America Online Acquires Time Warner:
The Rise and Fall of an Internet and Media Giant

Time Warner, itself the product of the world’s largest media merger in a $14.1 billion deal a decade ago, celebrated its 10th birthday by announcing on January 10, 2000, that it had agreed to be taken over by America Online (AOL) at a 71% premium to its share price on the announcement date. AOL had proposed the acquisition in October 1999. In less than 3 months, the deal, valued at $160 billion as of the announcement date ($178 billion including Time Warner debt assumed by AOL), became the largest on record up to that time. AOL had less than one-fifth of the revenue and workforce of Time Warner, but AOL had almost twice the market value. As if to confirm the move to the new electronic revolution in media and entertainment, the ticker symbol of the new company was changed to AOL. However, the meteoric rise of AOL and its wunderkind CEO, Steve Case, to stardom was to be short-lived.

Time Warner is the world’s largest media and entertainment company, and it views its primary business as the creation and distribution of branded content throughout the world. Its major business segments include cable networks, magazine publishing, book publishing and direct marketing, recorded music and music publishing, and filmed entertainment consisting of TV production and broadcasting as well as interests in other film companies. The 1990 merger between Time and Warner Communications was supposed to create a seamless marriage of magazine publishing and film production, but the company never was able to put that vision into place. Time Warner’s stock underperformed the market through much of the 1990s until the company bought the Turner Broadcasting System in 1996.

Founded in 1985, AOL viewed itself as the world leader in providing interactive services, Web brands, Internet technologies, and electronic commerce services. AOL operates two subscription-based Internet services and, at the time of the announcement, had 20 million subscribers plus another 2 million through CompuServe.

Strategic Fit (A 1999 Perspective)

On the surface, the two companies looked quite different. Time Warner was a media and entertainment content company dealing in movies, music, and magazines, whereas AOL was largely an Internet Service Provider offering access to content and commerce. There was very little overlap between the two businesses. AOL said it was buying access to rich and varied branded content, to a huge potential subscriber base, and to broadband technology to create the world’s largest vertically integrated media and entertainment company. At the time, Time Warner cable systems served 20% of the country, giving AOL a more direct path into broadband transmission than it had with its ongoing efforts to gain access to DSL technology and satellite TV. The cable connection would facilitate the introduction of AOL TV, a service introduced in 2000 and designed to deliver access to the Internet through TV transmission. Together, the two companies had relationships with almost 100 million consumers. At the time of the announcement, AOL had 23 million subscribers and Time Warner had 28 million magazine subscribers, 13 million cable subscribers, and 35 million HBO subscribers. The combined companies expected to profit from its huge customer database to assist in the cross promotion of each other’s products.

Market Confusion Following the Announcement

AOL’s stock was immediately hammered following the announcement, losing about 19% of its market value in 2 days. Despite a greater than 20% jump in Time Warner’s stock during the same period, the market value of the combined companies was actually $10 billion lower 2 days after the announcement than it had been immediately before making the deal public. Investors appeared to be confused about how to value the new company. The two companies’ shareholders represented investors with different motivations, risk tolerances, and expectations. AOL shareholders bought their company as a pure play in the Internet, whereas investors in Time Warner were interested in a media company. Before the announcement, AOL’s shares traded at 55 times earnings before interest, taxes, depreciation, and amortization have been deducted. Reflecting its much lower growth rate, Time Warner traded at 14 times the same measure of its earnings. Could the new company achieve growth rates comparable to the 70% annual growth that AOL had achieved before the announcement? In contrast, Time Warner had been growing at less than one-third of this rate.

Integration Challenges

Integrating two vastly different organizations is a daunting task. Internet company AOL tended to make decisions quickly and without a lot of bureaucracy. Media and entertainment giant Time Warner is a collection of separate fiefdoms, from magazine publishing to cable systems, each with its own subculture. During the 1990s, Time Warner executives did not demonstrate a sterling record in achieving their vision of leveraging the complementary elements of their vast empire of media properties. The diverse set of businesses never seemed to reach agreement on how to handle online strategies among the various businesses.

Top management of the combined companies included icons such as Steve Case and Robert Pittman of the digital world and Gerald Levin and Ted Turner of the media and entertainment industry. Steve Case, former chair and CEO of AOL, was appointed chair of the new company, and Gerald Levin, former chair and CEO of Time Warner, remained as chair. Under the terms of the agreement, Levin could not be removed until at least 2003, unless at least three-quarters of the new board consisting of eight directors from each company agreed. Ted Turner was appointed as vice chair. The presidents of the two companies, Bob Pittman of AOL and Richard Parsons of Time Warner, were named co-chief operating officers (COOs) of the new company. Managers from AOL were put into many of the top management positions of the new company in order to “shake up” the bureaucratic Time Warner culture.

None of the Time Warner division heads were in favor of the merger. They resented having been left out of the initial negotiations and the conspicuous wealth of Pittman and his subordinates. More profoundly, they did not share Levin’s and Case’s view of the digital future of the combined firms. To align the goals of each Time Warner division with the overarching goals of the new firm, cash bonuses based on the performance of the individual business unit were eliminated and replaced with stock options. The more the Time Warner division heads worked with the AOL managers to develop potential synergies, the less confident they were in the ability of the new company to achieve its financial projections (Munk: 2004, pp. 198-199).

The speed with which the merger took place suggested to some insiders that neither party had spent much assessing the implications of the vastly different corporate cultures of the two organizations and the huge egos of key individual managers. Once Steve Case and Jerry Levin reached agreement on purchase price and who would fill key management positions, their subordinates were given one weekend to work out the “details.” These included drafting a merger agreement and accompanying documents such as employment agreements, deal termination contracts, breakup fees, share exchange processes, accounting methods, pension plans, press releases, capital structures, charters and bylaws, appraisal rights, etc. Investment bankers for both firms worked feverishly on their respective fairness opinions. While never a science, the opinions had to be sufficiently compelling to convince the boards and the shareholders of the two firms to vote for the merger and to minimize postmerger lawsuits against individual directors. The merger would ultimately generate $180 million in fees for the investment banks hired to support the transaction. (Munk: 2004, pp. 164-166).

The Disparity Between Projected and Actual Performance Becomes Apparent

Despite all the hype about the emergence of a vertically integrated new media company, AOL seems to be more like a traditional media company, similar to Bertelsmann in Germany, Vivendi in France, and Australia’s News Corp. A key part of the AOL Time Warner strategy was to position AOL as the preeminent provider of high-speed access in the world, just as it is in the current online dial-up world.

Despite pronouncements to the contrary, AOL Time Warner seems to be backing away from its attempt to become the premier provider of broadband services. The firm has had considerable difficulty in convincing other cable companies, who compete directly with Time Warner Communications, to open up their networks to AOL. Cable companies are concerned that AOL could deliver video over the Internet and steal their core television customers. Moreover, cable companies are competing head-on with AOL’s dial-up and high-speed services by offering a tiered pricing system giving subscribers more options than AOL.

At $23 billion at the end of 2001, concerns mounted about AOL’s leverage. Under a contract signed in March 2000, AOL gave German media giant Bertelsmann, an owner of one-half of AOL Europe, a put option to sell its half of AOL Europe to AOL for $6.75 billion. In early 2002, Bertelsmann gave notice of its intent to exercise the option. AOL had to borrow heavily to meet its obligation and was stuck with all of AOL Europe’s losses, which totaled $600 million in 2001. In late April 2002, AOL Time Warner rocked Wall Street with a first quarter loss of $54 billion. Although investors had been expecting bad news, the reported loss simply reinforced anxieties about the firm’s ability to even come close to its growth targets set immediately following closing. Rather than growing at a projected double-digit pace, earnings actually declined by more than 6% from the first quarter of 2001. Most of the sub-par performance stemmed from the Internet side of the business. What had been billed as the greatest media company of the twenty-first century appeared to be on the verge of a meltdown!

Epilogue

The AOL Time Warner story went from a fairy tale to a horror story in less than three years. On January 7, 2000, the merger announcement date, AOL and Time Warner had market values of $165 billion and $76 billion, respectively, for a combined value of $241 billion. By the end of 2004, the combined value of the two firms slumped to about $78 billion, only slightly more than Time Warner’s value on the merger announcement date. This dramatic deterioration in value reflected an ill-advised strategy, overpayment, poor integration planning, slow post-merger integration, and the confluence of a series of external events that could not have been predicted when the merger was put together. Who knew when the merger was conceived that the dot-com bubble would burst, that the longest economic boom in U.S. history would fizzle, and that terrorists would attach the World Trade Center towers? While these were largely uncontrollable and unforeseeable events, other factors were within the control of those who engineered the transaction.

The architects of the deal were largely incompatible, as were their companies. Early on, Steve Case and Jerry Levin were locked in a power struggle. The companies’ cultural differences were apparent early on when their management teams battled over presenting rosy projections to Wall Street. It soon became apparent that the assumptions underlying the financial projections were unrealistic as new online subscribers and advertising revenue stalled. By mid 2002, the nearly $7 billion paid to buy out Bertelsmann’s interest in AOL Europe caused the firm’s total debt to balloon to $28 billion. The total net loss, including the write down of goodwill, for 2002 reached $100 billion, the largest corporate loss in U.S. history. Furthermore, The Washington Post uncovered accounting improprieties. The strategy of delivering Time Warner’s rich array of proprietary content online proved to be much more attractive in concept than in practice. Despite all the talk about culture of cooperation, business at Time Warner was continuing as it always had. Despite numerous cross-divisional meetings in which creative proposals were made, nothing happened (Munk: 2004, p. 219). AOL’s limited broadband capability and archaic email and instant messaging systems encouraged erosion in its customer base and converting the wealth of Time Warner content to an electronic format proved to be more daunting than it had appeared. Finally, Both the Securities and Exchange Commission and the Justice Department investigated AOL Time Warner due to accounting improprieties. The firm admitted having inflated revenue by $190 million during the 21 month period ending in fall of 2000. Scores of lawsuits have been filed against the firm.

The resignation of Steve Case in January 2003 marked the restoration of Time Warner as the dominant partner in the merger, but with Richard Parsons at the new CEO. On October 16, 2003 the company was renamed Time Warner. Time Warner seemed appeared to be on the mend. Parson’s vowed to simplify the company by divesting non-core businesses, reduce debt, boost sagging morale, and to revitalize AOL. By late 2003, Parsons had reduced debt by more than $6 billion, about $2.6 billion coming from the sale of Warner Music and another $1.2 billion from the sale of its 50% stake in the Comedy Central cable network to the network’s other owner, Viacom Music. With their autonomy largely restored, Time Warner’s businesses were beginning to generate enviable amounts of cash flow with a resurgence in advertising revenues, but AOL continued to stumble having lost 2.6 million subscribers during 2003. In mid-2004, improving cash flow enabled the Time Warner to acquire Advertising.com for $435 million in cash.
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