Valuing the AOL – Time Warner

Merger

Presented By:
Muhammad Awais
 Introduction
On January 10, 2000,Steve Case, CEO and chairman of
America Online (AOL), and Gerald Levin, CEO and
chairman of Time Warner, announced the merger.

Merger would combine:

AOL´s “extensive Internet franchises, technology and
infrastructure “
With

Time Warner’s “vast array for world-class media,

entertainments, and new brands” and its “technology
advanced broadband delivery system.”
 Introduction . . . Continued
On March 1, 2000, analyst estimated:

Table:

AOL Time Warner

Present Value $92 per share $138 per share

Target Value $102 per share $154 per share

Estimated Value of Combined Company

Approx. $500 billion

Merger created vertically integrated Company: Stretched across industries,

economic models, and geographic boundaries.
 Introduction . . . Continued
On June 11, 2001, deal closed and the world economy
had slowed.

AOL´s stock price had dropped from $72 at the time

the deal was announced to $47 per share.

Time Warner’s stock price had declined from $90 per

share to $71.

This case enables the analysts to analyze the challenges

which executives may face to define and execute
strategy during a period of uncertainty and change.
 AOL (Pre-Merger)
Launched in 1985 as an online information service named
Quantum Computer Services.

Renamed as America Online in 1989.

AOL services: Access to e-mail, games, special interest

community forums, etc.

AOL Partnership: American Airlines for travel reservation

services and CNN for online News and stock quotes.

In 1990, AOL began innovative marketing techniques:

Free copies of AOL software and several months of
subscription.
 AOL (Pre-Merger) . . . Continued

In 1994, AOL launched World Wide Web.

During 1997, AOL launched new services like “Instant

Messaging” and “Buddy Lists”.

Membership exceeded 10 million in same year.

By December 2000, company was the world’s leader in

interactive services, web brands, internet technology,
and electronic commerce services.

In December 2000, AOL employed 15000 employees.

 AOL Business Model
Interactive Services: Included AOL.com (27 million members),
CompuServe (3 million members), and Netscape’s Netcenter (40
million users), also on Mobile.

Interactive Properties: Provided online services also on partner and

competitors websites like Digital City, ICQ (Instant Messaging and
Chat), Moviefone (Online Movie Guide), spinner. COM, Winamp,
etc.

AOL International: Provided access to country specific versions of

AOL.com within 16 countries outside the United States. 33% users
were outside the united states.

Netscape Enterprises: Provided software products, technical

support, consulting, and training services for business users.
 Time Warner (Pre-Merger)
In 1918, Henry Luce and Britton Hadden conceived the idea of Time
magazine.

During the same year, Warner Brothers were developing their first
“moving picture” studio on sunset Boulevard in California.

By the 1980, Time Inc. and Warner Brothers had become leaders in
their respective industries.

During that period each company extended its business model by

introducing new products and by acquiring complementary
businesses.

In 1969, Warner Brothers acquired its first broadcast network and

renamed as Warner Communications.
 Time Warner (Pre-Merger)
In 1978, the company acquired its first Cable operator.

In 1989, Time Inc. and Warner Communications merged.

In 1996, Time Warner acquired Turner Broadcasting

Group which had been founded in 1976.

By late 2000, Time Warner had become World Leader in

media, entertainment, news and information delivery,
and broadband infrastructure.

The Company had over 70000 employees.

 Time Warner’s Business Model

Cable Networks(24% of revenue, 25% of EBITDA): CNN,

TBS superstition, TNT as well as HBO and emerging
networks like the Cartoon Network.

Cable Systems(19% of revenue, 40% of EBITDA): Time

Warner Cable was the second largest cable system
operator with 6.5 million subscribers. Also owned
Roadrunner broadband service.

Filmed Entertainment(30% of revenue, 14% of EBITDA):

Leader in Creation, distribution, licensing, and marketing
of movies, T.V. programming, Videos, etc.
 Time Warner’s Business Model

Music (Warner Music Group)(12% of revenue, 9% of

EBITDA): WMG was marketing US artists overseas and
creating greater global marketing opportunities for artists
with worldwide appeal.

Publishing(15% of revenue, 12% of EBTIDA): Include

creation and distribution of publishing and information
brands.
Brand Name Magazines, and Book Clubs.

Digital Media: Included the Company’s integrated

internet-related and digital media businesses including
Entertain Dom (Web Portal).
 Reasons For Merger

For Warner, merging with an existing company was a more effective

way to distribute its contents via online channels as opposed to
building its own capabilities.

AOL needed a strategy for moving its customers forward into the
world of high-speed "broadband" access, controlled by telephone
companies and cable TV operators (such as Time Warner).
 AOL- Time Warner Strategic Opportunities

Redefine the entertainment and media

industries to accelerate and exploit the
Transformational convergence of T.V., radio, telephone,
print, and computer technology
Opportunities industries.

Enhance the development and

growth of existing businesses and Strategic Options
services

Tactical Synergies Identified over 1$ billion

increase in Value during the
first calendar year.
Linking Strategy to Value

Concept

Revenue
Model Cost
Model

Capabilities

Value Asset
Model
 The Deal
Time Warner would be converted into 1.5 shares of an
identical series of AOL – Time Warner stock.

AOL stock would be converted into one share of AOL –

Time Warner stock.

AOL shareholders ended up owning approx. 55% of AOL

Time Warner.

Time Warner shareholders owned approx. 45% of

combined entity.
 Deal Announced: Deal Closed: January
January 10, 2000 11, 2001

Stock Price 100 90 80 71

72 70
80 60
50
47
60
40
40 Stock Price 30 Stock Price
20 20
10
0 0
AOL Tim e AOL Tim e
Warner Warner

Market Value of the AOL: $167 billion AOL: $107 billion

Companies Time Warner: $124 billion Time Warner: $98 billion

Percent Shareholder
AOL T. W. AOL T. W.
ownership
55% 45% 57% 43%

Common stock to 1 AOL Share: 1 AOL Time Warner Share

Conversion Ratio 1 Time Warner share: 1.5 AOL Time Warner share

Cost of Walking away AOL: $5.4 billion

from Deal Time Warner: $3.5 billion
 Valuing the AOL Time Warner Merger:
The View in Spring 2000
Salomon Smith Barney (SSB) analysts attempted to consolidate
AOL-Time Warner 2000 Financial matrices.

Gerald Levin described “three sources” of revenue and cash flow for
the combined company:

Subscriptions (cable service, cable network, and magazine

subscribers revenues): 27% gross margin in 2000 - Steady source
of revenue and cash flow.

Content (filmed entertainment, music, and book publishing

revenues): 13% gross margin in 2000 - Expected to provide
accelerated, long-term growth in revenue and cash flow.
 Valuing the AOL Time Warner Merger:
The View in Spring 2000
Advertising/E-Commerce (advertising and e-commerce revenues):
35% gross margin in 2000 - These activities would leverage the
“highly predictable and powerful signal” of growth.

Revenue Producing Synergies:

Advertising/E-Commerce: Generate $9 Billion and an additional

$290 million to $360 million in EBITDA by leveraging its
online/offline distribution and sales infrastructure in 2001.

Subscriptions: Additional $30 million to $40 million in EBITDA by

cross-marketing.
 Valuing the AOL Time Warner Merger:
The View in Spring 2000
Content: Additional $60 million to $72 million in EBITDA.

Cost Saving Synergies:

Reduction in marketing costs by 10% to 15%, yielding and

additional $230 million in EBITDA.

Save additional $125 million by Shutting down its digital media unit.

Elimination in corporate overhead services (e.g., finance, legal,

human resources) were anticipated to save up to $100 million in
2001.
Valuing the AOL Time Warner Merger:
The View in Summer 2001

Merger was finalized on January 12, 2001, and executives

immediately began to restructure the company.

On January 24, company announced 3% reduction in workforce

which was expected to save $300 million in personnel costs.

Decided to sell or shut down the Warner Bros. chain of retail stores,
Time Warner’s Digital Media Group, and World class Wrestling all of
which were losing money.

In Spring 2001, most analysts remained optimistic about the

company’s ability to deliver on its promises.
Valuing the AOL Time Warner Merger:
The View in Summer 2001

But as the worldwide economy stopped progress, this also

happened to AOL Time Warner’s aggressive revenue growth.

To boost revenues, US subscription price increased from $21.95 to

$23.90. The price increase would add over $350 million in revenues.

Despite the business slow-down, executives stated that they were

committed to increase $40 billion in revenue, $11 billion in EBITDA,
and 200% in free cash flow.

To support these claims, a number of cross business unit initiatives

were designed to leverage the firm’s diverse capabilities.
 Valuing the AOL Time Warner Merger:
The View in Summer 2001
Cross business unit included:
 Bank of America and AOL alliance
 AOL Time Warner and Samsung strategic marketing and
technology development alliance
 AOL Time Warner and WorldCom strategic marketing alliance
 AOL and Universal Pictures marketing alliance, etc.

New initiative to extend AOL Music’s current offerings: Included the

AOL Music Channel and its Spinner and Winamp sites, which
visited nearly 25 million unique users.

In an attempt to boos its e-commerce capabilities, on July 23, AOL

announced that it was making a $100 million equity investment in
Amazon. COM.

Finally, in early September 2001, AOL Time Warner bought AT&T,

for company’s cable assets. This would boost the number of
subscribers for the merged cable business to 27 million.
 What Went Wrong?
Cultural Clashes

AOL and Time Warner failed to implement their visions and

communicate them – e.g. marketing Time Warner content through
all channels possible. Each division did its own thing.

Lacked the ability to recognize new trends in the digital industry.

Failed to build a business model for Internet telephony or Voice over

IP (VoIP).

They were not able to promote their idea of a combined music-

platform.

AOL Time Warner missed in the recent years was the importance of
highly personalized web services.
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