Are New-Media Firms Ready to Buy the Old?

Are we about to see a New Media company swallow up an Old Media company?

Speculation about such a deal--something that would have been viewed as outlandish only a year ago--heated up Tuesday as a rumor about America Online’s purported interest in CBS resurfaced.

The speculation helped drive CBS shares to an all-time high of $43.69, up $1.81, on Tuesday on the New York Stock Exchange and sparked frenzied trading in the network’s options.

Both companies refused to comment, and AOL dashed cold water on a further rumor that it was planning to make a major media-related announcement today. AOL shares edged up 56 cents to a record $167.50 on the NYSE.

(Late Tuesday, sources said Seagram and Bertelsmann, which own large music companies, are planning to announce an Internet alliance.)

Many market professionals expressed doubt that AOL or any other Internet company is really financially strong enough to make a run at a profit-making entertainment company.

Still, Internet entrepreneurs and other observers of new media are convinced that a takeover of a traditional entertainment company cannot be far off, with AOL, Yahoo and Microsoft often mentioned as possible acquirers of CBS, the NBC unit of General Electric, Time Warner or even Walt Disney.

One reason is that many in both industries expect the Internet to evolve into a highly efficient distribution medium for traditional and new forms of entertainment and news material. Old-media companies also would benefit by having new ways to reach their audiences, and new-media companies could offer their customers a trove of content with proven allure.

“It makes a lot of sense,” said Scott Cleland, managing director of Legg Mason Precursor Group, a Baltimore consulting firm. “AOL wants to grow up to be more like a video content company [than an Internet access company]. It’s probably better for new-media companies to buy old-media companies, because they have the management that understands new media--the old media don’t get it.”

From the standpoint of pure arithmetic, the question of whether an Internet company might soon try taking over a traditional entertainment company becomes more relevant every day.

That is because the stock market currently values pure Internet companies at much higher relative levels than it does entertainment-oriented conglomerates.

With $169 billion in stock market capitalization, America Online, the lone blue chip among Internet stocks, is today worth nearly twice as much as Time Warner, which as the world’s largest entertainment company commands a market value of only $89.2 billion. AOL’s value is nearly three times that of Disney’s $64.2 billion.

This means that AOL could theoretically afford to offer to swap some of its stock--using it as currency instead of cash--for that of any such target.

The main obstacle to any such deal, however, is the enduring skepticism among many investors about Internet companies’ real value, their stock prices notwithstanding.

To many, the prices Internet stocks command relative to the companies’ revenues or cash flows are so high compared with what is normal for the stock prices of traditional media companies that “Internet mania” appears to be the only way to explain the phenomenon.

That skepticism has not been an obstacle when an Internet company wants to use its stock to buy another Internet company--as Yahoo did last week in agreeing to acquire Broadcast.com for $5.7 billion in its own stock. But it would be a problem should Yahoo or AOL try to use the same currency to buy a more reasonably valued company.

“I can’t imagine that the shareholders of CBS are going to accept a stock [AOL] valued at 300 times EBITDA [that is, earnings before interest, taxes, depreciation and amortization, or cash flow] for a stock trading at 16 times EBITDA,” said one CBS investor. “The [CBS] board would get sued for taking it.”

A similar mismatch of valuations has dogged a recent attempt to bring together old and new media--the proposed merger of the Internet company Lycos with parts of USA Networks, including Home Shopping Network and Ticketmaster Online.

Because USA Chairman Barry Diller insisted that the profitable companies he is contributing to the merger be valued higher than Lycos, which has never turned a profit, Lycos shareholders have balked at the terms.

Others say that accepting the market’s overvaluation of their stocks as a benchmark is the basic mistake many new-media entrepreneurs make in appraising the worth of their own companies.

“If you could get someone to take [AOL’s] stock, they could swallow just about anything,” said Tom Wolzien, an Internet analyst for Sanford C. Bernstein & Co. “That doesn’t mean that someone who’s built up a large company necessarily wants to take it as currency.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

New World Order?

America Online now ranks among the most valuable U.S. companies in market capitalization (stock price times number of shares outstanding), and Net firms Yahoo and Amazon.com are already worth more than many old-line U.S. firms. A sampling of brand-name giants:

*--*

Company ’98 sales (billions) Market cap (billions) Microsoft $16.6 $475 General Electric 100.0 371 Wal-Mart 139.2 218 America Online 3.3 169 IBM 81.7 168 Coca-Cola 18.8 147 Yahoo 0.2 42 Amazon.com 0.6 29 Sears 41.3 17 Goodyear 12.6 8

*--*

Source: Bloomberg News