in recent years, now realizes that it can't thrive long-term as mainly a glorified Internet-access provider. "AOL woke up one day and understood that their core competency wasn't pipes, but content," says Edward J. Zander, president and chief operating officer of Sun Microsystems Inc. "It's like when the train companies figured out they're not train companies, but transportation companies."
How will AOL get the most from Time Warner's distribution and content--and Time Warner gain from its links to the world's biggest online community? Even before the deal closes later this year, the companies are making plans to work more closely together. Entertaindom, the first of several miniportals Time Warner is starting, will be featured on AOL's entertainment channel. And Warner Brothers stores will have prominent displays of AOL sign-up disks.
But that's just cross-promotion. The key to the deal is developing new types of Web sites and services using Time Warner's rich content and getting them up quickly using AOL's vast Web infrastructure. Another plus: The companies will combine sales forces and back-end functions such as sales and customer support call centers. In all, the two companies promise to generate $1 billion in extra cash flow from "synergies" in their first full year together. That includes eliminating some of the $800 million AOL spends on advertising by using house ads across Time Warner media.
TUNEFUL. The first big stab at synergy may come in online music. Look for artists from Warner Music Group to be featured on AOL's music channel, where consumers can sample music and order CDs online--from CDNow Inc., which Time Warner partly owns. There is also potential for selling downloads on AOL. "We can help reinvent the business," says Case. "In the long run, we have the opportunity to create a personal jukebox that you carry with you--so you can listen to it on a pay-for-play, subscription, or pay-once-and-play-for-life basis."
Perhaps the greatest strength of the two companies going into the merger is the subscriber relationships they have with more than 100 million consumers. AOL has 22 million subscribers, and Time Warner's biggest sources of revenue are 28 million subscriptions to its magazines, 13 million cable subscribers, and 35 million paying viewers at its cable-movie service HBO. Plus, it draws fees from the 75 million households that take the TBS and TNT channels, and from TV services around the world that carry CNN. In addition, the new companies have a huge presence on the Web. Along with the AOL properties, including the Netscape portal, Time Warner has hundreds of sites including CNN.com.
SLICE AND DICE. That's a promising venue for advertisers, notes Renatta McCann, managing director for Starcom North America, a media buyer with $8.5 billion in annual billings. "The combined company will have a fantastic database," says McCann. "They will have a phenomenal way of slicing and dicing their consumer database to deliver the specific target audiences that I want."
That's the theory. How well it works in practice depends largely on how well the management of the two companies mesh. Ironically, the AOL deal was announced 10 years to the day after Time Inc. agreed to merge with Warner Communications. That deal, too, was supposed to deliver quick synergies but got off to a rocky start as execs from both sides jockeyed for position. "In any big transaction, probably the most significant risk is really people risk," says Levin. The 61-year-old Time Warner chairman plans to stay on as CEO of the new company until at least 2003. And he can't be removed unless three-quarters of the new company's board--which will be composed of eight directors from each company--agree. Even now, however, the media industry is betting that Pittman, 46, a former Warner exec who helped start MTV, will be the successor to Levin.
By most accounts, there is good chemistry between the scholarly Levin and the preppy Case. Their friendship blossomed last September on the 50th anniversary of the founding of the People's Republic of China. While attending a conference in Beijing, Case and Levin took in the festivities. "We stood together watching the tanks, the planes, and fireworks roll by," recalls Case. The next month, it was Case who called Levin to propose the idea of buying Time Warner--and keeping Levin as CEO. "If he had said no, I would have persevered," says Case. "Luckily, he's a smart guy and recognized...that it would be complicated to pull off but worth taking a shot."
STRONG PIPES. If AOL Time Warner does get sidetracked by internal politics, there are dozens of rivals looking for an opening. Players across the digital landscape--from Web rivals such as Microsoft and Yahoo! to the telecom giants to media companies like Walt Disney and Viacom--may have to recalibrate their strategies in the wake of the deal. AT&T, for example, plowed $110 billion into cable. But it has shied away from content and focused instead on creating broadband and local-phone links to homes--and a deal with Time Warner has been long delayed. Now, Levin says, he'll have broadband pipes, content, and the potential to add Internet telephony. Moreover, Case told BUSINESS WEEK in an interview that he has been talking with both AT&T and MCI Worldcom--on whose board he sits--about phone ventures.
Another complication for AT&T is the AOL Time Warner pledge to provide open access on its broadband networks. AT&T, which owns 26% of cable-modem service Excite@Home, has resisted open access, which would require it to let all online services use its cable pipes on the same terms as Excite@Home. "It's probably the nail in the coffin of the whole open-access debate," says Excite@Home CEO Thomas Jermoluk.
To compete more broadly with the New New Media giant, some analysts predict closer links between AT&T and Microsoft, possibly with ties to content companies such as Disney or Viacom. "This merger will make it easier for us to find partners among the other media companies," says Yusuf Mehdi, Microsoft Network's marketing director. "Will they want to partner with AOL now?"
Indeed, in the tangled media business, the AOL deal with Time Warner already produces complications: What happens with AOL's joint venture with Germany's Bertelsmann to roll out AOL in Europe? Bertelsmann competes heavily with Time Warner and its chairman has quit the AOL board.
Those are issues that Case, Pittman, and Levin will have to address--if the deal closes as expected later this year. Despite the falloff in AOL's stock and the retreat in Time Warner shares after an initial 50% surge, the merger is not in danger of immediate collapse because there is no "collar" on the deal that dictates the limits of share prices on either side. That was a concession that Time Warner made to get the 71% premium. At one critical board meeting, AOL director James Barksdale, the former CEO of Netscape Communications Corp., told fellow AOL directors: "Well, that's the price of eggs."
TWISTS. Another twist in the deal is the use of purchase accounting rather than a pooling of interests, which companies with hot stocks usually use. That, say people close to the deal, means the company will have to write off some $150 billion in goodwill. Bottom line: Charges of at least $15 billion a year against earnings for the next decade. But, insiders point out, it also gives the combined company the chance to pursue further acquisitions, joint ventures, or asset sales. Under a pooling of interests deal, AOL Time Warner would not be able to transfer more than 10% of its assets for two years. "We did not want to be hamstrung by the rules of pooling accounting," says Michael Kelly, AOL's CFO.
That means a long-rumored alliance between Time Warner and General Electric Co.'s NBC is still not out of the question. Nor are deals to bolster the slumping Warner Music Group, perhaps by joining up with with British music group EMI PLC. And the company could buy up more cable systems to expand its broadband reach. "We have a lot," says Case. "I wouldn't say we have everything we need forever." So the deal of the century may not be the last for the AOL Time Warner team.