Why did AOL think it could gain synergies with Time Warner? Have they failed, or was the gaining of synergies not the aim of the merger?

Both

"It's a watershed event because of the compelling strategy of combining content with state-of-the-art distribution," says Ken Berliner, head of mergers and acquisitions at Peter J. Solomon Company, based in New York City

AOL would get access to Time Warner's cable TV systems. Using those systems, which now serve 13 million subscribers, AOL could launch much faster Internet and interactive television services.

The [pounds]220bn merged entity also promises to offer advertisers new opportunities to integrate campaigns across global media

While AOL will benefit from Time Warner's US cable distribution capabilities, with music, film, publishing and news content, the latter will have access to AOL's 20 million registered homes.

AOL prizes both Time Warner's content and its cable subscriber base of around 35 million US homes

The key to the deal is developing new types of Web sites and services using Time Warner's rich content and getting them up quickly using AOL's vast Web infrastructure. Another plus: The companies will combine sales forces and back-end functions such as sales and customer support call centers.

In all, the two companies promise to generate $1 billion in extra cash flow from ``synergies'' in their first full year together. That includes eliminating some of the $800 million AOL spends on advertising by using house ads across Time Warner media.

Music will be first potential beneficiary from synergies

SLICE AND DICE. That's a promising venue for advertisers, notes Renatta McCann, managing director for Starcom North America, a media buyer with $8.5 billion in annual billings. ``The combined company will have a fantastic database,'' says McCann. ``They will have a phenomenal way of slicing and dicing their consumer database to deliver the specific target audiences that I want.''

Possible reasons against

"What was hindering some of these deals in the past were concerns over valuation, particularly the Internet company's multiple coming down with a combined entity. But that didn't happen in the Time Warner-AOL deal." Ken Berliner, head of mergers and acquisitions at Peter J. Solomon Company

Booz Allen's Hoffman advises caution. As with any partnership, firms should examine whether their goals and objectives mesh, whether both parties can deliver on promises, and whether management is sound, he says.

Proper planning for implementation??

Control – internet companies unfair share?

Business Week, (Jan 24, 2000) “Welcome to the 21st Century” The McGraw-Hill Companies, Inc. i3665 p36

very real concern about culture clashes

Time Warner empire, which has 82,000 employees and a distinctly Old Economy management culture that could rob 15-year-old AOL of the flexibility, speed, and entrepreneurial drive that are crucial in the New Economy

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5. WERE SYNERGIES NOT THE AIM OF THE MERGER?

Mergers and other diversification strategies are not always pursued for the exploitation of synergies. Firms may merge in order to reduce shareholder and management risk, or because of management’s personal objectives.

In buying Time Warner using their vastly inflated share price AOL acquired tangible assets of an established and hugely successful firm. Cynics argue that the merger was merely a way for the firms shareholding management to pursue their own objectives and get rich quick. Not least because immediately after the merger, when the share price was far higher than it is today, 14 executives realised $256m, including the new CEO Mr Parsons ($35m) and the former CEO Mr Case ($50m). 

Furthermore evidence suggest that top management’s salaries and prestige are correlated with corporate size rather than corporate profitability. A study by Roll (1986), Hayward and Hambrick (1997) adds to the argument that management may have merged for their own personal reasons pointing to the issue of management hubris. This is where management have “exaggerated pride or self confidence, often resulting in retribution” and so believe they can achieve more than is actually the case.

Conglomerate and horizontal mergers may also be pursued so as to reduce shareholder risk by ensuring revenue flows from a number of different sources. However, I do not believe that this was the motive behind the AOL Time Warner merger. It is widely known that if shareholders want to reduce their risk by diversifying they can achieve it at a far lower cost than can a firm (less transaction cost) by widening their portfolio or investing in a mutual fund.

Nevertheless AOL and Time Warner may have merged so as to reduce the risk exposure of its management. Given that cyclicality in profit levels is related to cyclicality in employment, provided employees are transferable between separate businesses of the firm, their may be benefits to management from the increased diversity of the firm – as it has more ability to smooth output fluctuations.

In the 2000 annual report Case and Levin wrote that they had a “fundamental focus on acting swiftly to realise the benefits of cross-promotion and shared infrastructures”. It is comments such as these that lead me to believe that the principle motive behind the merger of AOL and Time Warner was to exploit synergies. In the next section I discuss whether they have succeeded.

 

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5. HAVE THEY FAILED TO GAIN SYNERGIES?

On the face of it AOL Time Warner appears not to have gained any synergies. The share price has plummeted since they completed the merger by more than 60%, they reportedly made record losses in 2002, and much of their former management has left or is about to. Some argue that Time Warner is being dragged down by AOL, which is suffering from decreasing advertising revenues and slowing subscriber growth. Management openly admits that so far the merger has not reached expectations and many feel that, like so many others before it, the merger has failed. Scholars who oppose conglomerate mergers like this would point to theories (which I cannot prove in this case) that suggest that, because of influence cost and incentive effects, such diversification results in inefficient resource allocation between the divisions. They argue that the firms would have been more efficient if they had remained independent having to compete in the market to provide their respective distribution and content capabilities. Write better!

On the other hand, there are arguments to suggest that AOL Time Warner has been the victim of an adverse economic climate, and that their inability to exploit synergies have not been conclusively proven.

Firstly, as shown below, the fall in AOL Time Warner’s share price is less than that of similar companies, such as yahoo, and is largely in line with the NASDAQ trend. (Before the merger AOL was listed on the NASDAQ)

AOL Time Warner share price since March 2000 vs. the NASDAQ

(graph from Financial Times website – www.ft.com)

Factors such as the slowing global economy, September 11th, the bursting of the dot com bubble, Enron, and recent accounting speculation over the former AOL have all reduced shareholder confidence, and are not necessarily to do with poor exploitation of merger synergies.

Furthermore a substantial proportion of AOL Time Warner’s revenues are generated from online advertising, these have decreased, but largely in line with total spending on online advertising which has decreased from approximately $8.2 billion in 2000 to approximately $6.3 billion in 2002. In addition many of the percieved synergies of the merger have been eaten away by the illeagal downloading of music and film from the internet.

Empirical evidence from the 2001 annual report suggest that synergies are being realised. Revenues increased from $14,733 million in 2000 to $16,543 million in 2001, earnings before interest depreciation and amortisation (EBITDA) have increased from $8,394 million to $9,996 million.  Furthermore, in public at least, management boast about the synergies they have realized:“Our cross-promotions are already having impressive results. AOL continues to generate about 100,000 Time Inc. subscriptions monthly.”

I think that the merger has not failed and that they will and are exploiting synergies. AOL is still the world’s largest ISP with 34 million subscribers, which will do well when Internet advertising recovers. Furthermore synergies will only increase as AOL expands its introduction of broadband, which will enable them to deliver consumers even more of Time Warner’s content. I believe AOL’s founder, Steve Case, when he says: “The true value of this union lies not in what it can do today, but what it will achieve in the future.”

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5. CONCLUSION

My research of AOL Time Warner’s company literature has led me to conclude that, although there are other motives, a key reason for the merger was to gain synergies. I have discussed what other possible motives for merging there may have been, such as management’s personal gain; and why AOL Time Warner strategists thought they could gain synergies from economies of scale and scope, the internalisation of transaction costs, and financial synergies.

Many commentators believe that the merged firm’s attempts to gain synergies have failed, and all agree that their performance has been disappointing. However, I believe that this merger was not a mistake, and that in order for firms to remain competitive they must continually change and redefine the business in which they operate. I believe AOL Time Warner’s poor performance has largely been outside of management’s control, and is more a reflection of the difficult external economic environment.  Mergers require adjustment time, and AOL Time Warner may not yet have exploited all the synergies that exist, but they are beginning to, and I believe will continue to in the longer-term.

The decision to ‘Make’ rather than ‘Buy’ was found to be

positively related to the size of hold-up costs and negatively associated with human

asset specificity and the existence of uncaptured economies of scale and scope

when the component or task is internally procured.

Over the years an impressive

number of empirical studies have been carried out which obtain results consistent

with the prediction that asset specificity is the main determinant of vertical

integration

Internal procurement of a component may imply foregoing economies of scale or

scope in production which are available to an external supplier. Lyons (1995, p.

432) argues:

It is argued that the production cost advantage of the market

declines as assets become more specific because it becomes increasingly difficult

to aggregate the different demands of a number of buyers. However, this

aggregation of demands argument appears to rely on a singular relationship

between the ‘uniqueness’ of a given good or service and the specificity of the asset

which is used to produce it3. This is not merely an heroic assumption, but actually

runs counter to one element in the gamut of specific assets: the ‘dedicated asset’4.

In addition, the specification of economies of scale used by Lyons (1995) – and

also used in the empirical work described below – is in fact uncaptured economies

of scale resulting from a given firm’s demand requiring a level of production below

minimum efficient scale; in-house production therefore suffers from technical

inefficiency5. These uncaptured scale economies are governed by the firm’s level

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5. REFERENCES

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Lowry, T. and Henry, D. (July 29, 2002) “It’s not time to jettison AOL – yet”

Business Week, The McGraw-Hill Companies, Inc. p78

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Case,S. and Levin, G.M. (March 27, 2001) AOL Time Warner Annual Report 2000, 

Business Week, (Jan 24, 2000) “Welcome to the 21st Century” The McGraw-Hill Companies, Inc. i3665 p36

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Alsop, S. (Feb 17, 2003) “Dear Dick: Here's the Advice You Paid for--Keep AOL” Fortune, v147 i3 p148

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Examination” Financial Management 31(1), 51-81

Daniel Okrent (2000) “Happily ever after?” Time Magazine, January 24, pp43-47.

Crook, Proff J. (2002), Economics of Corporate Strategy Course - Lecture 6 Notes, School of Management, University of Edinburgh

Grant, R.M. (1998), Contemporary Strategy Analysis, Blackwell Publishers Ltd. p363-386

Singhania, L. (Jan. 14, 2003), “Case says AOL Time Warner merger a ‘disappointment’”, www.startribune.com/stories/484/3589346.html

Howe, P.J. “Analysts: AOL woes remain despite case plan to resign”,

Krane, J., (Jan 14, 2003)“Once Mighty AOL slipping behind the times”,

Waters, R. and Taylor, P. (Feb 26, 2003), “The internet after Steve Case: AOL may be reeling but the online world he helped to create is ready to burst into life”, The Financial Times

The Economist (US), (Jan 26, 2002) “Who's afraid of AOL Time Warner? Media giants”, Economist Newspaper Ltd, pNA

                                       

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