The AOL-Time Warner Story – A Case of Need
The AOL-Time Warner Story - A Case of Need
The AOL - Time Warner merger is the biggest to date and had worldwide implications. This paper will look at; the what, how and why behind the alliance, hereby referred to as a merger* even though it had the traits of a takeover. In the analysis we will be looking at the companies backgrounds thus understanding the need for the merger and the implications of such a large merger.
Media companies distribute information content through its many 'channels' that are television and print. Occasionally new technology opens up new possibilities to distribute the information, the latest being the internet and before that cable. Time Warner (TW) took on a huge burden of debt during the 1990s upgrading it's cable networks, a smart move considering cable is perceived as the best way of piping broadband Internet services.
The Internet competes with other media for people's attention; it is thus a threat and an opportunity that old media companies feel that they cannot ignore. Struggling to acquire customers, the Internet companies have discovered the importance of the real world. Promotion on a broadcast-television network can pull in new users, but it is pricey: establishing a new brand through television advertising costs £15m-30m in the first months. Quoting from The Economist "nobody is making any money on [the Internet]...The more important questions are whether they will make big profits later."†
What AOL lacked was the ability to bring broadband to the homes of customers; these are cable television lines that can carry vast amount of Internet content and capabilities. G
It just so happens that TW's cable-television infrastructure is the second largest in the USA. Everything that AOL needed to bring the revolutionary new technology to the homes of subscribers. AOL would stand to gain the transport capabilities for it's Internet Service but also the merger would also provide huge possibilities for content.
So directors of each company were faced with what corporate strategists call a "make or buy" dilemma. AOL's stock price was at a high and the fear was that "AOL's helium supported Internet valuation would be punctured and deflate." The idea was to use the capital (while the company was at this high) to buy concrete assets. On the other side of things, TW didn't have the money to pay for setting up on the Internet, "The company, in fact, could neither 'make' nor 'buy,' which left it with but one option - sell."(TIME) As mentioned the deal ...
This is a preview of the whole essay
So directors of each company were faced with what corporate strategists call a "make or buy" dilemma. AOL's stock price was at a high and the fear was that "AOL's helium supported Internet valuation would be punctured and deflate." The idea was to use the capital (while the company was at this high) to buy concrete assets. On the other side of things, TW didn't have the money to pay for setting up on the Internet, "The company, in fact, could neither 'make' nor 'buy,' which left it with but one option - sell."(TIME) As mentioned the deal was by most characteristics a merger‡ "the voluntary union of two companies where they think they will do better by amalgamating." (i.e. the concept of synergy.)
AT&T in 1998 bought up enough cable systems to turn itself into America's largest cable company. The threat was that AT&T planned on only allowing it's own ISP (Excite@Home) to get access to the technology. After complaints to regulators AT&T announced it would offer partial access to others. With the future of the Internet being broadband access, AOL had another motive for the unification with America's second largest cable company.
The Economist magazine§ identifies three good reasons to be dubious about the prospects for media companies and the Internet; I have expanded on these points.
* Advertising: Advertising helps pay (in part) for broadcasts but online advertising accounts for less than 1% of total ad expenditure (in the US).
* Portals: A portal is a gateway to the Internet or a starting place, Yahoo is a classic example. AOL is a service provide turned portal. The main point to be made is that competition is high because imitation is easy and it is hard to make money from users.
* Video - Most big media companies make most of their money from delivering moving pictures. Video over the Internet with a dial-up modem is slow and 'clunky'.
After analysing the above arguments we can reply to many of them in defence of TW and AOL. Firstly if we deal with advertising, TW is large enough to sustain the problem of advertising by subsidising it over many fields. Also one of its motives for merging with AOL was to acquire Internet presence and capabilities.
AOL is a portal but unlike Yahoo it operates on a subscriber basis and progressing this point further - it has 20 million of them. This goes some way at creating loyalty to the company. With TW, AOL will also have further advantage over the other portals quite simply because it will get noticed more. This is seen as so important that Internet companies' desperate need for promotion has been the basis of many old-and-new media alliances. Finally, the last point of 'video' TW has a substantial cable layout in the US. This is why AOL needed a large media company. The Economist also recognised another problem as being that of "economies of scale." Instead of the above two options AOL decided TW to be it's best suitor and as a result other big media companies must be concerned because there is only one AOL but there are many big media companies.
Conclusion
AOL and analysts began to recognise that it was a vulnerable enterprise. One that was dangerously dependent during the highly competitive time (that is now) when many other firms are offering free Internet access. This along with the AT&T threat of restricted cable access meant AOL needed to secure its future.
Under the terms of the deal, its shares are valued in effect at 75 cents on the dollar, a kind of discount for the instability surrounding the technology market. The fact that AOL chose the time it did to merger probably means that it felt there would never have been a better time to do so. As is concluded in both The Economist and TIME, Steve Case (AOL director) is declaring that he doesn't feel his stock is worth its Wall St. valuation if he did the trends illustrated that AOL would eventually be able to buy TW at half price.
I have only briefly touched on economies of scale. I should point out that newly merged companies do not always take advantage of this mainly due to lack of rationalisation, or alternatively diseconomies result from the disruption of reorganisation or a poor management by relative new comers. I have pointed out enough points to make economies of scale a lesser incentive to merge. Perhaps a greater one is 'merger for monopoly power', with less competition the firm will face less elastic demand and will be able to charge a higher % above marginal costs.
Finally, the consumer, I do feel that the merger will offer a lot to new consumers and all new possibilities (see appendix item 1.1). The companies will be able to find out a lot more about customer preferences e.g. what they buy and where from, where they live, what books they like, what music they listen to etc. Consumers will certainly have a lot more choice over their chosen forms of entertainment. Now for the question of the new firm having a 'monopoly'. TW AOL will almost certainly have monopoly power but no-one knows whether this will be bad, I think that regulators will be monitoring its activities closely, but the fact that they let the deal pass shows some faith in the new company. "The commission [was] worried about creating a dominant...Internet group that could, perhaps, control distribution." Distribution over both the Internet and the cable networks but let's not forget that there are many other media-internet partnerships (see appendix item 1.2).
Appendix
Time Warner
Properties
Possibilities with AOL
Studios
Warner Bros, New Line Cinema, Castle Rock
Development of Internet movie business, movies on demand.
Programming
Warner Bros. Televsion (e.g. Friends); the WB (e.g. Buffy the Vampire Slayer); HBO (e.g. the Sopranos). Also TNT, TBS, CNN and the Cartoon Network
TV will become a lot more interactive, users can request all sorts of information.
Music
The Warner Music Group includes the Atlantic Group, Elektra Entertainment and Warner Bros. Records.
AOL's online radio station can promote WB's music. Customers will be able to download music.
Publbishing
Thirty-Three magazines including Time, Fortunue, Life People etc. Also book; Warner Books and Little Brown.
Distribution of AOL 2get connected" CDs in Magazine covers and other cross marketing.
Cable
Time Warner Cable
Gives AOL broadband outlet access and access to TIME Warner Cable's 13 million customers.
AOL
Properties
Possibilities with Time Warner
ISP
AOL's online service, Netscape, Compuserve, MovieFone, Instant Messenger.
Speedier Internet and interactive TV services using Time Warner's cable lines.
Appendix item 1.1
Source: TIME magazine (Jan 2000) and The Economist (Feb 2000)
Date
Old Media Company
New Media Company
Details
February 1999
USA Networks
Lycos
Merges with USA Networks subsidiary
January 1999
News Corps
Yahoo
Cross-promotion
January 1999
CBS
AOL
CBS to provide AOL news
October 1998
Bertelsmann
Barnesandnoble.com
Bertelsmann buys 50%
August 1998
USA Networks
CitySearch
Merges with USA Networks subsidiary
June 1998
Walt Disney
Infoseek
Disney buys 43% of Infoseek
June 1998
NBC
Snap
NBC buys 19% of Snap
March 1997
CBS
SportsLineUSA
CBS buys 11% of SportsLine
March1997
NBC
Microsoft
Joint Venture
Appendix Item 1.2
Source: Various Company Reports/Economist -"Do they have anything in common?" - Feb 11th 1999
* "the term 'merger' is generally used to include both mutual agreements and acquisitions" - Economics Third Edition John Sloman - 8.2 Alternative Maximising Theories page 223.
† The Economist - Do they have anything in common? - Feb 11th 1999
‡ "the voluntary union of two companies where they think they will do better by amalgamating." Economics 6th Edition David Begg - Industry policy and competition policy (pg305)
§ The Economist - "Do they have anything in common" - Feb 11th 1999
- 1 -
