First Union Securities Covers AOL and TWX
By: First Union Securities
11/21/00 7:38:46 AM
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AOL-TWX: EARTHLINK DEAL SHOULD ALLEVIATE REGULATORY CONCERNS
America Online, Inc. (AOL-NYSE)
Stock Rating: 1;
Target Price: $80
Quote Snapshot
TWX 67.10 -2.51
AOL 45.02 -2.07
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Time Warner, Inc. (TWX-NYSE)
Stock Rating: 1;
Target Price: $120
KEY POINTS
--Commercially negotiated open access is a good thing for the combined company – the only question has been how it would be implemented by the FTC.
-- The recent concern has been that the FTC would require a deal with another ISP before allowing the merger to close, hence delaying the deal – this now appears a moot point.
-- AOL Time Warner’s pact with the #2 ISP EarthLink should allay the FTC’s open access concerns.
-- Financial and technological details have not been disclosed.
-- We continue to expect the merger to close by early next year without onerous concessions that will in any way hamper the long-term growth of the combined company.
-- AOL Time Warner is rated “Strong Buy” with an $80 price target – uniquely positioned company with superior growth and a compelling valuation. The merger closing is a major catalyst in our view.
Putting the Deal with EarthLink in the Bigger Context
Yesterday’s announced deal between Time Warner and EarthLink brings the company one step closer to completing its merger with AOL. The merger closing has never been a serious question for most observers (i.e., the arb discount has remained only about 1%); the preoccupation in the press has simply regarded exactly when it will close. In our view, late 2000 or early 2001 makes little difference in the bigger scheme of things as long as regulatory concessions do not arise that hamper the growth of the combined company. Fortunately, that is not the case. The issues are the issues at this point, and should come as no surprise to investors who have been bombarded with near-daily updates in the paper –- open access, not punishing third-party content, interoperability of instant messaging, etc.
The concession that has perhaps been the most debated by the Federal Trade Commission is open access. Commercially negotiated open access is a good thing for the combined AOL Time Warner, despite the talk that it is a concession that must be forced upon the company. After all, AOL did not link up with Time Warner to gain exclusive access to only 20% of the country. That would be somewhat short-sighted given its market share. The recent question has simply been how the FTC would implement non-exclusivity. The regulators have been considering two different options regarding open access: 1) AOL must wait to offer access over Time Warner’s pipe until at least one other ISP was signed on, or 2) Time Warner must have a definitive agreement in place with another ISP before the merger itself can actually close. While the latter way of implementation is overkill in our view, it should now be a moot point given the deal with EarthLink.
Given that EarthLink is the #2 ISP with 4.6 million subscribers, the FTC should find this agreement a satisfactory indication of AOL Time Warner’s desire for open access. Financial details of the deal are not available at this point, but we believe that it will be viewed as a fair, third-party deal given EarthLink’s clout.
Timing for the AOL Time Warner Merger
The recent uncertainty has been about how long would it take for Time Warner to sign up another ISP to satisfy the FTC, assuming they required such a deal to approve the merger as described above. With this question out of the way, we expect the merger to close by the beginning of next year. Here are the steps:
-- Step #1 FTC approval: While the FTC could decide sooner, the commission has said that it will issue a ruling by December 14.
-- Step #2 FCC approval: The FCC should be able to give its approval within a few weeks of the FTC. The FCC has said that it could take up to 30 days if the FTC changes the “structure” of the new company. Since we do not envision any structural changes to AOL Time Warner, we suspect the FCC will finish in less than 30 days.
-- Step #3: actually, there is no step #3. Shareholders have already approved the deal and the companies could presumably close the merger within a few short days following approval from the FCC. Our best guess is that the merger should close by mid-January, but it could clearly be sooner if everything went perfectly. The company has said that they expect the deal to close by the end of this year, or early next year. Either is fine in the grand scheme of things.
The Deal with EarthLink
Details of the deal with EarthLink are somewhat limited at this point, but here’s what we know. The pact announced yesterday will allow EarthLink, the nation’s second-largest ISP, to offer its services across Time Warner’s cable platform. According to the agreement, AOL will be able to offer its services only after EarthLink’s services become available in each market. An effective way to prevent exclusivity in our view.
In addition, Time Warner will market EarthLink’s service on a non-discriminatory basis and EarthLink will have access to Time Warner’s business segments to run various promotions. Nothing surprising or troubling.
EarthLink expects to begin offering its services in the second half of 2001 after the Road Runner partnership is restructured. Time Warner has already announced that it is currently working to restructure Road Runner as soon as possible with the co-operation of AT&T, which is required to shed its stake in Road Runner by the end of 2001 as a condition of its acquisition of MediaOne.
Investment Conclusion
It’s not over until it’s over when it comes to regulators, but we continue to believe that we are in the final stages of the regulatory process. The press reports about the regulatory problems facing this combination have been unavoidable, and it is easy to lose a bit of perspective. The deal has never been in jeopardy of not closing, and it makes little difference in the bigger picture if it is late December or January. Either way, a major catalyst is looming for a uniquely positioned company with superior growth and a compelling valuation. The current pro forma EBITDA multiple of 20x for AOL Time Warner represents a 15% discount to the company’s long-term EBITDA growth rate of 23%-25%. Our 12-month price target is $80 per share, based on a 27x multiple of 2002E EBITDA. Both AOL and Time Warner are rated Strong Buy.
Additional Information Available Upon Request.
Analyst holds a long position in TWX.
TWX is on the Analyst Action List
This is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments mentioned. Interested parties are advised to contact the entity they deal with, or the entity that has distributed this report to them. The information has been obtained or derived from sources believed by us to be reliable, but we do not represent that it is accurate or complete. Any opinions or estimates contained in this information constitute our judgement as of this date and are subject to change without notice. First Union Securities, Inc. (“FUSI”), or its affiliates may provide advice or may from time to time acquire, hold or sell a position in the securities mentioned herein. FUSI is a subsidiary of First Union Corporation and is a member of the NYSE, NASD and SIPC. Copyright © 2000 First Union Securities, Inc. FUSI is a separate and distinct entity from its affiliated banks and thrifts.SECURITIES: NOT FDIC-INSURED • NOT BANK-GUARANTEED • MAY LOSE VALUE |
