Will the AOL-TWX mega-merger turn to mush?
By Lisa Meyer
Redherring.com, November 27, 2000
What once was seen as the merger that would transform the media industry is losing its punch.
Beaten down by delays and compromises, America Online (NYSE: AOL) and Time Warner (NYSE: TWX) took yet more hits this past week in the wake of Time Warner's agreement to open its cable lines to Earthlink (Nasdaq: ELNK), the nation's second-largest Internet service provider (ISP). AOL fell 17 percent over the week, closing at $41.18 on Wednesday, while Time Warner dropped 15.7 percent to $61.50. Earthlink rose 17 percent on Monday following the announcement of the Time Warner access agreement but fell 15 percent since then, closing at $7.06 on Wednesday.
Since the AOL Time Warner merger was proposed on January 10, AOL's stock has slid 42 percent. Time Warner's shares have dropped just .9 percent since the deal was announced, but the stock is trading 40 percent below its 52-week high.
"Anytime that there is uncertainty on a deal, especially in such an important deal as this for both companies, the level of anxiety has caused investors to become nervous," says Ken Kiarash, an analyst at Buckingham Research Group.
And each new item added to the list of requirements has put off the date for the merger's completion, now estimated to be the beginning of next year. But even that new target date may be too optimistic.
WHAT WILL BE ENOUGH?
As a precondition to approving the merger, the Federal Trade Commission has mandated that Time Warner open its cable lines to ISPs other than AOL and that an actual deal must be signed before the new company is formed. Time Warner had been negotiating such a deal with Earthlink since the beginning of the year, but the talks hit a rocky path when Earthlink complained that Time Warner's proposal made it hard for it to make any money.
Many analysts believe that Time Warner is still negotiating terms with Juno Online Services (Nasdaq: JWEB), the third-largest ISP even though the two struck a deal in July. At that time, the companies said Juno would have access to Time Warner's cable lines, but the terms of the agreement, including a date for the access, were not set.
It seems that AOL and Time Warner's idea of equal access may not level the playing field, as the government had intended. According to a report by Buckingham Research, Time Warner had originally been demanding that ISPs give 75 percent of the gross subscriber revenue in exchange for being allowed access to its high-speed lines. The media company also wanted 25 percent of the ISP's advertising and e-commerce revenues generated from access to Time Warner cable lines.
"It came down to Time Warner bullying other ISPs if they wanted to get access to its broadband networks," says Mr. Kiarash. "It made no economic sense for these ISPs. So the FTC took a harsher stance."
Even though only the government has seen the terms of the Earthlink deal, Mr. Kiarash believes that this agreement, which would set a precedent for future deals, favors the ISPs over Time Warner. The government's pressure on Time Warner to strike equitable deals with competing ISPs puts them in favorable negotiating positions. "AOL Time Warner is being forced to do a deal that isn't good for them in the long term," says Scott Reamer, an analyst at SG Cowen Securities.
BIGGER FISH TO FRY
But while AOL and Time Warner may not be able to wrestle as much revenue from smaller ISPs as they had originally hoped, the two companies clearly have rivals much larger than Earthlink and Juno on their minds. And that's why we still think the deal makes a lot of sense.
As concerns about an advertising slowdown in both traditional and online media continue to escalate, it's clear that the two companies need this merger in order to maintain their competitive edge over rivals such as Fox, Disney, Viacom, and Yahoo. "The weakening fundamentals of AOL and Time Warner would be masked by the two companies merging income statements and balance sheets," says Mr. Kiarash.
But if the merger does go through, AOL Time Warner would be a media powerhouse, despite the competition from ISPs. AOL's existing membership of 25 million subscribers is far larger than Earthlink's 4.6 million subscribers. Together, AOL and Time Warner will penetrate 60 percent of U.S. households, according to Mr. Reamer.
Indeed, the slowdown in ad revenues for both companies could be remedied with the merger. The new company could increase ad revenues through customers won with offers of advertising packages appearing across various platforms. Moreover, the two companies combined would have a higher total of existing clients since only a handful of advertisers in the top 100 of AOL and Time Warner customers overlap.
The delays and compromises may have watered down the stock prices of AOL and Time Warner in the short term, but the combined company still stands to be a global media giant. "The deal has merits other than open access," points out Mike Kupinski, an analyst at A.G. Edwards & Sons. "AOL didn't buy Time Warner to have an exclusive deal, but rather for its content. And AOL brings Time Warner a new distribution channel."
When this deal actually will be consummated is still anyone's guess. We at Red Herring, however, think it's worth the wait. Despite the delays and compromises, the fusion of the world's largest ISP and the nation's second-largest cable provider should create a very valuable franchise. And with AOL's stock hovering near its 52-week low, we think it's still a good time to buy, especially for long-term investors. |
