BUSINESSWEEK ONLINE : JANUARY 24, 2000 ISSUE
COVER STORY Running the Numbers on the Deal Ted Turner may think that the joining of Time Warner (TWX) and America Online (AOL) is as good as making love for the first time, but average investors took a more dispassionate view. By Jan. 12, two days after the Merger of the Millennium was announced, the combined market value of AOL and Time Warner was actually lower than before the announcement--$260 billion, vs. $270 billion pre-deal. In the eyes of Wall Street, the much lauded deal actually destroyed value. That could well change in the days ahead, of course. Shares of AOL are notoriously volatile, and investors may learn to love the combination. But what the early sell-off showed is the difficulty of merging not just two companies but two sets of shareholders with different views of the world. AOL shareholders bought their shares as an Internet play. Time Warner shareholders acquired what they thought was a media company. Now, both groups will become owners of a hybrid that wasn't what either exactly bargained for. MISSING BILLIONS. Time Warner shareholders, to be sure, have nothing to complain about. Their company's market value was still up $22 billion as of Jan. 12, thanks to the generous ratio of shares they are slated to receive in the new AOL Time Warner Inc. The big losers were shareholders of AOL, whose market value fell 19%, or $32 billion, in the days immediately following the announcement of the deal. Out of that $32 billion, about $22 billion was effectively transferred to Time Warner shareholders and about $10 billion simply vanished in the stock's fall--in effect, the market was concluding that the companies were worth less together than apart. The deal calls for America Online shareholders to receive one share in the new company for each of their current shares, and for Time Warner shareholders to receive 1.5 shares for each of theirs. That represents a 70% premium for Time Warner shareholders, based on the pre-deal prices of the stocks and the numbers of shares outstanding. It gives AOL shareholders 55% and Time Warner shareholders 45% of the new company. In an interview with BUSINESS WEEK, AOL Chairman and Chief Executive Stephen M. Case said he thought last fall that the deal should be a ''merger of equals.'' Ordinarily, that would mean giving each set of shareholders 50% of the new company. When AOL shares started running up, he decided to ask for better terms. ''We were prepared to pay a premium, but there are practical limits,'' he says. Based solely on pre-deal market capitalization, Case says, AOL shareholders should have gotten 65% of the new company. On the other hand, basing the ratio on the companies' revenues or cash flow would have given AOL shareholders just 20% of the company, he notes. Says Case: ''They recognized the leap of faith that Internet valuations are real. We took a similar leap of faith that media assets are valuable and underappreciated. And we arrived at some place in the middle.'' EARNINGS HIT. So how much is AOL really worth, given its deal to acquire Time Warner? The method that Case favors--and that Wall Street analysts often use--is to project the combined companies' per-share earnings before interest, taxes, depreciation, and amortization (EBITDA)--roughly speaking, operating cash flow. That measure ignores the giant hit to net earnings that AOL will take by writing off about $15 billion of goodwill annually for 10 years. (Goodwill is the gap between the purchase price for Time Warner and the book value of the company's net assets.) Pre-deal, Time Warner shares traded at a multiple of 14 times EBITDA, while AOL's shares traded at an EBITDA multiple of 55 because of its higher growth rate. The multiple for the blended company will depend on whether investors see the hybrid as more like AOL or more like Time Warner. Merrill Lynch & Co. analyst Henry Blodget expects the multiple to range between 25 and 40, implying a price for AOL stock between $55 and $90 (table). In a Jan. 11 report, he advised that, if the merger goes well, the price could be $90 to $100 in a year. If so, AOL is a great buy at $60. If not, AOL shareholders may get a new message: ''You've got losses.'' By Peter Coy in New York, with Catherine Yang in Washington _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Welcome to the 21st Century COVER IMAGE: Men of the Century: Bob Pittman and Steve Case TABLE: How the Giant Fits Together Running the Numbers on the Deal TABLE: One Stab at Valuing the Stock Commentary: Is This Baby Built for Cyberspace? A Little Help from the Feds So Who's Next? ONLINE ORIGINAL: Loving AOL--Before Time Warner ONLINE ORIGINAL: AOL-Time Warner Creates "negative Synergy" INTERACT E-Mail to Business Week Online

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