AOL/Time Warner is merger of faith

Market: Investors believe in the union even though the reality of a smaller company swallowing a larger one goes against convention.

January 23, 2000|By Mark Minasi

WEEKS HAVE passed since America Online (AOL, to its subscribers and stockwatchers) and Time Warner Inc. (known as TWX to investors and known to the rest of us as the owners of CNN, HBO, Superman, Bugs Bunny, ER, the U.S. rights to Harry Potter, and a lot of other stuff) announced that they would merge, resulting in one of the largest corporate marriages in history.

But one is left scratching one's head, even after reading all of the analyses. First, there's the odd irony that in reality it's AOL who's swallowing Time Warner and not the other way around.

Here we have AOL, a company with a bit more than 12,000 employees and 12-month revenues of $5 billion, digesting Time Warner, a company with more than 67,000 employees and nearly five times the revenues for that same time period. How can this be possible? In two words: on faith. On a leap of faith on the part of Wall Street. Investors believe in AOL. You can tell how well a company's doing in the faith department by looking at its "market cap," a number that you get by multiplying the number of outstanding shares in the company by its stock price. Market cap has little to do with a company's size relative to other firms; it has more to do with how much investors believe that it can grow.

For years, the company with the largest market cap was General Electric, but a few years ago it was surpassed by Microsoft. While Microsoft is certainly a successful company, it's nowhere near as large as companies like GM, Ford, Exxon or Wal-Mart, the top four in the Fortune 500. But investors clearly believe that in time, Fortune's 109th-largest firm Microsoft - or whatever pieces of Microsoft the government creates next month - will surpass automobile, petroleum and retail giants.

Applying the logic of the market cap to the AOL/Time Warner merger clarifies things a bit.

AOL's market cap on Jan. 14 was $146 billion, compared to Time Warner's $108 billion. Wall Street believes that in time AOL will dwarf Time Warner. Give it a few years, and AOL could inhale Yosemite Sam's home in one gulp All good Wall Street logic. But is it right?

The sense of the merger, according to the pundits, is that AOL needs high-speed links to its customers, and Time Warner has huge cable television holdings. That's important because many cable television providers are exploiting their cable television lines to offer "cable modems," a high-speed Internet access method that allows Web surfers to access the Internet at rates dozens of times faster than could be offered by a standard modem and telephone line. Those high-speed links would enable AOL to connect with their customers at higher speeds.

AOL is more than an Internet service provider (ISP), a way to get onto the Internet. It is also a place to go on the Internet, the owner of mountains of information, or "content," in Internet-speak.

Buying Time Warner means that with the stroke of a pen AOL owns a whole lot of new content. What does Time Warner get? Access to a whole lot of new eyeballs.

AOL has millions of members, members who can't dial into the Internet without first sitting through whatever advertising AOL puts on their screen on startup. One day soon, so the story goes, Internet users - including all of those AOL folks - will be down-loading movies over the Internet on demand, rather than watching whatever happens to be on HBO at the moment, or having to run out to the video store to get a tape.

Time Warner's got the movies and the cable modems to distribute them, AOL's got the customers and understands how to use the Internet to use those cable modems to get the movies to the customers. But a closer look reveals some problems with this plan for happily merged bliss.

First, consider the question of high-speed Internet access. Yes, cable modems are fast links, but they are fast links shared by a neighborhood. In other words, if you are the only person using a cable modem in the neighborhood, perhaps you're surfing at 11 a.m. on a weekday, then you're going to get truly amazing data transfer rates. But log on around 6 p.m. and you'll find that the rest of the neighborhood is logged on, checking e-mail and buying online, and your connection's not so fast.

Also, Internet data usage tends to be irregular or, in net Work lingo, "bursty," which means that someone sitting at a computer surfing the Web tends to use the Net only in short, high-speed bursts punctuated by a lot of quiescent time.

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