AOL - Time Warner Merger

Presented by: Group 3, FMG 20 Sec E Reshma Soni (201127) Shruti Sharma (201155) Shubham Gupta (201156) Sonakshi Goyal (201160) Surya P. Naulakha (201162) Vibha Bansal (201174)

Timeline
Warner brothers registered as film production business Quantum Compute Systems name changed to AOL Time Warner and AOL merger

Quantum Computer Systems founded

1923

1925

1985

1986

1991

1996

2000

2009

Warner brother s went public

Warner acquire d Time

Time Warner acquired Turner Broadcasting System

Spin off of AOL

Time Warner- History

1923: Warner brothers registered as film production business

1925: Went public- Popular cartoon series (Looney Tunes) & movies (Casablanca)
Acquired various record labels 1989: Time (a publishing house then) acquired Warner Brothers for US$14 Billion- Time Warner 1996: Time Warner acquired Turner Broadcasting System to become 2nd largest cable television network Time Warner- became a multi-media company with
record labels motion picture & television production and distribution studio facilities and film libraries television networks book and magazine publishing

Time Warners Business Model

Five main divisions:

Cable Networks (CNN, TBS, TNT, HBO, Cartoon Network)

Cable Systems (Time Warner Cable)

Filmed Entertainment (Warner Bros., New Line Cinema) Music (Warner Music Group, WEA, Warner/Chappel Music)

Publishing (Time, Warner Books, Little, Brown and Company)

AOL - History
1985: Founded as Quantum Computer Systems Provided content and interactive services through dial-up modems 1991:Changed its name to America Online Inc. Pursued aggressive acquisition strategy in 1990s Since 1996: Began transformation from computer-networking company to media giant and made changes in its strategic direction to the investment community

At the time of the merger - had about 30 million subscribers, about

40% of total US online subscribers

AOLs Business Model

Four main divisions:
Interactive Services Group (AOL Service, Compuserve, Netscape, AOL TV and AOL Wireless) Interactive Properties Group (AOL Messaging, ICQ, Instant Messenger, AOL Local and AOL Internet Music) AOL International (operations outside the United States)

Netscape Enterprise (iPlanet E-Commerce Solutions)

Situation Prior to Merger

AOL
Internet Service Provider- generated 70% revenues 30 million + subscriber base

TWX
Diverse portfolio within media & entertainment sector Strong industry presence Broadband content distributor- revenue growing at 10%-15% p.a. High delivery & distribution costs Inability to exploit their cable and media assets and no clear Internet strategy Sentiment that future growth in sector could only be tapped through new media Opportunity to tap into convergence of media entertainment & IT sectors

Limited content
Rising competition in industry (Microsoft, low cost ISPs) Lacked broadband technology Falling revenues were projected early and expansion was required Uncertainty regarding the future of open access

Reasons for Merger Time Warner

High growth potential of Internet firms: An expansion opportunity AOLs brand name Internet infrastructure: Building own capabilities would be both very costly and time intensive 30 million big customer base: Increased revenue opportunity Expectation of significant synergies: Combining its media contents with the new distribution possibilities AOLs strong Internet presence provides Increased scale & scope of new company: Strengthened international position

Reasons for Merger - AOL

Need for broadband technology

Expansion of the content available to online users

Increase revenue: From subscriptions, advertising and e-commerce and content Huge potential for Operating Synergies: Cross-promotion, efficiency in marketing, cost reductions in launching & operating new technologies and new business opportunities Prevent collapse in valuation: Stock severely overvalued

Expected Result
Media value chain: Convergence of new and old media forms
New Benefits to the Customers Digital Revolution: In the Online Media and Entertainment industry Revenue opportunities: In areas such as advertising,

Growth opportunities: Increased numbers of cross-promotion and marketing for Time Warners content through the channels of AOL.
Marketing Efficiency: Across different platform and distribution systems, Cost Synergies: Shared business functions (i.e. R&D and cost efficiencies because of launching interactive extensions of Time Warner Brands).

The Merger
Form of Restructuring
Expansion Strategy through Inorganic growth

Type of Restructuring

Amalgamation: Formation of a new firm AOL Time Warner Inc.

Type of Merger

Primarily an Unrelated Diversification Horizontal: Content sharing across Internet & cable TV Vertical: Cost cutting by distribution through Internet

Strategy Methodologies

Strengths
Leverage brand name of both companies Additional 30mn+ user base TWs experience, rich content, rights & high revenues Broadband Technology Cost Savings Diversified business

Weakness
Integration issues, Culture contrast Failure to execute strategy Unrealized synergies Weak financial health of AOL Incompetent management and due diligence Not a merger of equals

SWOT Merged Entity

Opportunities
2nd phase of Internet usage- rich multimedia content, social networking, VOIP, etc. Making TW content available to AOLs cust. Broadband technology to AOL users as well Integrated media platform Expanded Reach Synergies Cross Selling Synergies

Threats
Local phone cos. having fist mover advantage in Broadband tech Dot com bubble burst/ Stock Market Crashes Competition from firms like eBay, Yahoo, Google, Amazon Possible merger of other companies in same fashion (e.g. Yahoo and Disney)

Logical Incrementalism
An incremental benefit will accrue to both the companies by integrating the two domains traditional media and internet

A logical step towards a holistic media conglomerate

Analytical Frameworks
Product Life Cycle Product-Market Matrix Value Chain Analysis Growth Share Matrix Strength Industry Attractiveness Matrix

Product Life Cycle

Time Warner

AOL

Product-Market Matrix
Product Present Market Present Low Risk High Risk
AOL -Time Warner

Related

Unrelated

Related High Risk

Unrelated

Highest Risk

Value Chain Analysis

Forward Integration

Backward Integration

For TWX
Distribution through internet channels: AOL

For AOL

Content sharing with TWX

Growth Share Matrix

AOL

TWX

Strength Industry Attractiveness Matrix

Industry Attractiveness
High Medium Low

Business Strengths

High

AOL Time Warner AOL Time Inc. Warner Inc.

Time TWX Warner

Medium

AOL AOL

Low

Theories of Merger
Efficiency Theory of Merger
Synergies Strategic Realignment to Changing Environments Q Ratio

Efficiency Theory of Merger

Two major efficiency theories of merger, which are: Differential Efficiency Theory Inefficient Management Theory

Differential Efficiency Theory

AOL: Internet Capability

TWX: Media and Entertainment

Synergies
Synergy = VAB - VA + VB = $342.6 ($189.5 + $90.7) = $ 62.4 billion

Financial Synergies
Great Investment Opportunity Still at Growth Stage High Expected Returns However, expected to bring only
18% of the revenues 30% of the operating cash flows

AOL

TWX

Exhausted All Profitable Investment Opportunity Reached Maturity Stage

TWX shareholders were to benefit with the increased value of the firm after merger

Operating Synergies
Leverage online/offline distribution and sales infrastructure to increase advertising revenues

Wider client base

Effective Cross-selling synergies: Increase in market share

Offer new content and services: To grow its broadband cable subscriber base

Increased revenue: From Subscription, Advertising, E-commerce, Content Cost Synergies: Shared business functions (i.e. R&D and cost efficiencies because of launching interactive extensions of Time Warner Brands)

Operational Synergies (contd.)

Synergies through Economies of Scale
Deliver same media products to more outlets Deliver existing product over Internet Cross-promotion of AOL & TW media products Selling of audiences to advertisers Create giant database of private information More muscle for international expansion

Synergies through Economies of Scope

Bringing innovation in product R&D of the combined entity Creating new media product & services for Internet delivery Facilitating online music revolution Accelerating race to high-speed service Accelerating development of narrowcasting, i.e. linking products with niche consumer demographic groups Prolonging the life stage of business by merging with a firm from a new born industry

Managerial Synergy
Expertise and talent of the management
Internet domain based by AOL managers Media and Entertainment by TMW managers

Corporate image and branding; leading to increase in revenues

Strategic Realignment to Changing Environments

Changing environment : Technological Revolution

TWX wanted to guard itself against the changing environment of shifting preferences from cable media to internet media.

What it didnt factor in was the fact that the internet companies were highly overvalued at that time and that future prospects were not promising.

Q-Ratio

The q-ratio is defined as the ratio of market value of the acquiring firms asset to its replacement cost.

The q-ratio for AOL was much more than 1 as this being an internet based firm, didnt have much value in the form of tangible assets, but was highly valued by the market riding on the boom of dot-com companies.

Thus we see that Time Warner went for the deal despite adverse recommendation on the basis of this theory

Are major problems likely when combining different cultures in this combination of bricks and clicks?

Challenges posed by cultural differences

AOL TWX

Click company Young Turks Centralized approach Top-down system Higher degree of openness Shorter time horizon

Brick company The feudalistic old school hierarchy of Time Warner Decentralized approach More improvisational approach

Result
Cultural clash one of the major reasons behind AOL Time Warner merger failure

Tumultuous ego clashes between the young turks of AOL and the feudalistic old school hierarchy of Time Warner

Within a few months after the AOL TW merger top-executives began to leave the company.

Discuss the issue of the integration of diverse compensation structures between Time Warner and AOL

Challenges in integrating Compensation Structure

AOL
Salaries of AOL employees less than industry average
Compensation mostly in terms of stock options at AOL

TWX

Fixed pay and profit sharing with employees in Time Warner

Merged

Generational gap between the employees of two companies High percentage of variable pay created a risk taking environment and dissatisfaction among employees of merged entity

Has the merger yielded the synergies forecasted for 2001 and 2002?

AOL-Time Deal Structure Warner

AOL Shareholders

TWX Shareholders

1 AOL Share: 1 AOL TWX Share

55% ownership in AOL TWX

1 TWX Share: 1.5 AOL TWX Share.

45% ownership in AOL TWX.

Stock Prices
90 80 70 60 50 40 30 20 10 0 90 73

71
47 AOL Time Warner

Deal Announcement: 1/10/2000

Deal Closure: 1/11/2001

Deal Announced: 10th January 2000. AOL: USD167 Billion Market Value of Companies Time Warner: USD 124 Billion

Deal Closed: 11th January 2001. AOL: USD 107 Billion Time Warner: USD 98 Billion

Deal Announcement:10-Jan2000

Deal Closure:11-Jan-01

43% 45% 55% AOL Time Warner 57%

AOL Time Warner

Ownership control in AOL Time Warner

Failure of Synergies
The stock price of AOL Time Warner fell from its peak of almost 90 US$ in 2001 down to almost 10 US$ in 2003 Hence, huge decline in value of the firm. Unable to capitalize on the potential synergies that were expected to emerge, due to cultural mismatch and management inefficiencies.

Reasons for Failure

Strategic Vision

Deal structure

Due Diligence

Post-merger integration

External environment.

Redistribution of Wealth & Control

So while Time Warner will initially provide roughly 70 percent of the combined companys profit stream, AOL actually will control a greater stake of its stock because of how highly Wall Street values the growth potential of the Internet.

Costs associated with the Merger

Restructuring liability for TWE of approx $210 million during 1st quarter 0f 2001

$55 million employee termination benefits

$155 million- lease & contract termination costs Restructuring liability for costs to be incurred for : - Exiting and consolidating activities at TWX - Terminate employees throughout TWX

Source: AOL Time Warner Inc. MDA, March 2001 ended Quarterly Report

Income Tax Benefit

Benefit from amortization of goodwill certain other non tax deductible expenses, and depreciation

AOL Time Warner- had income tax benefit of $73 million in 1st quarter of 2001

Source: AOL Time Warner Inc. MDA, March 2001 ended Quarterly Report

Share Repurchase
January 2001- Board of Directors authorized common stock repurchase program

AOL Time Warner to repurchase $5 billion of common stock over two-year period.

During 1st quarter of 2001- Company repurchased 14.1 million shares at an aggregate cost of $615 million

Why?: to reduce outstanding shares, increase share value

Source: AOL Time Warner Inc. MDA, March 2001 ended Quarterly Report

Regulatory Issues
Government regulators had been lobbied heavily by rivals such as Walt Disney

Rivals contended that the merger would create an unfair media monopoly.

It was Forced to offer one rival broadband Internet service provider access to its cable system before AOL can begin such a service, followed by at least two additional services within 90 days

What went wrong?

A Few Strategic Blunders

Dot Com burst

AOL failed to tap the Broadband market in time. Lost subscribers to other broadband networks. Post Dot Com burst, it was realized that very few synergies actually existed

AOL: Not an Equal Counter part Highly Overvalued in wake of Internet bubble. Steep Decline in Advertising Revenues

Failure to implement vision

Failure to recognize trends in digital industry. Broadband Internet Telephony Failure to market Time Warner content through all possible channels Never Executed their vision of combined music platform. Ex:- Apples itunes. Ignored trend of Highly personalized Internet Content Like social networking

Cultural issues
AOL High Tech Old-world Time Warner

Tight on finances/Cost Cutting

Casual, khakis and cotton shirt Centrally managed Smaller and younger

Spendthrift
Suit and tie Decentralized Big, mature-AOL, the size of one division

Top Down Management style Compensation-Stock Option-Internet Trend 20 something

Improvisational Approach Profit Sharing-Old School

Grey Beard

Focus on stock price

Focus on organic business growth

Controversy associated with AOL-TWX

Steve Case selling off his major chunk of AOL Stock

The fact that Case sold a major part of his AOL stock soon after the merger was announced in January 2000 (when the price of the stock was high) and made an estimated profit of $ 160 million evoked suspicion and anger among shareholders. They thought that Case was aware of the fate of the merger and accused him of making money, when the time was right, at the expense of the shareholders.

Time Warner was thinking it was they to mainly benefit from the merger since they could access AOLs media channels and promote their content through it.

AOL in contrast was the party that gained most through the merger because they were able to use Time Warners broadband cable network and extend their broadband business.

AOL Time Warner Split

Most Significant Corporate Failure Failure to Integrate

The $360bn (221bn) merger, announced in January 2000, is widely viewed as one of the most significant failure of corporate activity in modern times.

The merger's collapse was a result not only of the bursting of the dot-com bubble but also of the failings by AOL Time Warner management to ever actually integrate the two companies.

The Split of AOL-TWX: Spin off

Time Warner stockholders received 1 share of AOL common stock for every 11 shares of Time Warner common stock they held on the record date of November 27, 2009. The distribution of shares was made in book-entry form.
The number of shares of Time Warner common stock that you help prior to the spin-off did not change as a result of the distribution of AOL shares. However the trading price of your Time Warner shares no longer reflects the value of AOL. Fractional Shares were aggregated and sold in the open market.

Post Split Valuation Market cap Time Warner: about USD 36 billion. AOL: about USD 2.5 billion. The Decision to spin off AOL was seen by many analysts as the inability to find the buyer for AOL.

AOL: A Separate Entity

Time Warner

To operate its existing internet connection business Focus on growing its online content business.

Spun off its non core business. Focus on its Publication, Television and Film Businesses.

Thank You