The AOL-Time Warner Deal

| 16 Feb 2015 | 04:51

    So he put his Internet currency to work (best if used by the year 2000!) and bought Time Warner. The press loved it because it afforded them the opportunity to write about themselves. Wall Street loved it, at least at first, because it put bigtime revenues and earnings behind an Internet company. The lawyers loved it because it meant many, many billable hours. Washington loved it because greasing the deal meant lots of work for the fixers and plenty of campaign contributions all around.

    In some ways, it's a good deal. AOL needs broadband access to residential homes. Time Warner is the nation's second-largest cable television service. Combine those cable systems with AOL's existing agreements with Regional Bell Operating Companies and you have what they call in the trade "high household penetration." It's a position of strength that can be leveraged into a position of dominance.

    The problem is that Case and his deputy, Robert Pittman, seem more interested in the rest of Time Warner. This is unnerving. When was the last time Warner Bros. made a good movie? Has anyone ever watched anything on the WB network? Aside from The Sopranos, what's the point of HBO? Boxing? Dennis Miller? Bryant Gumbel? Yes, they have movies, but in three years you'll be able to watch any movie you want at any time for less than a video rental costs today.

    And then there's the "content" side of the house. Has there been one new magazine from Time Warner worth reading? Now that it has three major competitors (MSNBC, Newscorp and the BBC), is there any growth in CNN's future? If Little, Brown were put on the block, would anyone buy it? Who would want to own this stuff, all bureaucratically enmeshed on 6th Ave. and overseen by raving egomaniacs and their enablers? And if you did own it, wouldn't you want to spin off the various entities, piece by piece, so that each piece could realize something close to its real value?

    Generally speaking, you can tell a good Internet deal by its ability to meet the needs of both suppliers and consumers. is a good deal because it matches up empty airline seats with people willing to pay at least something to sit in a middle seat on a Wednesday afternoon flight. EBay is a good deal because it allows both sellers and buyers access to the widest possible market. E*Trade and Ameritrade are good deals because they make Wall Street accessible to anyone with some extra money in the bank. America Online is a good deal because it aggregates its customer base into a powerful bloc and in so doing, enables cheaper credit, lower long-distance service and a host of other services.

    Generally speaking, you can tell a good Internet company by its relentless focus on customer service. is a great Internet company for this very reason. It loses money, but builds value as it gains market share. Eventually, that value will convert into profitability. Yahoo is a great Internet company because it is constantly improving the customer experience. Earthlink is a great Internet company because its principal mission is to enhance customer service while it simultaneously protects customers' privacy.

    How, exactly, does the acquisition of Time Warner enhance AOL? Does it make it easier to pay bills? No. Does it cut the cost of financial services like insurance or home mortgages? No. Does it cut the cost of telecommunications services like long distance and Internet access? No. Does it make it easier and cheaper to shop for groceries or cars or clothes or whatever? No. Does it significantly improve the AOL customer's online experience? Not really.

    What's in this deal for the AOL customer? Not much that he or she can't already get on the street and for free on the Web. And that's what makes this deal so unnerving. It really doesn't have anything to do with customers. This deal is about converting Internet currency into hard cash. This deal is about transforming AOL into a media and entertainment conglomerate. This deal is about Case and Pittman making a cold calculation that technology would cut their market capitalization in half and that they'd better buy something while their currency still counted.

    So they bought Time Warner and a world of management woe. Actually, it's more like a universe of management woe. For beginners, there's the top of the house. There's Gerald Levin and Ted Turner and Dick Parsons and Norm Pearlstine and a host of Hollywood types, all of whom have fiefdoms and all of whom are fiercely resistant to change.

    Case was so unnerved by the prospect of dealing with these lunatics that he immediately caved and announced that Gerald Levin would be the chief executive officer of the combined enterprise. This was a stunning announcement, since Levin essentially admitted (by selling Time Warner) that he was clueless about the Internet, couldn't make it work, and sold out to an Internet company for that reason. AOL then turns around and makes him the head of the acquiring Internet company! The logic of that could escape even the dimmest of Wall Street analysts.

    Aside from what is called the "management issue" is the much larger problem of how you unlock the value inside Time Warner. TWX is perhaps the premier magazine publisher in the United States and yet it can't bring to market a magazine worth reading about the new economy or the Internet. It can't bring to market a magazine worth reading about men's sports (like golf or fishing). It can't bring to market a magazine worth reading about science. It can't bring to market a magazine worth reading about spirituality. It can't even bring to market a magazine about food or fashion. About the best it can do is continuously clone People magazine into InStyle and Entertainment Weekly and Teen People and so on down the dreary list.

    It's not as if the place is brain-dead. There are more smart people at Time Warner than there are in all of New Hampshire. But the management and idea people who run the place aren't getting the job done. So they have to go. The same situation applies at Warner Bros., where the profit margins are razor-thin and where in recent years the losses have been staggering. They have to go. The same situation applies at the WB network and at CNN headquarters in Atlanta and at HBO and at Warner Records and at Warner Books and at Little, Brown and on and on. So they, too, all have to go.

    In order for this deal to work, each and every one of these companies must be reengineered, its management realigned, its energy refocused and its culture remade. In order to do that, Case and Pittman and their deputies will have to spend literally years doing little else, while at the same time trying to stay one step ahead of technological innovation and relentless competitors.

    What will get lost in that time-famined environment, obviously, is AOL's customer base: 20 million of them who spend $21.95 a month for AOL's service. They can get Time magazine on the Web right now for free. They can watch the WB network on tv right now for free. They can subscribe to Sports Illustrated any time they want. They can watch HBO and CNN on cable or off the dish for $38 per month. About the only added value this deal gives those customers is the promise of some kind of discount. But if you're paying about $260 a year for access that will soon be free or one-third that price elsewhere, is it really a discount? And do you really want to pay $260 a year to be bombarded by cross-promotional advertising for Time Warner products?

    A while back in Fast Company magazine, I wrote a piece that argued that AOL would survive because it provided a haven from the Web on the Web. So long as the company remained focused on the needs of its customers, the piece argued, the company would not just survive, but thrive. The Time Warner acquisition indicates that AOL's senior managers are no longer focused on the needs of AOL customers and instead have decided to focus on themselves. They want to be entertainment moguls; big guys in the world of the screen and the magazine. On the other side, the Time Warner managers now see themselves as Internet guys, out on the cutting edge of the new economy. You can be one or the other, but you can't be both. They're very different businesses.

    Which is why, in the end, it seems likely that this deal will collapse of its own weight. In the event that Microsoft settles its differences with the government and shortly thereafter cuts the cost of its MSN Internet Access Service to, say, $6, and backs that up with a multimillion-dollar advertising and marketing campaign, then the AOL-TWX deal will almost surely come unstuck. Because the minute Microsoft does that, every other Internet access provider will do it as well (Yahoo is already offering Internet access for free) and AOL's customer base will begin to erode and its stock price will slide and the arbs and the short-sellers will come in for the kill and before you know it the whole thing will come crashing down with a thud.

    And people will look at the deal and say, yeah, it never made a bit of sense. The only way to salvage this deal is to do what Michael Lewis suggested (in an excellent Wall Street Journal column shortly after the deal was announced). Buy the whole thing, take what fits and sell the rest off like spare parts. The beauty of the Lewis solution is that it would cause the spare parts of Time Warner to reinvent themselves and, in so doing, create new companies of real value.