Time Warner Merger Still a Work in Progress : Media: The company is making headway on some fronts. But questions remain about ‘synergies’ and $10.8 billion in takeover-related debt.

It’s been a year this week since Steven J. Ross presided over the formal close of history’s biggest media company merger, but he gets questions about at least one aspect of it every time he asks for a menu.

“I’d love to go to a dinner where somebody doesn’t ask me what we’re going to do about the debt,” says Ross, who is chairman and co-chief executive of Time Warner Inc. “Even the waiters ask.”

The cross-examination continues because the issues, like the $10.8 billion in takeover-related debt, don’t disappear so easily.

The union of Time Inc. and Warner Communications Inc. stirred a caldron of questions about how the companies’ corporates cultures would mix, how the debt would be handled, whether a merger with an entertainment firm would compromise Time’s magazine journalism.

The world wanted to know what advantages justified the conglomeration--particularly when Time Inc. angered many investors by rejecting a $200-a-share takeover offer from Paramount Communications.

Now, as it enters it second year, Time Warner has answers to some of these questions, though it still struggles with others:

* The new company is making headway in melding the cultures of Time Inc. and Warner Communications and working out the “co-chief executive” role that Ross shares with former Time Inc. President Nicholas J. Nicholas Jr. Many observers say this is partly because Ross and his team are dominant, though Time Warner officials deny this.

* Time Warner has begun to exploit the special business advantages-- synergies-- of the deal, which were promoted in 1989 as a key reason for the merger. But while the ideas are numerous, the payoff seems so far to be modest, and top officials acknowledge that a sort of high-level synergy czar may be needed to advance the program.

* The company has made headway in persuading its 1,400 journalists--the company’s most skeptical internal constituency--that the deal won’t erode the impartiality of their coverage. But many reporters and editors remain worried about subtle pressures and credibility problems that can arise when they write stories related to Time Warner’s holdings.

* Time Warner has a long way to go to rid Wall Street of its fears about the debt, which has helped knock the company’s stock from $140 before the merger to $87.25 Friday. The company insists that it’s not a problem, and even the skeptics on Wall Street acknowledge the strength of Time Warner assets.

Ross and Nicholas have long since declared the merger an unqualified success. But Ross acknowledges that because of the takeover battle and a series of distractions, the company has fallen behind schedule in some areas, such as in forging corporate partnerships in Asia and Europe that will extend its global reach and cut its debt.

“We are today one company,” Ross says. “Have we accomplished everything we had wanted? No, not yet.”

The merger that was announced March 6, 1989, was history-making by any yardstick. To the combination, Time contributed a magazine group that included Time, Sports Illustrated, Fortune, Money and People; the Home Box Office and Cinemax pay-cable TV networks; the 82%-owned American Television & Communications cable TV systems, and book publishing units.

Warner’s assets included the huge Warner Music Group, Warner Bros. studio, Lorimar Television, Warner Books and Warner Cable Communications.

The combination created a company of $11.3 billion in annual revenue that bestrode the media world as No. 1 in the revenues of its magazines, records, pay-TV networks and TV programming, and No. 2 in cable systems. The Warner Bros. movie studio was first in box-office gross in 1989, though it slipped to third place last year.

The drama of the merger was only heightened when Time and Warner fought off a $12.2-billion hostile takeover bid from Paramount Communications. But to do this, they had to scrap their stock-swap merger and instead launch a deal in which Time bought Warner shares and greatly raised its debt.

The executives said the merger was needed so the company could compete with an emergent class of international media and entertainment companies, such as Australia’s News Corp., Germany’s Bertelsmann AG and France’s Hachette SA. The fusing would enable the company to exploit new communications technology and the opening of world markets to pump out a broadening river of U.S. media “software”--movies, TV shows, videocassettes, CDs and tapes, books and magazines.

The vision was inspiring, but from the start observers questioned how well Ross’ team would share power with the old Time management.

Under the governance agreement crafted in two years of negotiations, Ross and Nicholas are co-chief executives until 1995, when Ross retains only the title of chairman. The old Time businesses report first to Nicholas, and the Warner businesses to Ross.

But many have wondered how easy sharing power would be for Ross, who over a quarter century personally cobbled together Warner from a grab-bag of disparate properties and never succeeded in selecting a successor.

The physical and temperamental differences between the two men are marked. Ross is tall and imposing, garrulous, a regular companion of Hollywood stars. He abominates regular meetings, loves a free-wheeling style of deal-making.

Nicholas is short and trim, cautious in his decision-making and remote, say people who know him. A former Time chief financial officer, he is consumed with the inner workings of the business.

In interviews, the co-CEOs go to lengths to praise each other and describe themselves as full partners. “I don’t even know how I operated Warner without Nick,” says Ross.

Nicholas spends much of his time discussing the operations and budgets with managers of the former Time Inc. businesses. He’s consulted on major decisions concerning the old Warner units and is involved in the company’s all-important search for partners in Europe and Asia.

But, to many observers, Ross has the more important role, particularly in the efforts to add distribution reach and products for foreign markets.

In a report last fall, Wall Street analyst David J. Londoner of Wertheim & Co. declared flatly that Ross has “clearly emerged as the dominant personality in the combined business.” It also seemed clear, he wrote, “that the Warner executives have emerged as the more influential faction at the top.”

Ross has been the guiding intelligence in the partnership search, putting in about 80% of the work to Nicholas’ 20%, by one informed estimate. He has also played the more critical role in a number of key negotiations--most related to the old Warner businesses--that have added products and distribution.

Among them was a deal with MGM/UA Communications for long-term home video distribution rights to MGM/UA products, a lucrative agreement involving producers Peter Guber and Jon Peters and an exchange of assets with Columbia Pictures, and a deal to buy a 20% stake in the Six Flags theme parks.

One observer close to the company argues that a sign of Ross’ dominance is that Warner managers have also moved into many of the key jobs at the corporate level. Warner’s Bert W. Wasserman is now chief financial officer, for example. Warner’s Martin D. Payson was initially chief legal officer of Time Warner, and when he stepped down last fall the post was taken by Peter Haje, a lawyer from Warner’s longtime law firm of Paul, Weiss, Rifkind, Wharton & Garrison.

Enormous influence at the company also resides in two outsiders who have long been close to Ross: Paul Weiss lawyer Arthur L. Liman, who is one of Ross’ closest friends, and Oded Aboodi, an investment banker who was crucial to the merger and has been at the center of a series of major deals since.

Nicholas, however, maintains that the posts went to Wasserman and Payson because they were more senior than their Time Inc. counterparts. He says Haje received his job when a second candidate, from Time’s longtime law firm of Cravath, Swaine & Moore, said he didn’t want the chief legal officer post.

If Ross has had the dominant role, some company executives maintain that that doesn’t mean it will continue to be so. They say Nicholas is now a sort of “junior CEO” and that his role will grow.

The harmony that seems to prevail between Ross and Nicholas doesn’t mean that their views are always the same.

The company’s efforts to forge deals with MGM/UA stirred dissension within Time Warner when it was disclosed that MGM chief Giancarlo Parretti had been convicted of fraud in Italy. After the disclosure, board member Henry Luce III, son of Time Inc.’s co-founder, tried unsuccessfully to have the board of directors take a second vote on a deal--which later fell through--to have Time Warner guarantee a $650-million loan to MGM/UA.

Nicholas voted in favor of the transactions with Parretti and says, when pressed, that he was “totally” in favor of the final deal. But a knowledgeable insider says that, like J. Richard Munro, who stepped down in May as chairman and chief executive, Nicholas has “distanced himself” from the deal.

In interviews, Ross and Nicholas seem to have differing impressions of how much Ross’ role will be reduced in 1995.

Ross say he’s “not so sure there’ll be a dramatic change.” He says he looks forward to giving up more day-to-day administrative responsibilities, so he can “do what I like to do, which is dream about tomorrow, then go do it.”

Nicholas appears to expect more of a change. In his recounting, Ross has “said, ‘I want to be an active co-CEO for five years, and then, believe it or not, I don’t want to work this hard.’ ”

As the two men’s relationship has evolved, so has the prevailing culture of Time Warner. It’s becoming more like Warner’s.

The magazine company founded by Henry Luce was in general an organization run by rules and committee decisions and that followed the advertising rate card as a sacred writ.

To Time Inc. executives, decision-making at Warner seemed like what goes on at a Moroccan souk--every price was negotiable, and at the free-for-all executive meetings the loudest voice prevailed. Ross treated managers to some extent like the Hollywood stars who are friends, giving them wide latitude, paying them well and abiding their occasional mistakes.

These days, Time Warner divisions are becoming more autonomous, as Warner’s always were, in keeping with the thinking of both CEOs. In the magazine division, for example, managers down to the level of magazine art directors now are free to decide how to spend their budgeted funds.

One sore point for some Time Inc. managers in the early stages of the merger was the higher salaries and perks given their Warner counterparts. Managers on the Time side have now been told that their compensation scale will be gradually nudged upward.

Some former Time Inc. executives who held Time stock and options are also unhappy with the disappointing performance of the shares, which Time’s investment bankers predicted during the takeover battle would be trading by now between $133 and $213. As they watched their new colleagues from the Warner side sell Warner shares, some bought more Time Warner stock in hopes of rapid appreciation.

“People in this business saw all their friends bought out, make a lot of money, and the Time people here are still waiting for the fairy godmother to come,” said Michael J. Fuchs, HBO’s chairman and chief executive. Fuchs says the drop “has colored my thinking a little bit” on the merger, but he blames it on external economic factors rather than the company.

The merger decision created initial unhappiness in many corners of the company, but perhaps the greatest unease was among some of the company’s journalists, who worried that it represented an ascendancy of entertainment values that would compromise their coverage.

They were chilled when some Wall Street analysts began talking about how the magazines might be used to promote Time Warner’s entertainment products.

To non-journalists, such concerns sometimes seem overblown and perhaps a bit self-dramatizing. But at Time Inc., the separation of the “church” of journalism and the “state” of the company’s business interests was from the Luce era the most celebrated aspect of its corporate culture.

The journalists were suffering from a feeling of diminished importance anyway, because the division that was the entire business in the founder’s time has shrunk to 17% of sales, largely through expansion. The reduction, however, has also come through wrenching staff cuts and belt-tightening since 1986.

In the view of Editor-in-Chief Jason McManus, the past year has demonstrated to the journalists that there has been no change in the sanctity of the church-state separation. The year has been a period of “settling down about some anxieties . . . as opposed to realities,” McManus says.

The division’s top executives insist, and some journalists concur, that, if anything, the movie and TV reviewers have gone out of their way to demonstrate their independence. It began with Time magazine’s June, 1989, panning of “Batman”--which Warner Bros. Chairman Robert Daly says “sort of blew us away.”

Jim Calio, West Coast bureau chief for Life magazine, says he doesn’t think “anybody thinks twice” in reviewing a Time Warner product. “If anything, we’ve been a bit harder on them.”

Magazine division officials believe that they have taken lumps they haven’t deserved. One came last June, they say, when Newsweek lambasted Time magazine for putting writer Scott Turow on the cover. Newsweek noted that Time didn’t point out that Warner Books had paperback rights to Turow’s 1988 “Presumed Innocent” and last year’s “Burden of Proof” and that Warner Bros. had filmed “Presumed Innocent.”

In fact, the story idea was pitched by a publicist for Turow’s hardcover publisher, Farrar, Straus & Giroux. The Time editor and writer principally responsible for the cover were unaware of the corporate ties, although a decision to put the story on the cover clearly was also approved by senior editors.

Nonetheless, some reporters and editors say they believe that the deal has created a credibility problem. Highers-up are sometime suspected of toning down or changing stories to avoid offending others in the company, a standard conspiracy theory in newsrooms everywhere.

When Time Warner’s 11-month-old Entertainment Weekly magazine was assembling a list of “101 Most Influential People in Entertainment” for a cover story last November, McManus and other top editors told the magazine staff to add two Time Warner executives to the list--Robert J. Morgado, the music group’s senior executive, and HBO’s Fuchs, say people close to the magazine.

McManus says top editors added only one--Morgado--and argues that he deserved inclusion as head of the largest company in his industry.

In McManus’ view, the incident in fact demonstrated how scrupulous the magazine division has been. Ross, who appears as No. 4 on the power roster (after Disney Chairman Michael D. Eisner, Creative Artists Agency Chairman Michael Ovitz and Fox Inc. Chairman Barry Diller), was the only person in the top 10 who declined to be interviewed for the story. When Entertainment Weekly editors asked McManus to try to solicit Ross’ cooperation, McManus declined, saying the company code requires that Time Warner journalists get no special treatment.

“How’s that for reverse synergy?” he says.

Some argue, however, that the conflicts will arise not in overt attempts to promote Time Warner interests--which would yield damaging publicity--but in subtler ways. Editors might avoid stories that have a bearing on Time Warner interests, if only because they entail more soul-searching and effort.

Jeff Jarvis, who was founding editor of Entertainment Weekly but resigned in a dispute over the magazine’s direction, says during his tenure that he felt pressure from above to “be nice” to Hollywood.

He said McManus and corporate editor Richard Stolley were unhappy that the new weekly trashed Disney’s popular “Pretty Woman.” They also objected, he said, to his running capsule movie reviews that the reviewers rated “F,” arguing that it did no service to readers to dwell on Hollywood failures.

McManus acknowledges that the senior editors were “astounded” at the panning of “Pretty Woman” but contends that they didn’t try to change the review. He says he didn’t try to produce more favorable coverage of Hollywood but tried to refocus for a mass audience a magazine that was “too arcane and inside.”

Some critics maintain that, with the best intentions, Time Warner’s journalists will now inevitably have a harder time persuading readers that they have no secret agenda. Readers will be suspicious, some say, when Fortune runs a cover story like the one in the Dec. 31 issue, which detailed the world’s growing appetite for American pop cultural products--such as Time Warner’s.

And some assert that, whatever the editors’ intentions, articles such as Time’s Turow cover will inevitably raise questions of conflict of interest. Katharine Graham, chairman of the Washington Post Co., which owns Newsweek, made this argument in a recent speech, saying “when it comes to news, synergy can have a down side.”

Even as they vowed in 1989 that the merger wouldn’t compromise news coverage, Time Warner executives were promising that the deal would produce a host of cross-media ventures.

Today, Ross has a list of about 50 such synergy initiatives that are under way or planned. Company officials note that the merger is still new and that more projects will follow.

But of those discussed, many seem to be in the early stages of development, and some could have been accomplished if the companies had remained separate, some analysts say. Among those in the works:

* A unit called Time Warner Entertainment Direct Enterprises is looking for ways to applying Time Inc.’s direct marketing expertise to sales of CDs and tapes.

* Warner Bros. executives are considering development of a TV show based on People magazine.

* Warner Bros. has used magazine division subscription lists to test the direct marketing of two movies, “Witches” and “Memphis Belle.”

The most important cross-media project is a $40-million-plus “Rediscover America” advertising deal that Time Warner struck last month with Chrysler. The deal will give the auto maker use of the company’s magazines, books, movies and direct-marketing know-how. Chrysler will be sole sponsor of special issues of Fortune, People and Life and will use Warner Bros. records and Time Life videos for special promotions.

HBO’s Fuchs says he believes that synergy represents “the real vigorish” on the merger. But he allows that in a report card for the first year “I guess we wouldn’t get flying marks.”

Such projects have usually foundered because line managers are more concerned about their division’s bottom line than projects that may help the larger corporation but complicate their lives. Fuchs believes, and Ross agrees, that the company may need to appoint a senior official to promote such projects.

It’s also hard to identify the profits from such efforts. “There’s no magical number,” says Geoffrey W. Holmes, senior vice president. But Holmes argues that if synergy efforts add just 1% to sales, they are highly profitable. At such an increment in sales, overhead expenses have been covered and profit margins are often 25% to 30%.

In any case, Wall Street’s key worry is not profits from such efforts, but Time Warner’s debt.

From the beginning, it was clear that accounting for Time’s purchase of Warner would require non-cash charges that would plunge the company into losses until 1992 or 1993. But investors became more nervous at the end of 1989, when a weakening economy and crumbling junk bond market made Wall Street skittish about the cash-rich, debt-heavy media concerns they once loved.

The worriers point out that Time Warner has $2.8 billion in bank debt due for payment in March, 1993. They say that with cash flow that’s now $2.3 billion a year, Time Warner may fall far short of having enough cash flow to meet the payment from earnings.

Analysts note that the value of some of the most salable assets have tumbled--cable systems, for instance, are selling for about $1,500 a subscriber, down from a peak of more than $2,800.

Also, it may be tricky to forge the partnerships that may be another source of cash, some analysts say. The plan is to sell minority stakes in businesses such as motion pictures or records to Asian or European companies that can provide distribution or products in their countries.

But some analysts believe that it may be hard to find good partners who will be willing to buy a non-controlling stake and form a somewhat ambiguous relationship that is intended to last for decades.

Some outsiders worry too that the co-CEOs have given the divisions no debt-cutting plan, instructing them instead to keep investing for future growth. The magazine division alone spent about $300 million in 1990, including the $215-million acquisition of Sunset magazine’s parent and what analysts say is the $50-million-plus first-year costs of Entertainment Weekly.

“My biggest gripe is that they don’t seem to be doing anything about (the debt),” says Henry Goodrich, a former board member who says he has written the company to urge a reduction in its debt.

Time Warner says the debt isn’t a threat. Company officials have told analysts that with cash flow growing at more than 8% a year, Time Warner is healthy enough that in a pinch it could persuade its banks to further postpone the repayment.

Ross and Nicholas say they’re surprised that the corporate debt is even an issue and assert that raising cash is only a secondary aim of the partnership talks.

Analysts expect Time Warner to report losses of more than $200 million for 1990 but say operating income should grow about 7%, despite the slower growth at HBO and Entertainment Weekly’s costs.

“We can make the cost of servicing the debt now, and we will more than meet it in 1993,” promises Nicholas.

TIME WARNER AT A GLANCE Time Warner is the world’s largest media-entertainment company, with 31,000 employees and an estimated $11.5 billion in 1990 sales. The company has 57.4 million shares oustanding and $10.8 billion in debt. The segments are: * Magazines: Including Time, Sports Illustrated, Life, People, Entertainment Weekly, Fortune, Money, Southern Living, Sunset (17% of 1989 revenues) * Filmed Entertainment: Warner Bros., Lorimar (26% of 1989 revenues) * Music Group: Warner Bros. Records, Atlantic, Elektra, WEA International (24% of 1989 revenues) * Cable: American Television & Communications (82% owned), Warner Cable Communications (14% of 1989 revenues) * Programming: Home Box Office, Cinemax pay TV networks (11% of 1989 revenues) * Books: Time Life Books, Book of the Month Club, Little, Brown & Co., Warner Books (11% of 1989 revenues) Financial data Pro-forma operating earnings*, January-September, 1990, versus 1989

1990 1989 Percent Business Segment (millions) (millions) change Magazines $177 $210 -16% Filmed Entertainment Group $307 $232 +32% Music $383 $359 +7% Cable $565 $464 +22% Programming-HBO $136 $129 +5% Books** $50 $46 +9%

* Earnings before interest, taxes, depreciation and amortization ** Excludes the contribution of Scott, Foresman, a textbook publisher which was sold in December, 1989.