Lessons From the AOL-Time Warner Disaster
A very special date came and went last weekend: the 15th anniversary of the AOL-Time Warner merger. When the deal was announced, the combined companies boasted a market cap of $350 billion. Now, split once again, AOL is worth $3.6 billion and Time Warner $68.9 billion. The most notable AOL-Time Warner synergy was probably the $99 billion loss it posted in 2003. Surely no one company could manage that on its own. The marriage is considered one of the worst in the annals of business.
As a former Time Warner employee, it seemed apropos to commemorate the date by burning as much money as I could get my hands on, firing all my friends, and axing my Time Warner Cable and magazine subscriptions. Those ideas might sound destructive and unnecessary in hindsight, but I assure you that they sounded great at the time.
The press, however, largely ignored the anniversary, possibly because it's such a downer. Reporters instead are hearing from executives that the potential for growth and innovation at the intersection of technology and media is still huge. Venture capitalists invested hundreds of millions in content creators last year. Deal makers are enthusiastic about the potential for industry consolidation, too.
As the startup economy soars, media companies that present themselves as tech-media hybrids are getting venture backing and growing more valuable than traditional media companies. Vox Media is reportedly worth about $380 million, BuzzFeed $850 million and Vice $2.5 billion. (BuzzFeed, in fact, is a "full stack startup.") By contrast, the New York Times has a $1.8 billion market cap. Some old school media players are trying to remake themselves as tech players, too, presumably to boost their perceived growth potential. For example, Fortune now describes Disney as a tech powerhouse, even though the bulk of the company’s revenue comes from content such as movies and sports.
With real money being showered on this tech-and-media intersection, now might actually be the perfect time to reflect on the AOL-Time Warner deal. One can’t help but wonder: Is it ever a good idea to value media companies the same way we value software companies? Is it ever a good idea for tech companies to acquire media properties, especially legacy companies with a lot of costs? Just what sorts of synergies can generate enough revenue to support big valuations?
The world has changed a lot since the height of the dot-com bubble, but tech and media still have very different value propositions. Software is a relatively high-margin business. Once the upfront costs to design it have been paid, most of the revenue flows to the bottom line. It’s easy to scale without increasing costs at the same rate. Content is more expensive to produce because you need a sea of humans to create it from scratch again and again. You can’t scale it without significantly increasing head count and costs. Margins shrink further when media companies have huge overhead and legacy expenses, such as printed newspapers, that eat up profits.
As for AOL-Time Warner, the main lesson that bears remembering is that cheap distribution doesn’t automatically create value for the content producers. When Time Inc.’s print products were distributed cheaply online across AOL’s network, they decreased in value: The new distribution model hurt demand for high-cost print ads.
Today, streaming music services get music to listeners more cheaply than ever before, but they haven’t made it more profitable for labels and musicians to produce music. BuzzFeed et al pay very little to get content in front of readers and viewers, but online ads alone aren’t enough to support their growing newsrooms. That’s why they’re experimenting with things like native advertising. The idea is that native ads (once called advertorials or paid content) should bring in more money than a typical display ad. BuzzFeed is building out an in-house creative agency to help advertisers, which could help them generate more revenue. But we’re far from knowing whether one can build a sustainable business on top of native ads.
AOL-Time Warner also taught us that content is king, but you can’t overpay for it and succeed. AOL used an inflated stock price to pay more than $160 billion for a business that had just north of $1 billion in earnings. (AOL's earnings were smaller.) When it was clear that AOL had overpaid, the company was forced to take a huge writedown. The job cuts and belt tightening that followed hamstrung the conglomerate, and it eventually had to spin off AOL, Time Warner Cable and Time Inc.
Today, companies such as Facebook and YouTube -- Internet companies in the business of selling ads against visitor traffic to their platforms -- are trying to mix in more premium content with the user-generated stuff because advertisers are willing to pay more to be associated with professional writing and film. Old school players such as Yahoo and Verizon are reportedly thinking about buying media businesses with big legacy costs just to get their hands on premium content. Amazon and Netflix are pouring money into original programming. This is all well and good, but if it’s too pricey to get the content, it won’t matter how good it is. Both parties will eventually suffer.
Much of the innovation in media is fascinating, but the convergence between it and the tech sector isn’t an automatic recipe for fast-growing revenue when those two worlds collide.
(Corrects ninth paragraph to refer to Time Warner and AOL's earnings.)
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