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Lies, Damn Lies, Statistics and the AOL-Time Warner Merger


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August 01, 2006

Lies, Damn Lies, Statistics and the AOL-Time Warner Merger

Tim Mullaney

The always interesting Henry Blodget's recent posts on the AOL-Time Warner merger disaster are worth reading, if not for the reason you might think. The received media history of this deal is straightforward: The media thinks Time Warner vastly overpaid for AOL and should cut its losses. The truth is that AOL, which was the acquiring party, vastly overpaid for Time Warner. But I agree with Blodget -- and, if published reports are right, with former AOL CEO Steve Case -- that the merger should be unraveled.

On Aug. 2, however, Time Warner will unveil the latest AOL strategy that's expected to stop short of a breakup. Unfortunately, this all probably happens too late for AOL to once again become a truly first-tier independent Net company.

What? Everyone knows that's nuts. AOL wrecked Time Warner. It was in the New York Times! Lately this school of thought got an unusually pure, but typically uninformed, restatement on the wildly overrated Valleywag. But it was the other way around.

Argue with the charts. With apologies to Shakira, charts don't lie.

Here's how Time Warner looks compared to other Web leaders since the merger closed. Obviously, Time Warner is by far the worst of the bunch.

Here's how Time Warner looks compared to other cable companies. It's middle of the pack: Comcast has done better, but Cablevision, Charter and Adelphia (not shown here, because its stock has collapsed into pink-sheet territory) have done much worse. Cox, which has been acquired, also did better. AT&T was a major cable player in 2001, but now it's just a part of what used to be SBC Communications.

The lesson: By the time this deal was done, the real bubble was a cable bubble, much more than an Internet bubble. The price of cable assets fell apart and stayed down. The price of Net assets had mostly fallen apart before AOL-Time Warner closed, got worse for a while, and then rebuilt.

But the real ways Time Warner wrecked AOL are more subtle.

First, consider what has happened to the market for search-based advertising since 2000. It went from 1% of an $8 billion U.S. Web advertising market to 40% of a $12.5 billion Web ad market in 2005. This year, the U.S. search market will likely be about $7 billion. AOL mostly missed it. Why? Because it was too broke to buy Overture Services, the pay-per-click advertising pioneer that is the foundation of Yahoo's business model as we know it today. Overture became Terry Semel's signature deal instead. At AOL, as one exec recently told me, they're at the mercy of what revenue a partnership with Google brings in. A partnership managed by Google, and with Google controlling relationships with the advertisers. "In search, we'll always be renters," the exec says.

Why was that? Because Time Warner's geniuses borrowed something like $7 billion to buy out Bertelsmann's half-interest in AOL Europe -- in a deal announced right after the AOL-Time Warner merger was announced, in 2000, and consummated after the merger. And they paid cash, not stock! Doh! Back then, that kind of money might well have been enough to buy Google, let alone Overture. But who needs Google? Honey, the good news is we'll always have Paris. The bad news is, I mean AOL Paris, er, AOL Europe. In February 2000, then Time Warner CEO Gerald Levin said (according to a company press release) "AOL Time Warner will have the financial capability to be opportunistic in developing new businesses." Uh, wrong. And wrong because of Time Warner, which was the group that brought all the debt to the table, from the Europe buyout to the debt for building cable networks. Show of hands: Anyone think Steve Case, on his own, would have paid cash for AOL Europe? None of the other big Net mergers were cash deals.

Time Warner also, somehow, managed for years not to use the AOL brand to drive consumers to Time Warner's high-speed Internet access service, which stuck with the Roadrunner brand. Double doh! The easiest way to get AOL's narrowband customers to buy broadband, for more money, would almost certainly have been to let them do it without leaving the brand they trusted. After all, AOL only had about 26 million domestic Web-access customers at the peak. Can't imagine why Time Warner Cable would want them. Levin, in the same speech, said Time Warner would have "the flexibility to adapt to new trends." Wrong again.

As trends in the consumer Internet go -- or media in general, for that matter -- they just don't get much bigger than the rise of search advertising and broadband. Time Warner, not AOL, blew them both, with a combination of bad financial planning, bad strategy -- and, to judge from the outside, ego.

If after you think about all this you still think funky accounting on the Realtor.com ad deal or Bob Pittman's arrogance to Time Warner guys sank AOL, I really can't help you much. You're probably one of those people who believed that AOL had no value at all by 2002 or early 2003; The Wall Street Journal floated that idea. Google just paid $1 billion for 5% of AOL, neatly disposing of that thesis.

There has been almost five years of revisionist hooey about AOL. But the truth is pretty simple. The thing went into a bust -- driven by collapsing cable valuations from an unsustainable high, as well as a weakening Web ad market. But when the Web came back, AOL was in the hands of leaders -- Time Warner leaders -- too blind and too broke to exploit it. And so AOL is just likely to putter along in third place for as far as these old eyes can see.

Now, in my next post I'll dissect what you can expect from AOL's latest restructuring plan. The answer: Probably more than the press will initially think, in part because of a very smart and fairly unappreciated deal they made in 2004, which BW wrote up recently, but not enough to get excited about.

Why harp on the past this way? Because history matters. We have to get it right, lest we repeat it.

05:12 PM

M&A

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