America Online, Time Warner Propose $163-Billion Merger

In an audacious deal bringing together traditional entertainment and the new world of the Internet, America Online and Time Warner Inc. on Monday announced they will merge in the largest business transaction in history.

The $163.4-billion merger would combine the most successful brand name on the Internet with the world’s largest entertainment company, whose brand names include the Warner Bros. studio, the WB television network, HBO, CNN, and Time Magazine. Time Warner is also the nation’s second-largest cable systems operator, providing AOL with sought-after access to the vaunted high-speed pipeline into American homes.

It is the first purchase of a major media company by an Internet company. Such a transaction has long been anticipated but was hampered because of uncertainties about the real values underlying the often euphoric trading of Internet stocks.

Many in the investment community believe the AOL-Time Warner deal could presage a torrent of similar transactions, with such well-known names as the Walt Disney Co., Yahoo, and Viacom and CBS (which are themselves in the process of merging) prompted to seek complementary partners.

On its own terms, the proposed deal creates a critical mass of about 100 million customers, including AOL’s more than 20 million Internet subscribers, Time Warner’s 12 million cable customers, and the Time publications’ 28 million subscribers--whose attention spans could be sold en masse to advertisers around the globe.

“This is a perfect fit as a unified entity,” AOL Chairman and Chief Executive Steve Case told an audience of Wall Street analysts shortly after the deal was announced Monday morning. “No company will be better equipped to capitalize on the convergence of media, entertainment and communications.”

AOL and Time Warner executives said the deal could take nearly a year to complete. That could add some risk to the merger, given the volatile price swings of AOL and other Internet companies’ high-flying stocks. Some analysts question whether the active traders who are AOL’s shareholders will bail out if the stock declines or begins trading more like a traditional media company.

Moreover, questions about how the cultures of the two companies will mesh are inevitable. At a news conference Monday launching the merger, Time Warner Chairman and Chief Executive Gerald Levin appeared ostentatiously tieless, as though to signal his solidarity with what he called the “hip and socially minded” culture of AOL.

But others noted the contrast between Time Warner’s bureaucratic culture and AOL’s storied aggressiveness in the fast-changing Internet space.

Case said since the two chairmen began discussing a combination this fall, he has tried to impress upon Levin the need to operate the new company at “Internet speeds.”

Under the terms of the deal, AOL’s Case, 41, will become chairman of the merged entity, which will be known as AOL Time Warner and trade on the New York Stock Exchange under the ticker symbol AOL. Levin, 60, will become chief executive of the new company.

Complexity of 2 Firms May Present Challenge

The deal raises fresh concerns about the increased concentration of information media as well as the combined ownership of information sources and distribution networks.

“To live in a country with 260 million people that is dominated by only 10 media companies should be alarming,” said Robert McChesney, a professor at the Institute of Communications Research at the University of Illinois. “This kind of concentration of wealth undermines freedom of expression.”

The sheer size and complexity of the two companies may represent a huge analytical challenge for the Federal Communications Commission, which regulates cable and telecommunications companies, and the Department of Justice and the Federal Trade Commission, which oversee corporate mergers with antitrust implications. The proposed merger follows a period of unprecedented consolidation among entertainment and telecommunications companies.

The merger, which was a closely held secret until unveiled Monday morning, was hailed by Wall Street and industry leaders as a bellwether of the convergence of entertainment content and the Internet.

“Simply stated, content was recrowned as king of the media age,” said Sumner Redstone, chairman and chief executive of Viacom Inc.

Cable executives similarly took credit for the huge premium Time Warner got in the deal, saying that the price tag reaffirmed their networks as the preferred pathway into the home for Internet, phone and television services.

In trading Monday on the New York Stock Exchange, AOL fell $1.13 to $72.63, including a slight rebound in after-hours trading that increased the value of the deal to $170 billion from the close of regular trading. Time Warner, whose shareholders will receive a nominal 71% premium for their shares over Friday’s price, soared $27.50 to $92.25, including after-hours trading activity. Other entertainment and cable stocks also rose sharply.

Case and Levin said they foresaw no regulatory difficulties.

The deal is contingent on the approval of shareholders of both companies. Both boards approved the deal unanimously, the companies said--and Time Warner highlighted the endorsement of its vice-chairman, the mercurial Ted Turner. The 61-year-old Turner compared his glee at signing the papers Sunday night to vote his 9% stake in favor of the merger to “the first time I made love 42 years ago.”

It is unclear, however, how Time Warner’s influential institutional shareholders will vote their positions. In particular, sources say Gordon Crawford, the powerful Los Angeles-based money manager who oversees the nearly 10% equity position in Time Warner held by Capital Research & Management Co., was unwilling to back an earlier proposal by AOL that valued Time Warner less generously because he was uncomfortable with AOL’s inflated trading levels.

One source close to Crawford said the huge run up in AOL’s shares since the fall allowed the Internet company to sweeten the premium, making the current offer hard to reject.

The transaction is structured as an all-stock purchase of Time Warner by AOL that will be tax-free to existing holders of both companies. Yet the terms may be challenging for investors because America Online is valued by the stock market at nearly twice Time Warner--$173 billion, compared with $101 billion as of Friday’s market close--even though it has one-third Time Warner’s annual revenues.

Because of this mismatch in market valuations, investors have been leery of proposals to merge old and new media companies. The last such proposed deal, a bid by USA Network Inc. for the Internet portal Lycos last year, collapsed because the two sides had such divergent views of the real value of Lycos, which had never made a profit.

Levin and Case said they had worked carefully to strike a reasonable compromise on the values of their two companies.

“One of the creative breakthroughs was in the valuation,” Case told The Times in a joint interview with Levin. He said the key to coming to a final deal was Time Warner’s “recognition that these Internet values are real.”

The result was a deal in which AOL shareholders receive one share in the merged company for each of their AOL shares, and Time Warner holders will receive 1.5 shares. AOL shareholders will gain 55% and Time Warner shareholders 45% of the merged company.

Case said both sides assumed that the disparity in valuation would disappear over time as the virtues of the merger became clear.

“We figured it’s better to own 55% of the new company than 100% of AOL,” he said.

For all that, the deal will call for the merged company to take about $150 billion in charges against profits over 20 years for “goodwill,” or the excess AOL is paying for Time Warner over the latter’s tangible value. That means it may not report any profits for decades.

“This establishes the Internet as a viable medium,” said Christopher Dixon, media analyst at PaineWebber in New York.

The key to the merger is that it fills strategic voids faced by both companies. As AOL President Robert Pittman--a former Time Warner executive--put it Monday, “We are each the missing piece of the other’s puzzle.”

AOL Faces Threat to Core Access Business

AOL is by far the strongest brand name on the Internet. Its more than 20 million subscribers, who pay as much as $21.95 a month for access to the World Wide Web and a range of proprietary information and entertainment offerings, have made it one of the few profitable companies in the sector. AOL earned $762 million on $4.8 billion in sales in the year ended Sept. 30.

But it faces a threat to its core telephone-based Internet access business from the rise of high-speed, or “broadband” Internet connections. The most effective such connections are provided by cable TV operators who have closed their networks to AOL. Time Warner, for example, has required its estimated 700,000 broadband customers to subscribe through Road Runner, its 50%-owned Internet Service Provider.

AOL viewed this threat so strongly that it waged a nationwide campaign asking federal and local regulators to force the cable industry to provide “open access” to its high speed networks to all Internet providers.

AOL executives made it clear that access to Time Warner’s broadband network was their top incentive in pursuing the deal.

“If you were an AOL shareholder, you went to bed last night a little bit worried about broadband,” Case told Wall Street analysts Monday morning. “Now you no longer have that worry.”

Time Warner, for its part, commands perhaps the broadest array of top entertainment brand names in the world. In television and filmed entertainment those brands include CNN, HBO, the WB network, the television shows “ER” and “Friends,” the cartoon characters Bugs Bunny and Daffy Duck, and the Batman film franchise. In music, the company’s top stars include Jewel, Cher, REM and Metallica. Its publications include Time, Fortune, Sports Illustrated, and People magazines. And its cable systems serve regions encompassing 20 million homes.

But the company has had a history of fumbling, if pioneering, efforts to exploit those brands, often having to import entrepreneurial managers through acquisitions. Having missed out on much of the early success of cable programming, for example--except through HBO--Time Warner addressed that problem by taking over Turner Broadcasting System in 1996. The move gave it CNN, and the entertainment channels TBS and TNT as outlets for its Warner Bros. productions.

Meanwhile its “Pathfinder” Web site, which gave users one-stop Web access to its magazines and other branded content, has never been a popular success, in part because of its confusing design.

And its interactive television experiment in Orlando, Fla., the Full Service Network, was shut down after the loss of millions of dollars over several years, without ever having garnered substantial audience support.

The merger with AOL not only gives Time Warner a captive audience of more than 20 million subscribers, but a management team with proven skills at placing information and entertainment content before a large online audience.

“AOL’s culture is similar to Turner’s,” said Michael J. Wolf, an entertainment consultant at Booz Allen & Hamilton. “It moves quickly and sets a fast pace.”

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Mammoth Mergers

America Online Inc.’s agreement to buy Time Warner Inc. for about $163.4 billion in stock would rank as the largest takeover in history. The world’s biggest merger and acquisition deals, ranked by dollar value:

(billions)

Companies: 1. America Online/Time Warner

Date: Pending

Value: $163

*

Companies: 2. Vodafone AirTouch/Mannesmann

Date: Proposed

Value: $129

*

Companies: 3. MCI WorldCom/Sprint

Date: Pending

Value: $122