Merger of Time Warner, Turner OKd

After a nine-month marathon review of antitrust concerns, federal regulators have negotiated an agreement to allow Time Warner Inc. and Turner Broadcasting System Corp. to merge and create the world’s largest entertainment conglomerate.

The $6.5-billion merger, which was announced in September and still requires shareholder approval, would combine a powerhouse in movies, television and cable distribution with the owner of some of the most popular cable channels. Together the companies possess some of the best known brands in the world, including HBO, Warner Bros., Time magazine and the Cable News Network.

The deal has been in limbo for months as the Federal Trade Commission evaluated whether the combined company would inhibit competition in the cable industry. Approval of the deal, with certain modifications, is a strong indication that government antitrust regulators will not stand in the way of a consolidation that is transforming the entertainment industry, driven by looser federal rules, emerging digital technologies and the growing appetite for movies and TV shows abroad.

“The government has woken up to the fact that telecommunications companies are operating in a much bigger pool and that they need a larger scale to compete” said Christopher Dixon, an analyst at PaineWebber Inc. “To make the massive investments in new products and services needed to be globally competitive, media companies need to be able to spread the costs over a broader base.”

While Time Warner is a huge producer of movies, records and TV shows, it lacks the basic cable channels that have served as growth engines at companies like Viacom and that can be used as leverage in building international strongholds. Time Warner owns the venerable Warner Bros. movie and television studio, the world’s largest record company, the WB TV network, Home Box Office, the second-largest U.S. cable system and a publishing arm that includes Time, People and Sports Illustrated.

Turner has arguably the strongest stable of cable channels, including CNN, Cartoon Network, TBS and TNT. But it lacks the breadth that analysts say is needed to remain in a business increasingly dominated by just a few giants. Ted Turner, the entrepreneurial chairman of Turner Broadcasting, said last year that Walt Disney Co.’s agreement to purchase ABC for $19 billion figured heavily into his decision to sell to Time Warner.

Telecommunications reform passed in Washington in February has accelerated the consolidation and convergence, allowing telephone companies to compete with each other and against cable operators like Time Warner in television. It also permits broadcasters to substantially expand their reach, prompting acquisitions like the one announced Wednesday of New World Communications Group by News Corp. to create the largest TV station group in the country.

No top executives of either Turner or Time Warner were available for comment Wednesday. Time Warner released a statement confirming the preliminary agreement, and sources at the firms said that with the final hurdles to the merger now cleared, the deal could close by September or early October.

Sources expect the FTC commissioners to approve the decree within a few weeks. The decree aims to prevent Time Warner from using its cable juggernaut to gain an unfair advantage in the market.

Among other things, the company has promised the FTC not to bundle cable channels like HBO and CNN to force higher prices or unwanted services on cable operators. The decree also attempts to put up a firewall between Time Warner and Tele-Communications Inc., which is the nation’s largest cable operator and would become one of the largest shareholders of Time Warner when it converts its Turner shares in the merger.

Wall Street was clearly relieved by the development, after months of uncertainty over whether the FTC would block the merger. Time Warner surged $3.375 to close at $36.625 a share. Turner B shares rose $2.75, to $26.75. The value of the deal based on Wednesday’s close is about $6.5 billion, roughly a billion less than when the merger was announced last fall and Time Warner was trading above $40.

Entertainment stocks were taking a beating even before the general market turned down in recent days, in large part because of the debt required by industry consolidation and the slow payoff.

Management experts, in fact, say the biggest challenge for Time Warner and its acquisitive rivals is in wringing cost-savings, “synergies” and new revenues from these high-priced purchases.

“Whether they can create value for their shareholders from this deal depends on aggressively cross-promoting, streamlining the overheads of the two companies, using the Warner libraries on Turner’s networks and creating new businesses.” said Michael Wolf, partner at Booz Allen Hamilton. “But as a company, Time Warner has lagged Viacom, MCA and Disney in their ability to integrate their businesses.”

Many investors are already discouraged by Chairman Gerald Levin’s progress in reducing debt, streamlining the financial structure and extracting returns from expensive investments in cable.

Despite FTC modifications, some consumer groups and cable programmers fear the concessions may not be sufficient to protect against rising cable rates and a limited choice of channels.

“It’s a good-faith effort to deal with some of our concerns, but there is nothing limiting the company from ratcheting up cable rates,” said Bradley Stillman, telecommunications policy director at Consumer Federation of America.

Stillman said cable rates have already increased by more than 10% nationwide since telecommunications reforms relaxed restrictions on cable rates. He said he worries the alignment of the economic interests of Time Warner and TCI could continue that trend.

Through his Liberty Media Corp. programming arm, John Malone, the powerful head of TCI, controls a 23% stake in Turner that would be converted to a 7.5% holding in Time Warner. Time Warner and TCI together control almost half of all cable households.

The biggest concern of the FTC was the influence the deal would give Malone, and the ability of the two companies to control what cable channels consumers see and how much they pay. Critics believe the companies will decline to carry cable services they don’t own.

Another red flag was 20-year contracts negotiated to win Malone’s support for the deal. The contracts give his systems discounted rates for Turner channels, and rival cable operators complained that the deals put them at a disadvantage.

Consumer groups had lobbied the FTC to make approval of the deal contingent on Malone’s sale of his shares in Time Warner or Time Warner’s sale of its cable holdings.

The FTC fell short of those requirements, apparently doubtful that they could make such demands stick if the case ended up in court. Under the consent decree negotiated with the FTC, Malone relinquishes the 20-year discounts, although sources said his size would still make it eligible for volume discounts.

While the original deal would have put his Time Warner stock in a voting trust controlled by Time Warner Chairman Levin, the consent decree requires that TCI take nonvoting stock, sources said.

Malone did not negotiate a board seat even under the original deal, although he would become one of the company’s top shareholders, along with Ted Turner, Capital Group Co. and Seagram & Co.

The decree allows him to increase his holdings to 9%, although sources say Malone is applying for a ruling from the Internal Revenue Service that would give him favorable tax treatment for putting the stock into a new company that could buy up to 14.9% of Time Warner. Sources involved in the negotiations said the new company would be spun off to Liberty shareholders and not controlled by Malone.

Although he cannot vote the stock, critics say Malone still has an economic incentive to help Time Warner perform and therefore could steer TCI to act in alignment with its cable rival. “Half a loaf is better than none,” said one executive about the FTC decision and its affect on cable programmers. “Any time you have 45% of the cable households under the same tent you have a problem.”

In a deal that would show its willingness to carry the programming of competitors, Time Warner may be close to an agreement to put a new Fox news channel on some of its cable systems.

Malone has been a wild card in the merger from the start. Because of his special Turner shares, he had the singular right to veto the merger between Turner and Time Warner and could have aborted the deal again by refusing to go along with FTC’s demands. But at five minutes before 11 p.m. in Washington on Tuesday, his lawyer, Joe Sims, of Jones Day Reavis & Pogue, signed the consent decree, along with Time Warner’s representative Robert Joffe, an antitrust lawyer at Cravath Swaine & Moore and William Baer, director of the FTC’s Bureau of Competition.

“Turner was blockaded in its growth by its ownership structure,” said a source close to the negotiations, pointing out that both Time Warner and TCI had veto power over even small acquisitions by Turner. “Malone knew the deal could unlock the value of Turner. This is a sign of good faith in Time Warner, whose stock he thinks is undervalued.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Murdoch Will Buy TV Group

Creating the largest TV station group in the United States, Rupert Murdoch’s News Corp. agreed to acquire New World Communications Group in a stock swap valued at $2.4 billion. The station group will be a powerful platform for launching programs. The deal links Fox Broadcasting with a group of stations reaching nearly 40% of all homes in the nation. D1

* EMPIRE BUILDER: Time Warner’s Levin proves his mettle as a deal maker. D1

* THE BIZ: Merged giants likely to bless sale of two movie firms. D6

* REGULATORY ISSUES: FTC staff comes up with complex solutions to hurdles. D6

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

The Cable Market

Market share data for major cable companies (percent of the 62 million U.S. cable households):

TCI: 23.5%

Time-Warner: 19%

Continental: 7%

Comcast: 5.5%

Cox: 5.2%

Other: 39.8%

Source: Paul Kagan Associates

Researched by SCOTT COLLINS / Los Angeles Times