Commentary: AOL Time Warner: The Thrill Is Gone

Gerald M. Levin has put his tie back on. Last January, when the Time Warner Inc. ( TWX) chief executive announced he was selling his company to America Online Inc. ( AOL) in an unprecedented deal marrying Old and New Economy forces, he appeared at the press conference sans tie. Much was made of Levin's awkward fashion choice that day, an obvious attempt to appear that he was down with his cool new Web partners. But these days, Levin looks to be back to his Old Economy, buttoned-up self, tie squarely in place.

Levin's neckwear might just be a message that Time Warnerites aren't as smitten with the idea of a New Media marriage as they once were. Clearly, the heady days of January, when Net-company valuations were sky-high, are long gone. With AOL's stock down 20% from the Jan. 10 deal announcement and each day bringing more news about regulators picking away at the $120 billion AOL-Time Warner combination, the once-vaunted union seems strained. Does the deal still make sense?

ANGST. Surely, the longer it takes to lock things up, the more time each side has to contemplate the looming collision of two contrasting cultures. While Levin and other Time Warner execs continue to publicly trumpet support for the deal, angst is spreading at Time Warner's entertainment and news units about whether teaming with AOL is worth it. ''If talks had dragged on into March, I don't think we'd have a deal today,'' says a Time Warner executive.

Of course, March was when the floor first began to fall out from under Internet stocks. AOL took the ride south along with the rest of its bloated brethren. Back at the birth of the new millennium as the two parties must have been giddily finalizing the deal's terms, AOL shares closed at 83, a puffed-up currency that could snap up the entertainment giant. On the day the deal was announced, AOL closed at 73. Today, the shares are trading around 58. That puts AOL's market value at about $35 billion less than it was on the day of the announcement. Even the tepid Standard & Poor's 500-stock index has posted a better performance since Jan. 10--down 1.5%. Time Warner stock got the bigger lift: It's trading 33% higher than it was on the day before the deal.

LAYOFFS. But Wall Street must now wrestle with how to value the combined behemoth: Is it an Internet company, a media company, or some hybrid? Putting together AOL and Time Warner runs against today's grain as more companies look to issue tracking stocks, allowing the market to value specific businesses. ''I think this deal is the proper solution for both companies. But the Net is not as exciting a place as it was, especially in the consumer markets'' says Jeff Sadler, an analyst at FAC/Equities who dropped coverage of AOL in August to focus on business-to-business companies. Just look at Net entertainment companies such as NBCi and MTVi, which have announced large layoffs in the past several weeks.

The decline in AOL shares might sting less if a ''collar'' had been in place, but no such clause exists. A collar is a safety measure written into deals to automatically readjust terms if the two companies' stocks trade outside a designated range before the deal closes. Since AOL is a tech stock and dealmakers anticipated big ups and downs, Time Warner didn't insist on a collar, showing a commitment to get the deal done. And the breakup fees--the cost of walking away from the deal--are hefty: $5.4 billion for AOL, about $4 billion for Time Warner.

If the stock market is causing trepidation, then the regulatory process unfolding in recent weeks must be unnerving. The Federal Trade Commission and the Federal Communications Commission, as well as regulators for the European Union, have been particularly tough on this merger. One of regulators' biggest worries is that AOL Time Warner would have an unfair advantage since it could try to block competing Internet service providers (ISPs) from using Time Warner's high-speed cable lines. The companies vowed to provide open access.

FIEFDOMS. But now come reports that Time Warner might be telling regulators one thing while trying to exert control over other ISP partners and levy large fees to hook up to their systems. Time Warner insists it is committed to providing fair and open access. But as more ISPs come out of the woodwork to complain about Time Warner's requirements to get carried, the ire of regulators is certain to rise even more. They already appear to be itching to impose conditions on the deal, so any double-talk from Time Warner could just strengthen the government's resolve to play hardball.

Meanwhile, European antitrust regulators continue to scrutinize the AOL-Time Warner deal, along with Time Warner's proposed $20 billion joint venture with British music giant EMI Group. For weeks, Time Warner seemed pressured to rip holes in its EMI deal to appease European regulators, concerned about the clout Warner Music/EMI would wield in Europe. The companies were considering sacrificing EMI's Virgin Records label to get the green light, but as of Oct. 4 they had made no formal offer.

Still ahead is the formidable task of integrating two vastly different organizations. Internet company AOL has 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 movie studios to cable systems, each with its own subculture. ''There is a lot of concern around here about how this all shakes out when AOL becomes boss,'' says a Time Inc. employee. And this comes just as Time Warner was smoothing out the rough edges of its 1996 acquisition of Turner Broadcasting System.

Will becoming a vertically integrated Internet and media giant lift up both companies or drag each down? James T. Waggoner, an analyst at Sands Brothers & Co., says the prospect of melding the two is troubling. He likes AOL as a stand-alone Internet company just fine. A merger with Time Warner will dilute AOL's 20%-plus annual revenue-growth rate, he says, which is why he has had a ''neutral'' rating on AOL since the deal was announced. ''A full merger was not necessary,'' says Waggoner. ''Why not a partnership or strategic alliance? They could have struck a royalty or licensing arrangement without merging the companies.''

''DEFENSIVE DEAL.'' Despite the mounting pressure, there are those who think AOL and Time Warner have to hang tough and proceed according to plan. ''It's a defensive deal,'' says Tom Wolzien, an analyst at Sanford C. Bernstein & Co. Time Warner, after several embarrassing missteps to launch a digital strategy and an Internet platform for its content, will get that in one swoop with AOL, whose subscribers have grown by 5 million, to 25 million, since December. And AOL, looking to establish itself as something more than a Net company, gets lots of popular content to put online and the high-speed cable lines to distribute it.

The companies are confident the deal will be finalized by yearend--or sooner. Says AOL Chief Financial Officer J. Michael Kelly, who will be CFO of the new company: ''There are always apprehensions about the concept behind big deals. Is it real? We have a unique plan to create something that has never been created before.'' But each passing week seems to throw down another obstacle in front of a proposal that looked so right back in January. And nobody is talking much anymore about the next big blockbuster Old and New Economy alliance; no copycat deals have materialized. Remember speculation about Yahoo! and Disney? Ten months later, AOL and Time Warner still may have plenty of good reasons to get hitched, but the thrill is gone.

By Tom Lowry
Lowry covers media from New York.

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Commentary: AOL Time Warner: The Thrill Is Gone

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