Fool's Eye View

[ January 10, 2000 ]

Spending Time with AOL

By Maynard Paton (TMFMayn)

Carburton Street, London -- Hot off the presses this lunchtime came the announcement of the biggest merger in history. America Online (NYSE: AOL) and Time Warner (NYSE: TWX) have announced a "strategic merger of equals to create the world's first fully integrated media and communications company for the Internet Century". The newly created entity is to be called AOL Time Warner, and the deal is due to be completed by the year end, subject to shareholder and regulatory approvals. Additionally, both parties have agreed a series of marketing and promotional agreements in the run up to the final transaction.

Firstly, the financial terms of the deal. Time Warner and America Online stock will both be converted to AOL Time Warner stock at fixed ratios. Time Warner shareholders will receive 1.5 shares of AOL Time Warner for each Time Warner share owned. America Online shareholders will receive 1 AOL Time Warner share for each America Online share owned. When complete, America Online shareholders will own 55% and Time Warner shareholders will own 45% of the new company. The all-stock deal is expected to value the final group at $350m and will create a business that will generate $40bn in revenues and $10bn in earnings before deductions (EBITDA). Management comments suggest a figure of $1bn of cost savings can be produced through the deal.

There are two parts to the overall merger logic. The main benefit is to bring Time Warner's significant media "content" on to AOL's huge Internet "distribution" network. Also, there are the advantages of mixing AOL's popular interactive "services" with Time Warner's advanced broadband cable "distribution".

The whole objective is to lever additional growth and synergies from piping a whole range of media products -- magazines, television programmes, Internet services and just about any other form of general entertainment -- through any of the new communication channels of tomorrow.

AOL Time Warner, according to Bob Pittman, President of America Online, will "transform the landscape of the industry overnight". Pittman continues that the new company will "launch the next Internet revolution". Specifically, as the convergence of Internet, the computer, the television and telephone continues, AOL Time Warner will aim to supply the content, the distribution and the infrastructure for the future transformation in the media industry.

Entertainment Content

The real key attribute to the deal is Time Warner's content. Its appeal to AOL is the subscription-based services and the advertising "gateways" these products have created. A quick look at Time Warner's four content divisions gives a mouth-watering prospect for AOL.

Publishing: The bedrock is the 76-year-old Time magazine. Other notable names in the 33-magazine catalogue are Sports Illustrated, People, Fortune and Entertainment Weekly. Over 120m worldwide subscribe to a Time magazine. Over 20% of all US magazine advertising revenues fall into Time Warner's pockets.

Television Cable Networks: The division is dominated by the 1996 acquisition of Turner Broadcasting, Inc. Ted Turner brought to Time Warner a range of entertainment channels and the world famous CNN news channel. Entertainment channels include TNT, reaching 75% of US homes, the Cartoon Network, reaching 59m US subscribers and Turner Classic Movies, reaching 36m US subscribers. CNN has 76m subscribers in the US, with over 1bn people worldwide having access to the news channel. HBO and Cinemax, sport and film channels, have 35m subscribers throughout 40 countries.

Filmed Entertainment: The Warner Brothers operation not only produces films for the big screen (four films surpassing the $100m mark in the box office in 1999), but supplies primetime television shows as ER and Friends. There's also Bugs Bunny and his famous Looney Tunes cartoons.

Music: Warner Music has over 1,000 musical artists on its books and over 1 million music copyrights. Time Warner see this content division, more than any other, as benefiting from the initiatives taking place. The downloading of this "evocative art form" from future interactive services, over a variety of hardware platforms, is one of the most exciting areas of growth, according to Gerald Levin, Time Warner's chairman.

AOL and Cable Distribution

America Online brings to the deal the "first mover" advantage of the Internet industry. America Online is the world's largest online services company, with operations in fifteen countries. Time Warner admitted that "it would take ten years" to get their equivalent services up to America Online's member numbers. This is the key part of the merger for Time Warner -- to join forces with the established leader in the new electronic method of content distribution.

Through its brands of AOL, with more than 20 million members, and Compuserve's 2.2 million subscribers, AOL leads the way in worldwide Internet services provision. The group has nine times as many subscribers as its nearest US competitor.

Interactive services such as the 50 million member community service ICQ, the consumer directory website DigitalCity and the AOL MovieFone cinema ticketing e-commerce site, and owning the Netscape Internet browser, all have helped consolidate AOL' s position as the dominant player in the US.

Time Warner is the second largest cable operator in the US. The group has access to 21m US homes and has aggressively upgraded this network to make it the world's most advanced digital system -- the RoadRunner. This high-bandwidth delivery network is probably the future for digitised information and services.

Marketing Agreements and Growth Opportunities

Accompanying the merger details are a string of cross-promotional activities and growth opportunities.

AOL services will feature further Time Warner magazine content, expanding the current Time Warner offering already available on its websites. Time Warner's CNN.com and Entertaindom.com will feature "prominently" on various AOL services. Time Warner and AOL MovieFone will participate in cross-promotion of the marketing and selling of tickets to Time Warner movies. "Broadband CNN" will be made available to AOL members, while America Online will make available AOL Search, Instant Messenger and MovieFone on the Time Warner RoadRunner cable service. Numerous other growth opportunities have been identified. Overall, Bob Pittman comments, "In terms of the Internet, we're still scratching the surface". The cross-promotion possibilities for both AOL and Time Warner do look limitless.

In Summary

This deal takes the worldwide media industry into a new era. The AOL Time Warner group will create a huge advertising gateway -- currently Time Warner publications, AOL and Turner Broadcasting are numbers one, two and three in the "most sought after" locations for US advertisers. Several regulatory issues have been raised immediately. Domination by this new Goliath in the US Internet industry could follow -- created by the irresistible concoction of leading paid-for content, over 100m subscribers world wide and a substantial head start on the information superhighway.

If the deal goes ahead then the synergies of content and distribution of the two biggest players in their respective industries should make for an unbeatable combination. Bob Pittman summed up the potential of the deal perfectly for both parties during a conference call this afternoon. "It's a perfect one plus one equals three situation". There is no doubt that other media giants will be looking for partners to perform similar mathematics very soon.

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