STUDENT CASE: AOL-Time Warner Merger
In January 2000, shortly before the bursting of the tech/internet bubble, one of the largest media conglomerates in the world was created when America Online Inc. (AOL), the world’s largest internet company, announced a merger with Time Warner, the largest U.S. media and entertainment corporation. This collaboration, which was supposed to create the world’s largest branded information, entertainment and communications portal, was hailed as the deal of the century, as the combined market capitalization came in at more than $350 billion, with estimated revenues of over $30 billion annually.
AOL was founded in 1985, under the name Quantum Computer Systems, as a popular interactive services firm providing content and services to residential customers via dial-up modems. As the internet grew in popularity, AOL also began to provide internet access to large numbers of people, and in 1991 it changed its name to America Online Inc. Through the late 1990s, rapid growth ensued, fueled by a simple strategy that involved a large number of acquisitions and geographical expansions.
Time Warner was first formed through Warner Brothers, which went public in 1925, with the launch of its popular cartoon series. In the years leading up to the AOL-Time Warner merger, Warner Brothers merged with Time Warner, whose name it adopted, and the Turner Broadcasting System. These acquisitions allowed Time Warner to be transformed into a multi-media company consisting of record labels, motion picture as well as television production and distribution, studio facilities and film libraries, television networks, and book and magazine publishing.
The merger of AOL and Time Warner was negotiated by Steve Case, the chairman of the former AOL, and Gerald Levin, the chairman and CEO of the former Time Warner in a deal valued at $178 billion, consisting of $160 billion in stock and the remainder covering Time Warner’s outstanding debt. Case continued his position as chairman while Levin became the new CEO of the merged company, now called AOL-Time Warner.
Under the merger agreement, Time Warner and AOL shares were converted into AOL Time Warner stock at fixed exchange ratios: Time Warner shareholders received 1.5 shares of AOL Time Warner for each Time Warner share they owned, and AOL shareholders received one share of AOL Time Warner for each AOL share.1 Using market values, AOL valued Time Warner at about $110.60 per share, an astonishing 70% premium over the market’s closing price. After the merger announcement, the stock price for the combined companies increased 36%.
Under the deal, although AOL contributed only 18% of the merged company’s pre-deal revenues and 30% of the operating cash flow, AOL shareholders still received the majority of the shares in the merged company. The end result was that AOL shareholders owned approximately 55% and Time Warner shareholders 45% of the new company, even though Time Warner contributed substantially more real assets.
The very high valuations for “New Economy” internet stocks made this deal possible. One commentator wrote that “the deal also has huge significance because it is the first time one of the highly priced new media companies has attempted to convert its Wall Street rating into real money with a merger or takeover.”2 Another commentator, looking back at this period, writes that “during the 1990s, many upcoming internet start-ups, the so-called dotcoms, were tremendously overvalued and … without ever having made profit were worth as much as established blue-chip companies because investors believed in their potential.”3
Is this merger surprising given the environment of the time and in light of the merger theory ? Discuss the various incentives of the managers of the two firms.