Synergy Proved Their Undoing

In June 2000, as they completed negotiations over a merger that would create the world’s second-largest entertainment conglomerate, Edgar Bronfman Jr. pulled aside Jean-Marie Messier, whose Vivendi was about to take over Bronfman’s Seagram Co., the owner of Universal Studios and other marquee properties.

“You know what they say in the U.S. about entrepreneurial families?” Bronfman asked, according to Messier’s recollection. “The first generation creates, the second makes the fortune, and the third destroys it. I represent that third generation. But with [this merger], I’m assuring the future of the generations to follow.”

Scarcely two years later, the merger launched with such great expectations has cost the Bronfman family billions of dollars. Messier has been unceremoniously ousted as chairman and chief executive of Vivendi Universal, and the media giant he built is on the verge of being dismantled by the French traditionalists who have taken over.

The upheaval at Vivendi Universal is only one of three high-profile management shakeups to roil media conglomerates this season. Just last week, the German publishing, music and television conglomerate Bertelsmann ousted its chief executive, Thomas Middelhoff, who was still talking up the benefits of media-Internet “convergence” despite evidence that the policy had produced huge losses at other companies.

AOL Time Warner, also fashioned by merger in 2000, last month pushed out Robert W. Pittman, the head of its AOL Internet unit and formerly a candidate for chief executive; Gerald M. Levin, its chief executive and an architect of the merger, resigned under pressure the same month.

Of course, each of these companies had unique problems--financial and cultural--that contributed to the turbulence in the executive suites. But the former leaders of AOL, Vivendi and Bertelsmann shared a conviction that combining the Internet with leading entertainment brand names--CNN and Warner Bros. in AOL’s case, Universal Studios in Vivendi’s, and the distributors of Britney Spears and ‘N Sync in Bertelsmann’s--would generate explosive growth in their profits and stock prices. All were willing to borrow and spend heavily to reach that nirvana. But as reality fell dramatically short of their expansive visions, the demise of the executives behind them became inevitable.

Other leading media companies that averted the latest turmoil also face unsettled times, thanks to an advertising recession, poor operational performance and questions about management succession. From the downfall of their brethren, leaders throughout the industry have learned that nothing should be concealed from shareholders.

“Investors today are looking for complete and total transparency,” said Walt Disney Chairman and Chief Executive Michael Eisner, who has come under pressure from investors and board members because of lagging performance at almost all of the company’s entertainment divisions and a long-term decline in its stock.

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Some See a Return of Conservatives

Media and entertainment experts believe that the turbulent summer presages a new era of conservative management in the industry. Boards and shareholders are likely to treat their CEOs’ grandiose visions more skeptically--a trend emerging across the business world. Some of the combinations wrought over the last three or four years are likely to be unwound, meaning that once-highly valued properties such as Universal Studios, America Online, and the Universal and Bertelsmann music groups may return to the sale table.

That doesn’t mean that the original visions were entirely flawed, only that the pioneers may have spent too much on premature expectations of synergies between traditional media and novel technologies such as the Internet.

“I don’t think synergy as a concept is dead, but it has to arise viscerally--come from a need rather than being imposed,” said Barry Meyer, chairman of AOL Time Warner’s Warner Bros. movie and television studio.

Clearly, however, the days of lavish overspending for Web properties is long gone.

“Investors need to get paid today rather than invest in the promise of tomorrow,” says Christopher Dixon, media analyst at UBS Warburg. “When you throw in the management credibility at companies like WorldCom, Enron and Arthur Andersen, why is anyone surprised that investors and board of directors are looking to lower their overall risk portfolios at the major media companies?”

That new outlook represents the end of an era that lasted a scant 2 1/2 years, dating from the blockbuster merger announcement of AOL and Time Warner in January 2000. In his autobiography “J6M” (subtitled “Who’s Afraid of the New Economy?”), Vivendi’s Messier recalled hearing the first word of the huge merger from Middelhoff and thinking: “A mastodon has been born, lacking nothing.”

The news prompted him to redouble his efforts to reinvent the water utility and real estate company of which he had become CEO in 1996. Under Messier, Vivendi had expanded rapidly into wireless communications, pay TV, publishing, and Internet service, but he still harbored a yen to add entertainment properties to the portfolio. The AOL-Time Warner merger, he felt, validated his conviction that owning both content providers and a means of distribution over the Internet was the route to riches.

The result was Vivendi’s acquisition of Seagram, the Canadian liquor distributor controlled by the Bronfman family. Under the leadership of Edgar Bronfman Jr., a onetime songwriter, Seagram had paid $5.7 billion for MCA--the owner of Universal--in 1995, selling off $8.8 billion in DuPont stock to help finance the deal. Bronfman subsequently acquired Polygram Records for $10.4 billion, solidifying Universal’s stature as the world’s largest recording company.

But Bronfman evidently still believed that MCA was too small to compete in a world of media mastodons. Therefore he was receptive to Messier’s interest in adding the company to the Vivendi portfolio. The acquisition was completed at the end of 2000 for $33 billion, of which nearly $10 billion went to the family. One year later, Messier acquired USA Networks, combining the television production and cable company with Universal’s television unit at a cost of an additional $10.3 billion.

If Middelhoff’s ambitions were not quite as grand at Bertelsmann, the reason was the relative conservatism of the Mohn family, which controlled the company through a family foundation.

The boyish 49-year-old Middelhoff had given the company an early entry into the Internet boom by becoming a 50% partner in AOL Europe; when the company decided to sell its shares in March 2000 because of antitrust pressure from the European Commission and its own uneasiness at being in business with Time Warner, a potential rival, it garnered a $7-billion profit.

But Middelhoff’s vision of a mass media empire clashed with the company’s past as a publisher of hymnals and stolid periodicals. He proclaimed his intention to turn its music division, built in part through the acquisition of Sony Music, into the world’s largest. But that dream was dashed by the EC’s rejection of its proposed merger with Britain’s EMI Group.

More curious was Middelhoff’s dalliance with Napster, the Internet-based music-sharing system that was under legal assault by the recording industry, which charged that it was nothing more than a device for copyright piracy. Bertelsmann spent an estimated $100 million trying to turn Napster into a system that would pass legal muster--a project whose future has become exceedingly doubtful with Middelhoff’s departure.

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Corporate Direction Unsettles Observers

By late 2001, disaffection with the companies’ acquisition strategies was setting in among shareholders and entertainment experts, particularly when the purchases were being financed with borrowed money, as was the case at Vivendi and AOL.

Almost all attempts by major media companies to build branded Web sites to attract audiences had ended in costly failure: That year saw the demise of Disney’s Go.com, NBC’s Snap.com and AOL Time Warner’s Entertaindom.com. Such companies as Viacom and Rupert Murdoch’s News Corp., which had taken their time plunging into the Internet and been ridiculed for their tardiness, were now congratulated for their prescience.

“People have gone broke waiting for [convergence],” said Jon Miller, former chief executive at USA Interactive’s information and services group (and the leading candidate to replace Pittman as head of AOL’s America Online unit).

“Everyone looked at the Internet as the next growth engine after analog cable channels maxed out,” he said. But selling entertainment content via the Internet did not seem to be a profitable business model. The money was to be made online, as it turned out, in transactional businesses like Ebay’s auctions and the sale of concert tickets and travel accommodations.

Inside the merged media companies employees nursed resentments, especially as investors beat down their share prices because the promised synergies had not materialized. Stock options, which were once worth more than cash salaries, were now worthless. Cultural conflicts deepened between traditional media executives and Internet entrepreneurs forced to work together. Earlier this year, senior operational executives from the Time Warner side told incoming Chief Executive Richard Parsons that they felt “betrayed” by the declining fortunes of the company since the merger.

By early 2002, the stock of Vivendi and AOL showed the toll. Vivendi shares had declined by 75% in a year; AOL had lost roughly 90% of its value since the announcement of the merger.

At privately controlled Bertelsmann, Middelhoff had bristled at not having a publicly traded stock to use as currency in acquisitions. But the relentless devaluation of media stocks made the controlling family even more skeptical at his proposals to float public shares. The Mohns had agreed to trade 25% of the company to the investment firm Groupe Bruxelles Lambert on the understanding that the shares could be publicly sold in 2005. But they retained the right to buy them back before then, which could forestall the public offering, and staunchly resisted Middelhoff’s urging that they offer as much as 49% of the company to the public.

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CEOs Talk Big, Then Scale Back

Like Middelhoff, the chief executives of AOL and Vivendi also stood accused of over-promising gains from their mergers and acquisitions.

AOL’s Levin continued to promise strong revenue and profit gains through 2001, even as the advertising market in traditional media dried up and subscriber growth at America Online flattened; in the first few months of 2002, the company had to scale back its forecasts twice.

But it was Messier who pushed the envelope the most. French shareholders grew exasperated at his self-conversion to an American-style star CEO, complete with a $17-million Manhattan apartment and an adoring write-up in Vanity Fair, as corporate results deteriorated.

Within weeks of each other, both Vivendi and AOL set dubious financial records. In March, Vivendi announced an $11.8-billion loss for 2001, the largest in French corporate history, thanks in part to a $13-billion write-off of “goodwill,” reflecting the reduced value of many of its acquisitions. AOL followed in April by announcing a $54-billion charge against earnings--the biggest write-off in U.S. history--to reflect the diminished value of America Online since the merger. Even that left $80 billion of goodwill on the company’s books, equal to half its total assets.

The results set the stage for the coming executive ousters.

For their part, the Bronfmans appeared to be suffering a powerful bout of sellers’ remorse, having seen the value of their 5.5% stake in Vivendi reduced to less than $1 billion from $3 billion. The Bronfmans had insisted on selling Seagram for Vivendi shares rather than cash, evidently to avoid tax on the transaction; meanwhile, the value of their $8.8-billion stake in DuPont would have ballooned to $16.4 billion over seven years, had they not sold it to buy MCA. Concluding that Messier was unable to assuage investors’ concerns, they allied with a board effort to throw him overboard. On July 2 he was fired, replaced by a former French pharmaceutical executive cut from more traditional cloth.

At AOL, Parsons continued what appeared to be a purge of executives from the old America Online. In addition to Pittman’s departure, at least four major former AOL executives have been moved out of operational roles to various corporate Siberias. The last one left, AOL founder and Chairman Steve Case, plays little if any role in day-to-day operations.

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Incoming Leadership Faces Complex Task

The new leaders at all three companies are now facing the challenge of cleaning up their financial structures and unraveling some of the more extreme ventures backed by their predecessors.

Bertelsmann’s new chief executive, Gunter Thielen, a 22-year veteran of the company, may consider selling off his lackluster record division, Bertelsmann Music Group. Not only does BMG rank last among the world’s five recording giants, but its North American division has failed to post a profit in nearly a decade. Last year, the company lost more than $40 million. And now, because of a controversial contract provision, BMG must pay a staggering $3 billion for Jive Zomba, an independent label with a small roster of over-familiar pop stars including Spears, ‘N Sync and the Backstreet Boys.

AOL Time Warner will have to find ways to stem the declining subscriber growth at America Online and address the 42% decline in online advertising and commerce revenue it suffered in the second quarter this year, compared with the year earlier. But some analysts downplay suggestions that AOL and Time Warner would split up, particularly given that AOL has 30 million subscribers and is a viable distribution outlet that benefits Time Warner’s various content businesses.

“When you reach 25% of the TV households, that’s something you don’t walk away from--not lightly,” said Tom Wolzien, media analyst for Sanford C. Bernstein & Co.

The most complicated task may be that facing the new management of Vivendi, where Messier is judged to have assembled a stable of properties without an overall strategy for integrating them. The company is reportedly considering selling Canal Plus, its money-losing French pay TV service, and its 44% holding of the French phone company Cegetel. Selling Universal Studios and Universal Music Group would probably be difficult in today’s desultory market for media properties; the company may consider spinning them off as a separate public company to be run by the experienced Hollywood mogul Barry Diller, the chairman of Vivendi Universal Entertainment.

For all that, many industry experts believe that the just-departed generation of executives may eventually prove to have been prophets before their time.

The Internet, Wolzien says, “is a mass medium that ultimately everybody will have to be actively involved in. In the long term, it may well be they were correct strategically. But they were woefully wrong in the handling of their investors’ money.”

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(BEGIN TEXT OF INFOBOX)

A Look at Entertainment’s Fallen Chieftains

Jean-Marie Messier

Determined to reinvent sleepy French utility Vivendi as a media “mastodon,” the chairman and chief executive rapidly expanded into wireless communications, pay TV, publishing, Internet service and acquired Universal Studios and USA Networks. He was unceremoniously ousted this spring after the company posted an $11.8-billion loss and the stock dropped 75% in a year.

Gerald M. Levin

As head of Time Warner, he was a key architect of its merger with AOL in 2000, and at the time touted the great “synergies” to be achieved from combining the media and entertainment giant with the leading Internet company. By 2002, AOL had recorded the biggest financial write-off in U.S. history, the stock had lost roughly 90% of its value and Levin had resigned.

Thomas Middelhoff

Within four years, the brash young chief of Bertelsmann turned the stolid German company into one of the largest media conglomerates in the world. He fiercely clung to the idea of media-Internet “convergence.” But his vision clashed with the conservative controlling company, and he was replaced last week.

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Times staff writers James Bates, Corie Brown, Claudia Eller, Sallie Hofmeister, Chuck Philips, Thomas S. Mulligan, Edmund Sanders and Carol J. Williams contributed to this report.