Executive Summary
The merger of AOL and Time Warner has been judged to be a merger between two
companies in fear. AOL feared that its business model needed continual adaptation to a
changing internet and wanted to ensure broadband access. AOL needed to continue its
growth by acquisition strategy in order to justify its high market capitalization. Time
Warner feared that its outdated network of traditional media outlets (television
broadcasting, publishing, movies, magazines, and newspapers) needed a facelift. Time
Warner believed that for it to remain competitive it needed an immediate injection into the
internet.
But mergers out of fear are rarely successful. The valuation that analysts predicted (above
$90 per share) never persisted as the two companies have not been able to fully integrate.
AOL and Time Warner have not been able to formulate a strategy which can help the
combined company move forward, the managers have failed to win the support of all
divisions, and the dynamics and technologies of the internet have changed and have left
AOL behind.
Time Warner
History
The history of Time Warner traces back to Warner Brothers. According to the popular
legend, four brothers convinced their father to sell his golden wristwatch and to buy one of
the first cinematographs (Edison-cinetoscope). With this cinematograph, the four brothers
went from town to town showing films to the rural population. Later, they produced their
own films. Warner Brothers has been formally registered in 1923 in Hollywood. In 1925,
Warner brothers went public and in 1930 they launched their popular cartoon series. The
Looney Tunes, such as Bugs Bunny and Daffy Duck were central figures and shaped the
companys image in the public. Warner Brothers made a number of well-known classic
films, such as Casablanca and a number of Hitchcock thrillers. Warner Brothers also began
to acquire many record labels.
In 1989, Warner Brothers merged with the publishing house Time to Time Warner. Time
acquired Warner for about US$14 Billion and transformed it into a multi-media company
consisting of record labels, motion picture as well as television production and distribution,
studio facilities and film libraries, television networks, book and magazine publishing. In
order to increase its product portfolio Time Warner acquired Turner Broadcasting System in
1996 and hence became the second largest cable television network. Its printing arm could
secure more than 20% of all expenses for print advertisement in 2000 in the US, which
makes it the dominant player. The history of the company shows that Time, Warner, and
Turner Broadcasting grew through acquisition strategies (Exhibit 1: Time Warner History).
modems. Originally, customers who subscribed to AOL were limited to AOL content and email (as was typical of online service providers at the time). AOL was the first on-line
service requiring the use of proprietary software, instead of a terminal standard program,
resulting a graphical user interface well ahead of the competition (AOL was considered the
online service for people unfamiliar with computers, in contrast to its main competitor
CompuServe, who was oriented to the technical community). As the Internet grew in
popularity, AOL also provided Internet access to the World Wide Web in addition to its
proprietary content. In 1991 it changed it name to America Online Inc. The simple intuitive
interface and an aggressive marketing led the company to extremely rapid growth in the
late 1990s, fueled by a large number of acquisitions and geographical expansion. AOL
aggressively pursued an acquisition strategy to increase its online presence and desire to
provide members with original, interactive, and needed content (Exhibit 2).
Market Situation Prior Merger
At the time of the merger, AOL had 27 million subscribers, amounting to about 40% of
total US online subscribers. AOL grew in just eight years from a small Internet start-up,
competing with the likes of Prodigy and the commented CompuServe (which was acquired
in 1998), into a media conglomerate. On the way, the drivers of its profitability and growth
have shifted from subscriptions and usage time to advertising and e-commerce deals.
Despite the change in its strategy, one of AOL's features has been its pursuit to make ensure
that investors understand its business model. Since 1996, when it began its transformation
from computer-networking company to media giant, AOL made changes in its strategic
direction to the investment community, even when doing so might have seemed perverse or
damaging. The market registered with strong approval. AOL's stock price increased 1,468%
from October 1996 to January 2001, compared with a 100% increase in the S&P 500,
which AOL joined in December 1998.
Reasons for Merger
The reason for the merger was allow each of the companies to get a piece of the Internet
future which each of the companies could not provide for individually. For AOL, the
merger was about technology: America Online was the dominant leader in what might be
termed the sort of first stage of Internet usage, that is, people was going on-line for e-mail
and Web surfing. But AOL did not have a strategy for the next generation of internet users
who would require broadband access (where access to the Internet would be much faster
and would allow users the ability to complete much more complicated tasks like media
downloading, telephony, gaming, virtual offices, etc):
On the surface, what happened Monday is simple: AOL, the leading provider of dialup
Internet service, needed a strategy for moving its customers forward into the muchballyhooed world of high-speed "broadband" access, controlled by telephone companies
and cable TV operators (such as Time Warner). Time Warner, the ungainly media
conglomerate, needed a credible way to salvage its Internet strategy after a decade of
failure in the digital realm -- from the colossal flop of its "Full Service Network" interactive
television experiment to the spectacular flameout of its misconceived Pathfinder Web
portal.
Put the two companies together and you get something like Monday morning's press
conference announcing the deal: A torrent of references to "synergy," "one plus one equals
three," "the media value chain," "the convergence of media, entertainment and
communications," and "new benefits to consumers." You also get an avalanche of hype:
One analyst declared, "It is probably the most significant development in the Internet
business world to date."1
For AOLs Board of Directors, the portfolio of brands created with the merger of the two
companies would cover the full spectrum of media entertainment and information, and this
would led the company increase the revenues at the three major areas that had AOL:
subscriptions, advertising and e-commerce and content. They believed that Time Warners
cable systems would expand the broadband delivery systems for AOL computer services
technology and, over all, they assured that the new business would be benefited from huge
operating synergies (cross-promotion, more efficiency in marketing, cost reductions in
launching and operating new technologies) as well as major new business opportunities.
AOLs subscriber base and advertising revenues were growing exponentially until the crash
of 2000 occurred. AOL suffered increasing demand from Wall Street to generate big
advertising deals to meet rising expectations. When this failed, AOL resorted to
unconventional methods to boost its financial numbers (utilizing legal action for an ad deal,
booking E-Bay ad revenues as their own). AOL stock was severely overvalued and this
merger was the only way to prevent a collapse in valuation. AOL, as the new corporate
giant created by the Internet boom, was using its sky-high value of its stock to acquire an
older Fortune 500 company. AOL's high market capitalization relative to that of Time
Warner made the acquisition possible.
Proposed Synergies
When AOL and Time Warner announced their merger in 2000 they had a clear vision of
their synergies. AOL believed that the combined companies had the means to be uniquely
positioned in order to bring interactive media into customers everyday lives and to further
penetrate this market.
The merger will combine Time Warner's vast array of world-class media, entertainment and
news brands and its technologically advanced broadband delivery systems with America
Online's extensive Internet franchises, technology and infrastructure, including the world's
premier consumer online brands, the largest community in cyberspace, and unmatched ecommerce capabilities. AOL Time Warner's unparalleled resources of creative and
journalistic talent, technology assets and expertise, and management experience will enable
the new company to dramatically enhance consumers' access to the broadest selection of
high-quality content and interactive services.
By merging the world's leading Internet and media companies, AOL Time Warner will be
uniquely positioned to speed the development of the interactive medium and the growth of
all its businesses. The new company will provide an important new broadband distribution
platform for America Online's interactive services and drive subscriber growth through
cross-marketing with Time Warner's pre-eminent brands.2
AOL at that time was believed to have the necessary experience to help Time Warner
transform their divisions to the digital channels. Additionally Time Warner was believed to
help AOL build next generation broadband. Together with Time Warner, AOL believed they
could build a set of brands customers trusted in. Additionally, AOL Time Warner thought of
building up facilities beyond just personal computers but also involving wireless devices,
television, phones or PDAs. With the help of Time Warner AOL thought it could deliver
any kind of content at any time to any place (AOL Anywhere). As most likely synergies of
the merger the board of AOL regarded cost reductions and opportunities of growth.
Revenue opportunities were seen in areas such as advertising, growth opportunities were
seen in increased numbers of cross-promotion and marketing for Time Warners content
through the channels of AOL. Efficiency increases were seen in marketing across different
platform and distribution systems, cost synergies were likely to arise due to shared business
functions (i.e. R&D and cost efficiencies because of launching interactive extensions of
Time Warner Brands).
Time Warner, in general, believed that through the integration of traditional and new media
and communication and business technology the new company would be uniquely
positioned in order to have a strong basis and take full advantage of the digital revolution.
From Time Warners view this strategic advantage emerged from multiple brands, vast
array of content, extensive infrastructure and strong distribution capabilities and that
therefore the value of AOL Time Warner combined will be higher than the value of the
single companies. Time Warner regarded AOLs extensive Internet infrastructure as a new
distribution medium for its brands and content. Also Time Warner believed its broadband
system was an ideal distribution platform for AOLs interactive services. Furthermore,
AOLs e-commerce system was regarded to be an opportunity to promote Time Warners
music labels. Linking Time Warners established brands with AOLs interactive services
promised opportunities for subscriber growth. Finally, the Time Warner board thought that
through the merger the international position of the brand would be strengthened as well as
the benefit for consumers increased.3
Proposed Valuation
The hype surrounding the AOL and Time Warner merger was fueled by and in turn helped
to refuel the growing internet bubble. Wall Street analysts, internet gurus, and media
moguls all hoped that this newly formed company would successfully integrate traditional
forms of media with the new. A valuation of these two companies was complicated and
unprecedented. This was the largest corporate merger to date and no one knew for certain
what types of synergies and growth rates would be possible for the two companies.
Under the assumptions of a 25% supernormal growth rate and a 5% terminal period growth
rate the valuation of the company was over $93 per share (Exhibits 7, 8, and 17). While
these growth rates were reasonable in the context of the environment of the late 1990s their
sustainability was never questioned. Many questions remained unanswered. Could AOL
continue to grow subscriptions and advertising revenues? Could AOL take advantage of
Time Warners extensive cable network (if so what would this cost and how long before it
materialized)? Could two large behemoths merge together? Was it AOL saving Time
Warner or vice versa? The sensitivity tables attempts to answer some of these questions
with technical analysis and try to judge their impact upon the share price of the newly
formed firm (Exhibits 7-17). It is clear that the growth assumed in 2000 never occurred. A
more realistic supernormal growth rate for the two companies would have judged their
synergies to deliver 5-7% growth for the short term.
Reasons for Failure
Viewing back upon the merger several reasons can be found why the merger did not work
out as the former managements had hoped it would. One of the main reasons is that AOL
basically never was an equal counterpart to Time Warner. At the time of the merger AOLs
stocks were overvalued mainly due to the Internet bubble4. During the 1990 many
upcoming Internet start-ups, the so-called dotcoms, were tremendously overvalued and to
some extent without ever having made profit worth as much as established blue-chip
companies because investors believed in their potential. Indeed only a few companies
survived the new economy-era and are now established companies (e.g. Amazon or
EBay). Since, however, AOL according to its stock price was worth as much as Time
Warner at the time of the merger they got the same voting rights and power. There still
exists much controversy around Cases profit taking from the sale of his shares (Exhibit 4):
The fact that Case sold a major part of his AOL stock soon after the merger was announced
in January 2000 (when the price of the stock was high) and made an estimated profit of $
160 million evoked suspicion and anger among shareholders. They thought that Case was
aware of the fate of the merger and accused him of making money, when the time was right,
at the expense of the shareholders.5
Yet, today AOL is certainly less worth than Time Warner. So, from todays perspective AOL
received a too high price for its share or Time Warner paid too much for what it received in
return. The stock price of AOL Time Warner fell from its peak of almost 90 US$ in 2001
down to almost 10 US$ in 2003 and right now is just at 13 US$. Also, since AOL turned out
to be an unequal partner AOL Time Warner changed its name back to just Time Warner in
the mean time and almost the whole AOL board has been replaced while still many of Time
Warners directors are in charge6.
Another reason why the merger failed is that in the time after the merger AOL and Time
Warner failed to implement their visions and communicate them e.g. marketing Time
Warner content through all channels possible. Additionally, they even lacked the ability to
recognize new trends in the digital industry. One trend apart from broadband Internet was
Internet telephony or Voice over IP (VoIP). AOL Time Warner as the main player in the
digital revolution as they defined themselves hardly took notice of this trend and they
failed to build a business model for that. Secondly, they were not able to promote their idea
of a combined music-platform. Again, it was another company to gain the first mover
advantage in this area (Apple with their introduction of the iTunes Music Store). And
thirdly, one of the main trends AOL Time Warner missed in the recent years was the
importance of highly personalized web services. Examples are MySpace.com, a platform
for everyone to express oneself, which was bought by Rupert Murdochs News Corp. last
year for about $580 million7 or Snapfish, a service that allows everyone to store pictures
online and make them publicly available. AOL Time Warner in contrast believed that
delivering serious news and facts was more promising than highly personalized content.8
A new thread came up for AOL in the recent years. AOL used to be the most important
Internet Service Provider in many countries. However, they failed to offer broadband access
as soon as possible. So it was the local phone companies to have the first mover
advantage9. As a consequence of this not only lost AOL subscribers to their Internet service
but also their portal lost importance leading to a loss in opportunity to promote AOL Time
Warner content10. As a further consequence income from advertising is decreasing.11
Furthermore, the CEOs at the time of the merger, Mr. Case and Mr. Levin, still today regard
themselves as being the wrong persons for having done the job at that time. In an interview
Case states that not only him but also the whole board of directors in each of the companies
really believed in the success of his idea; yet he admits that he was the one to blame for the
failure since it was his idea. Indeed at that time AOL needed Time Warners broadband and
cable business as a strong partner for further growth12. In contrast, it is to question whether
Time Warner really needed AOL or whether a strategic partnership wouldnt have been the
better choice13. One major mistake seems to have been in the assumptions about the
merger itself. Time Warner was thinking it was they to mainly benefit from the merger
since they could access AOLs media channels and promote their content through it. AOL in
contrast was the party that gained most through the merger because they were able to use
Time Warners broadband cable network and extend their broadband business.14
A final reason for the failure is the fact that AOL and Time Warner were not able to
encourage a climate within the companies to initiate the synergies that were proposed. As
Peter S. Fader, a Wharton marketing professor, says it is impossible to manufacture
synergies, oftentimes they are just nothing more than serendipities.15 A clear and concise
strategy never emerged from the two companies:
Wharton business and public policy professor Gerald Faulhaber has heard this spiel before.
AOL is an enormous asset, but it has a management problem, says Faulhaber. AOL has
the audience, but Time Warner has demonstrated that it doesn't know how to take advantage
of it. There are plenty of unanswered questions about AOL, Faulhaber adds. For example,
what does AOL have to become in the future? What can AOL create that's unique? How can
it garner profits from its instant messaging dominance? How will it convince its customers
to stick with AOL as broadband Internet access grows in popularity?16
Even though there was hope for a complete integration of the companies and the ability of
both companies to leverage the others strengths, this never materialized. The integration of
services which was editorialized by many cartoonists (Exhibit 3) never occurred.
to him to take over the entire company as it fell on bad times. AOL
was a loose culture in which its managers had a fly by the seat of
your pants management style. It was a relatively new company in a
rapidly growing high-tech industry that made long-term strategy planning
difficult at best. Time Warners culture was much more structured
and conservative. It did not respond well to being thrust together with
AOLs unconventional and brash executives. When AOLs performance
faltered, Time Warner management rebelled and refused to accept
a subordinate position to AOL, which they felt was pulling down
the whole company. The rebellion was also spurred on by the news
of accounting irregularities at AOL, which was accused of improperly
booking $190 million in revenue.
Over time Levin grated on Case and major shareholder Ted
Turner, and both wanted Levin ousted. 3 Levin was reported to have
failed to show sufficient respect for Case. When the combined company
suffered, Levin, its CEO, received much blame for the debacle.
Having alienated Case and Turner, whose wealth had suffered
greatly during Levins reign at the combined company, Levin found
himself on the chopping block.
LESSONS FROM THE AOL TIME WARNER DEAL
The strategy and how its proposed synergies were going to be
exploited needed to be clearly set forth. This deal had a strategy that
was vague at best and more accurately was confused and nonexistent.
Levin and his colleagues wanted to exploit the Internet distribution
channel of AOL but did not really know how they were going to do
it. What benefits would this strategy bring, and how valuable would
it be? This was a huge question that they never came close to answering.
How can Time Warners board say that they were satisfied with
the answers they got to this all-important question?
The overriding lesson we can take from this deal is that the strategy
should be clear. Synergistic gains are difficult enough to realize
when we think we see the path to their realization clearly. The future
is always uncertain, and it can place many unforeseen obstacles in the
pursuit of corporate success. When we cannot even see the path, how
do we know if one exists, or even where it leads? If management does
not clearly delineate the path to the synergistic gains to the directors,
then it needs to hoist a red flag and send managers back to the drawing
room.