Nearly 10 months ago, the world was first introduced to the Deal of the Century--America Online Inc.'s (AOL) acquisition of Time Warner Inc. (TWX) This New and Old Media marriage promised to create a peerless company, using AOL's powerful Internet brand to leverage Time Warner's deep lineup of entertainment, news, and cable properties. Despite a tough regulatory review in Brussels and Washington and the spring dot-com shakeout that punished technology stocks, nobody remains more bullish on the potential of AOL Time Warner than Time Warner CEO Gerald M. Levin. He insists the deal is on track to close by the end of the year. On Oct. 19, in a public forum that was part of BUSINESS WEEK's "Captains of Industry" series, Levin sat down with BUSINESS WEEK Editor-In-Chief Stephen B. Shepard at the 92nd Street Y in Manhattan to talk about the status of the deal, why he believes it still makes sense, his competitors--and even soft money.
Q: You have said that the Internet is such a transforming technology that a traditional media company such as Time Warner wouldn't be able to fully realize [a New Media] vision, and it was necessary to go outside. Putting AOL together with Time Warner has to be fundamentally revolutionary within your own company.
A: But also revolutionary for AOL, because now you have CNN, you have Warner Bros., Time magazine, and HBO. Normally, in most mergers, there is what the Street calls risk of execution. Over and over again, two people stand up, they high-five, [they say] "this is the greatest thing. We're going to have all these synergies." And you know it just can't be that great, and then a year later one of the two is gone and things haven't quite worked out. In this case, I have to say, and this is not an arrogant statement, the concept of putting these two companies together is profound. The Internet is not going away, whatever the dot-com crash, the tech crash. This is not only here to stay, but it's causing such rapid change--most of it positive, by the way--that we are trying to overlay old doctrines, regulatory or old management ideas, onto this system. So, yes, it's a revolutionary change.
Q: When the deal was announced, AOL's stock was at about $73...and that represented a 71% premium to Time Warner shareholders. Now AOL's stock has declined 38% as of today, to 45. The value of the deal to Time Warner shareholders is only a 5% premium over Time Warner's pre-deal price. Why is this still a good deal for Time Warner shareholders?
A: First of all, the deal was never done in the traditional sense that there was a control premium, because control was not surrendered...there is a 50-50 board. I'm the one who came up with the exchange ratio [each Time Warner shareholder will get 1.5 shares in the new company for each share of Time Warner]. No bankers. This was very hard to arrive at. It is not an acquisition premium for control. It's simply a way of trying to balance the two stocks to represent the value that's intrinsic in Time Warner and recognize that AOL is on a trajectory, so that over a period of time it is going to be the equivalent in revenue and operating cash to all of Time Warner.
We needed that 1.5 shares of AOL for each share of Time Warner in order to do that. So it was not an acquisition premium. If you look at the [earnings] numbers [released Oct. 18], you can see how this is going to happen. AOL's revenues grew 34%. Advertising [and] e-commerce, 80%. Time Warner's advertising grew 17%. I'm proud of it. So this is a merger of equals. We could have had a one-to-one exchange. But the reason it's 1.5 is because there's a gap in time, and it was also designed to take into account the fact that, yes, the Time Warner assets are historic and understood. The AOL assets don't have the same 70- or 80-year history.
Q: If AOL stock was at 45 and the deal was being done in AOL's stock, would you have done the deal?
A: It depends on where Time Warner's stock would have been at the time. When you put the two numbers together, and I'm now thinking of Time Warner shareholders, you have a company next year that's large. It's going to have north of $40 billion in revenues, growing at a 12% to 15% rate. But its operating cash, what we euphemistically call EBITDA, is going to grow at a 25% to 30% rate off of an $11 billion base.
That kind of financial engine should command a premium multiple. We have also [told] the Street that over a period of time, the company will have $50 billion in capacity. Time Warner couldn't deliver those kinds of numbers.
Q: Often a collar is put on a deal, meaning a mechanism that protects the acquired company or the merged company from the share price going below what it was at the time of the deal. You didn't seek a collar for this deal?
A: No, because a collar is traditionally used where there is indeed an acquisition, where there is a premium, and the acquired company is trying to get a zone of protection, and outside that zone is uncomfortable with the deal. A, this was not an acquisition; B, there was no need for a collar, which only forces a lot of arbitrage activity; and C, with a collar, the implication is that you are really not sure--your commitment to the valuations is somewhat insecure, and you need this kind of protection. I wanted to make a statement that I believe in it. It will be good for Time Warner shareholders, it makes sense for AOL. In other words, no collar deal, not an acquisition, means a total commitment to the deal come hell or high water.
Q: Let's talk about regulatory issues. One is open access to Time Warner cable for other Internet service providers, not just AOL. You've stated you're in favor of open access.
A: Yes, I don't use the phrase open access. I'm very much in favor of what we call multiple [Internet service providers]. It's obviously good for the consumer, but it also means that all these services come in and market. So what I've said--this has been lost in the underbrush--as a business matter, I've wanted to do multiple ISPs. Not because there is a regulatory issue--we've made that quite clear. I've offered my e-mail address to any ISP that wants to come in and negotiate. Not surprisingly, there are lots of companies that are taking this occasion to try and better the commercial terms they might otherwise have by running to Washington.
Q: You can declare yourself in favor of access, but then in the negotiation [with an ISP], the price [of access to Time Warner's cable lines] might become so onerous that no one wants to do it.
A: Cable is competing with what's called DSLs. Cable is in a competitive environment. The only way it can succeed is to offer as much consumer choice as possible. So it's more than just "trust me." I'm saying it's essential to the business of cable to have as many ISPs as possible to compete against the other services.
Q: If you don't favor your own content, then what's the point of the merger? You may as well not have merged and just partnered with anybody you wanted to for content.
A: There's a whole infrastructure at AOL that will facilitate the Internet activity of Time Warner. Also, the ability to cross-promote is significant, which all companies do. I have been asked, why not just enter into the kind of arrangements you are currently doing, just make joint ventures? Companies are human, too. It makes a big difference if you're part of the same family or not as to the cooperation, the ability to make things happen, and most partnerships usually come apart.
Q: It's probably also true that most mergers don't work, either.
A: And most mergers fail, that's correct. And 50% of marriages fail, too.
Q: You said this question of access depends on trust and fair negotiations. Yet when you had a contract dispute with Disney, ABC was knocked off your cable network. Why did you do it, and how do we know that something similar won't happen again?
A: Well, this was a product of a part of the law that I think is misplaced. It's called "re-transmission consent," and that is for a cable company to carry a broadcast signal it can choose something called must-carry, or if they don't, you have to negotiate. Unless the broadcaster gives you permission, you are not authorized to carry the signal. So our cable company was engaged in a negotiation and had reached an agreement at the end of last year. With the announcement of the AOL-Time Warner deal, some of our friends at Disney, and [CEO] Michael [Eisner] in particular, became concerned and paranoid, and all of a sudden, the terms changed.
We kept getting extensions for the right to carry the ABC signals. We finally reached a point where we were running out of the last extension, and it wasn't helping our consumers because in one particular market, Houston, if a signal is going to come off, the FCC rules say you have to send 30 days' notice. So in Houston they said you're not going to be authorized, and they started to put ads in the paper saying come and get your satellite antenna, so we had to put out a notice. It was really jerking around the consumer.
I'll take full responsibility. It was a mistake. I felt we didn't have an agreement and, therefore, we were not authorized to carry the signal. So at midnight we took it off because under the law you are in violation of copyright.
Q: So what was the mistake?
A: The mistake was, I should not have been so technical about it. I should have violated the copyright and kept the signal on.
Q: Suppose it were Disney merging with AOL. Would you be any less paranoid than Michael Eisner is? Would you behave any differently in running to Washington?
A: Absolutely. Obviously I would say this--but I think it's a mistake to lobby for certain things, particularly in this area where it's hard to figure out how the government should regulate the Internet. How should the government regulate interactive television? You're going to end up with something that is going to come back to bite you, so you better try and solve your problem through commercial negotiation with [the other] party or have your own strategy. Which is ultimately what Disney will do. Having said this, Michael and I have known each other for more than 30 years and have a very nice relationship--except when it comes to business.
Q: Before the merger, of course, AOL was lobbying to get greater access to cable systems.
A: That is correct. There are a couple of things AOL has done that I haven't believed in. For example, I've cut out all soft money at Time Warner. We can get into that discussion. But AOL does [give soft money contributions]. So there are certain things I will do differently.
Q: Would the merged company not use soft money?
A: I don't believe in soft money. I think it's horrendous. As a matter of fact, what I did this year was to take--I'm embarrassed to say--the almost $2 million we may have given in the past almost on an annual basis and give it to CNN, our five local cable news services, and Time magazine and said: "Do extra coverage of the issues," which they have done.
Q: As CEO of the merged company, are you saying that the merged company would not use soft money in political campaigns?
A: That's correct.
To see the entire interview on video, go to the Business Week Online Media Center at www.businessweek.com/mediacenter/