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So we've experienced one day of trading activity based on news of the biggest merger in history -- America Online's (AOL) proposed $160 billion acquisition of Time Warner (TWX). That doesn't tell us much about how the mega-merger will play out with investors. This deal, in the words of Steve Case, AOL's chairman and CEO, will "accelerate the next Internet revolution." Yet what occurred on Jan. 10 was only the first shot. "I doubt that even Steve Case has figured out all the implications," says Barry Parr, director of consumer e-commerce research for International Data Corp.
The truth is that the market reacted on Jan. 10 to some pretty simple, surface observations. Because AOL is buying Time Warner at a huge premium to its current market cap, Time Warner's stock rose 42%, to close at 92 1/4. And since AOL is combining with a much slower-growing company that has a dramatically smaller price-earnings ratio, its shares fell 1 5/8 points, to 72 5/8.
Investors also pushed up the shares of other media companies such as Disney (DIS), Viacom (VIA), and Seagram (VO), which are now seen as possible acquisition targets of major online players. And they were quick to surmise that cable assets were key to the deal -- and so they bid up the stocks of such cable-TV operators as Cox Communications (COX) and Comcast (CMCSA).
NOT SO SIMPLE.
What makes for short-term trading opportunities on a big news day may trip up long-time investors, however. For example, while AOL shares slipped, analysts are nearly unanimous in their opinion that this is a great strategic move. And although Time Warner shares shot up, some Internet naysayers believe that Time Warner CEO Gerald M. Levin may ultimately look like a chump for selling out his media powerhouse for stock in the midst of an Internet bubble. Merrill Lynch media analyst Jessica Reif Cohen noted in a Jan. 10 research report: "The initial reaction to this deal has been very positive, although we do think that the market will have to come to terms with the issue of valuation."
Ken Shapiro, who runs money management firm Condor Capital in Martinsville, N.J., is similarly cautious. He says he's staying on the sidelines for now, but he may buy into stocks that could be part of future deals -- such as Disney -- once they are cheaper. "I don't want to get caught up in the hype," he says.
While Wall Street tends to focus on the next few quarters, "the merger is predicated on a 5- to 10-year vision," says Edward Hatch, a media analyst at SG Cowen Securities. Indeed, investors would do well to heed Case, who told a press conference that "the value of this merger lies not only in what it is today but in what it will be in the future."
For now, here are some key areas investors should be thinking about as the merger takes shape and other industry players react, plus some wild cards to ponder:
Cable:
Analysts agree that the deal was triggered by AOL's need to get access to high-speed cable pipes. Time Warner's system includes 13 million homes. "Merging should be nirvana for AOL since it instantly solves the broadband access issue," says Hatch. But it may also change the shape of the cable business. "It's a whole, crowded, convoluted space," says Jordan Rohan, an analyst with Wit Capital, who recommends several cable companies. "That's why you have to buy in. If you're not in it, you're left out."
AOL also gets access to Time Warner's rich music and video libraries, which it can distribute via broadband. With high access speeds and rich content allowing it to charge a premium price, AOL also won't have to worry as much about competition from free Internet access providers. Some analysts believe this will even let AOL offer a free version of its service, setting back free ISP companies such as NetZero and the soon-to-be public Alta Vista, and then charge a premium for a high-speed version of AOL's service.
Consolidation:
"I think we will continue to see major consolidation in the sector," says Ryan Jacob, manager of the Jacob Internet Fund. "Yahoo! and Microsoft are watching very closely and may step up their consolidation activity to keep up with the new juggernaut." The new model from the AOL-Time Warner deal is for new media to acquire old media. This has fueled some speculation that Yahoo! could acquire Disney, for example.
Peter S. Cohan, a management consultant and angel investor, thinks the deal could spur Internet companies to buy their more traditional counterparts, in a bunch of industries such as retailing or the brokerage business. Jacob also expects lots of smaller Internet and media companies to merge.
Content:
While AOL needed Time Warner for its cable properties, it also wanted its content -- magazines, music, movies, and news. Steve Harmon, CEO of Internet investment firm e-harmon.com, points out that the deal shows how undervalued content has become. In fact, the deal "may lead to a renaissance of content on the Web," says IDC's Parr. This could lead to a new valuation of some content companies that have hit hard times, such as TheStreet.com, CBSMarketwatch.com, or iVillage.
Customers:
AOL has already shown that it knows how to give consumers what they want on the Internet. It commands an estimated 60% of the online audience. To that audience it can now add Time Warner's 13 million cable-TV subscribers and millions more magazine subscribers. "One thing forgotten is the tremendous distribution and household reach Time Warner brings to the table," says Hatch. Those new consumers will be combined with AOL's 20 million paid subscribers -- and the company will cross-sell them all. "Once you have the customer, you have the ability to sell up," says Rohan.
While good for the new AOL Time Warner, such a powerhouse of consumer brands could be bad for other consumer-oriented companies, says Robert Burgoyne, technology strategist at Monument Funds. For instance, it could be a setback for consumer-oriented Web companies such as Amazon.com and Yahoo!, since AOL will be so dominant. "It puts that much more pressure on anyone else who is trying to address a large consumer audience," he says.
Communication Services:
Down the road, consumers can expect to be offered an array of bundled communication services. From one company they'll get cable, Internet, phone service, possibly on a whole new generation of interactive devices in the home, plus portable wireless devices. "TV over the Internet is the real thrust of this deal," says James Waggoner, an analyst at Sands Brothers.
Investors should keep in mind that the agreement isn't expected to close for 12 months, and it will get plenty of scrutiny from regulators. They aren't expected to block it, but they could impose conditions that would alter the deal's investment implications. "It would be kind of premature to change my rating" (now "accumulate" for both stocks), says Standard & Poor's analyst Mark Cavallone. "I want to make sure it is going to go through and then take a second look." That sounds like good advice for investors as well until some of the dust settles.
Stone is an associate editor at Business Week Online Mica Schneider and Margaret Popper contributed to this report See also: Can AOL Avoid the Wor
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