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Introductio= n


            This paper provides an executive level evaluation of the merger of America Online (AOL) and Time Warner corporations. This merger involving two giants of industry amounted to one of the largest mergers to date. AOL purchased controlling shares of Time Warner for $106 billion dollar. This paper will = look at the valuation strategies, financing methods, and analysis of each compan= y in deciding to pursue such a merger. The paper will consider appropriate finan= cial theories for decision making and which theories were misappropriated in the decision making process. The evaluation will contain an overview of the companies after the transaction along with an analysis of the theories used. This paper provides a general overview and does not contain in depth statistical analysis of the outcomes.

Key Leaders

            The merger of America Online and Time Warner appeared to be a match made in hea= ven, the largest and oldest media conglomerates and the biggest name in the upst= art Internet business. Each group seemed to gain tremendously from the experien= ce and consumer base of the other. This merger took place in January 2000 among glowing reviews and many fears from competition. The merger combined 82,100 employees and $930 million dollars in net income. Ravendran (2002) stated, “The merging of AOL and Time Warner consolidates unparalleled power i= nto one huge organization in at least three media categories – cable, pri= nt and the Internet – and gives the firm considerable sway in motion pic= ture production, music sales and magazines” (p. 10). This merger allowed f= or consolidation of media power in a way never before seen.

            The key players in this merger would be Gerald Levin, Chairman and CEO of Time Warner, and Steve Case, Chairman and CEO of AOL. News stories continued to circulate through the time of the merger defining the two men as different = yet similar in leadership style and driving forces in their respective industri= es. Case was viewed as the technology expert while Levin was seen as the corpor= ate leader. Ravendran further stated, “It points to the strategy of revol= ving media frenzy around the dynamic albeit divergent personalities of Case and Levin – “the men behind the merger”” (p. 31).

Valuation Strategies

            Pekar and Margulis noted,

What drive= s senior executives to do M&A transactions? PWC has found that the top three rea= sons are: 1) access to new markets; 2) growth in market share; and 3) access to = new products. However, the real question is not about the objectives themselves, but whether acquisitions are the best approach for achieving them? (para 34= )

AOL used a strategy of acqu= iring rivals and out marketing them for valued customer bases throughout the mid 1980’s through the 1990’s. AOL went public in 1992 and relied heavily on free disks and other promotions to push past rivals Prodigy and CompuServe. Hoovers= news service also reported, “The company also invested $800 million i= n Gateway[SLB1]  as part of a joint-marketing pact and agreed to launch a co-branded Internet service with Wal-Mart” (History, para 4). AOL used an aggressive valuation strategy through the ti= me of the merger. Expenses amortized over long periods allowed profits and cash earnings to remain high. The company had long had a cash flow problem. Pale= pu, Healy, and Bernard (2004) quoted a Newsweek article reporting,

On October= 10 [AOL] raised about $100 million by selling new shares. AOL sold the stock e= ven though its shares had fallen to $55.37 from about $72 in September, when the sale plans were announced. Most companies would have delayed the offering waiting for the price to snap back. AOL, didn’t, prompting cycics[SLB2]  to thing the company really needed the money. . .” (p. 2-25)

Financi= ng methods

   = ;         According to documents filed with the SEC, Time Warner uses a free cash flow system of accounting. The method described by Time Warner is as follows:  

The Company also utili= zes Free Cash Flow to evaluate the performance of its businesses. Free Cash Flo= w is cash provided by operations (as defined by accounting principles generally accepted in the United States) less cash provided by discontinued operation= s, capital expenditures and product development costs, principal payments on capital leases, dividends paid and partnership distributions, if any. Free = Cash Flow is considered to be an important indicator of the Company’s abil= ity to reduce debt and make strategic investments. (p.1)

This practice would serve t= he company well and assure it is meeting the minimal requirements provided by = the SEC to meet the standards and practices of responsible accounting practices required by law.

Cornehls n= oted in questioning the purchase of the companies,

But why wa= s Time Warner[SLB3]  willing to be bought by AOL, a comp= any with a price to earnings (P/E) ratio of 700 to 1 and far fewer tangible ass= ets and employees than Time Warner? The= only plausible answer is that the corporate heads expected the deal to result in= a huge surge in the share values of the newly merged companies, which would s= well their own financial assets and those of their boards of directors and major stockholders. What actually happened is another story entirely. (pp. 41-2)<= /p>

Cornehls stated, “Between August 1994 and January 2001, America On Line[SLB4]  (AOL) participated in a n= umber of mergers and made more than twenty acquisitions of other corporations, ranging from Redgate Communication to Netscape (China Daily 2001) (p. 57). Through this process AOL used acquisitions and added earnings to pay for new companies and the new companies added to the financial income of AOL.

Quantitative and Qualitative Methods

            It is clearly defined within the data the executives of one company did not lo= ok at the quantitative measures of the others. As noted above, AOL had a price= to earnings share of 700 to one with few if any tangible assets. This would le= ad to the conclusion that management did not look at the quantitative measures when accepting the merger. AOL did see a clear advantage in gaining additio= nal cable subscribers and increasing methods for getting its message to the pub= lic through print and other media sources. The managers of both companies saw economies of scale and methods of distribution for each product that curren= tly were unavailable.


            Evans wrote in describing the effects of multi-sided platform markets,

The economics of multi-sid= ed platform markets brings to light a novel understanding of the pricing, production, and investment decisions of those businesses. A fundamental ins= ight of the theoretical research is that these businesses need to determine an optimal pricing structure-one that balances the relative demands of the multiple customer groups-as well as optimal pricing levels. That insight has implications for many other strategic variables. (p. 331)

The managers of both compan= ies and members of the board of directors saw the merger as one that would allow for tremendous growth with little risk. The industries while different were sim= ilar enough that growth was deemed not only possible but probable and the net in= come from any changes would amount to substantial increases in stock prices.

Finance Theories

            The specific theories that relate to this merger involve economies of scale, increasing market share, eliminating or neutralizing the competition, and allowing for more flexibility in the corporate structure. The company appea= red to follow a capital asset pricing model allowing for acceptable risks and rewards to be allocated over time. AOL and the management team at Time Warn= er appear to have used a risk management strategy allowing both sides to opera= te and generate the proper value on both sides. Each side saw a benefit to the union and believed the profits from the merger to be substantial.

            Resourceful, evaluative, maximizing model (REMM) is supplementary of the theories listed above as each set of managers believed in the benefits that the merger would provide for them. Even with a tremendously high P/E ratio of 700 to 1 AOL w= as seen as a beneficial partner to Time Warner with methods of delivery not available in the past.

            The financial theories fell through or could be analyzed as simply not being properly addressed. No company with a P/E ratio of 700/1 should successfully buy out a company with substantially more wealth and earnings potential. De= Jean quoting from Motavalli stated,

Just because Time Warner (= and News Corp. and NBC and Microsoft and a few hundred other companies) have sp= ent the last decade convinced that the Internet is their next playpen doesn't m= ean that it is actually "media" in any way that's meaningful to (that= is, that will ever make a profit for) these companies. (p. 112)

Theories and practices fall by the wayside as greed and = the human desires or greatness get in the way. The companies failed to see the possibility of failure simply by choosing not to look at the price to earni= ngs ratio and the fact AOL had few assets to bring forward to the merger. Though the companies were similar in business, similarities do not equate to samen= ess. The businesses are entirely different with different core markets that requ= ire different strategies to operate efficiently.

            One strategy that may have assisted in making the outcome beneficial to all par= ties would require the application of an Economic Value Added (EVA) system to all aspects of the business. This system may have benefited AOL in removing earnings per share from the equation and requiring the use of a system by w= hich all portions of the company were subject to adding value rather than simply remaining at status quo.

            Additional research in the areas of culture and diversity would add benefits to the cultural merger. As companies assess the possibilities of such mergers ther= e is a growing concern of the synergies of management styles as it relates to the business culture. The use of the Stock Market Efficiency Theory would have served the merger well. By studying the stock market and the trends occurri= ng in 2000-01 the view of the dotcom impending bust would have led investors a= nd board members away from such a transaction at the time. Studying the books = and determining AOL’s use of creative financing showed a shift in market strategy and ways of acquiring wealth while not illegal may have been viewe= d as fraudulent.


            The corporation after the merger remained solid with reduced cash flow. There is evidence the company uses a discounted cash flow method for determining the financial outcome and benefits to the shareholders. Time Warner also uses a capital Asset Pricing Model to allow investors and managers to evaluate each division independently and determine the risk and required reward of each. Currently there are no decisions to remove any portion of the company or al= low them to spin off or sell them outright. Though AOL has not reached the heig= hts in growth and revenue it once held, Time Warner continues remains committed= to the company.

As com= panies move forth and study different methods of financing deals and bringing about corporate mergers the fact remains is it in the good of the investor or are these deals being made to prove they can be made[SLB5] . Are companies now becoming giant conglomerates not to benefit the stockhold= er but for corporate CEO’s to fatten their wallets? Both AOL and Time Wa= rner appear to have used a version of Value at Risk (VAR). Culp, Miller, and Nev= es showed VAR to be effective in certain cases and defined it as, “a sum= mary statistic that quantifies the exposure of an asset or portfolio to market r= isk, or the risk that a position declines in value with adverse market price cha= nge” (p. 463). With this in mind, it is possible to envision corporate leaders seeing large profits from the merger of the two companies.

            Another theory that seems to be prevalent in this particular case is one involving cultural conflict. Weber and Camerer (2003) stated,

While cult= ure may seem like a "small thing" when evaluating mergers, compared to product-market and resource synergies, we think the opposite is true because culture is pervasive. It affects how the everyday business of the firm gets done-whether there is shared understanding during meetings and in promotion policy, how priorities are set and whether they are uniformly recognized, whether promises that get made are carried out, whether the merger partners agree on how time should be spent, and so forth. (p. 400)

Through this example, it be= comes clear, in some cases like[SLB6]  companies may not share the same culture, leading to internal and external conflict. The authors showed a similar problem within Daimler-Benz and Chrysler. This led to falling stock prices and a less than successful merge= r. The same can be said concerning AOL-Time Warner. The culture of the two companies remains different and in many cases at odds with each other. Thro= ugh the course of this transaction both Case and Levin have resigned, and the companies have eliminated AOL from the company name, reverting to Time Warn= er. Though not directly related to finance, cultural differences can be shown to have a major impact on the financial future of the companies as they merge.=

    =         As we move into the 21st century, it is clear there is a need for further monitoring of mergers and acquisitions. Companies are moving away f= rom their core markets and acquiring companies simply to acquire them with no regard to the financial implications of the merger. As shown above, a compa= ny with a price-to-earnings ratio of 700 to 1 was able to acquire a much larger company and impose its will upon it. As businesses and corporations become global in nature, there is a need to assimilate cultural differences and ev= en company culture into the business climate for the future. A search for information concerning AOL through Hoovers returns 475 news articles within the last 90 days. Whether the investor or consumer values the giant mergers, they remain in the news and play a major role in the lives of many.


            Since the merger both Steve Case and Gerald Levin have resigned their posts, and = the AOL name has been dropped from the Time Warner name. Revenues and expected earnings are not at the level expected when the merger was first conceived. Though revenues remain high, the overall view of the company is in question. Time Warner has stated recently there would be no spin-off or divestiture of AOL, yet AOL remains stagnant in growth and income. The merger at first gla= nce showed great promise and worried many competitors of monopolistic implicati= ons from the two giants becoming one. The merger has remained unsuccessful and = has resulted in considerable loss of wealth from many of the key players and employees. In this example, it is clear that bigger does not always mean better.


Chew, D. H., (Ed.). (2001). The new corporate finance: Where theory meets practice. New York: I= rwin.

Cornehls, J.V. (2004). Veblen’s Theory of Finance Capitalism and Contemporary Corporate America. Journal of Economic Issues= . 38, 1.

DeJean, D. (2003). Media companies and the Internet. Nieman Reports. 57, 2.

Evans, D.S. (2003). The antitrust economics of multi-sided platform markets. Yale Journal on Regulation. 20, 2.

Palepu, K. G., Healy, = P. M., & Bernard, V. L. (2003). Bu= siness analysis and valuation (3rd ed.). Mason, OH: South-Western.

Pekar, P. Jr., & Margulis, M.S. (2003). Equity alliances take center stage: Th= e emergence of a new corporate growth model. Ivey Business Journal Online.<= /i>

Ravendran, S., (2002). Public Relations for Corporate Mergers: The AOL Time Warner Mer= ger Case. Retrieved from ProQuest Digital Dissertations May 28, 2004. (UMI No. 141488= 7).

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (2004). Retrieved from Mergent Online ProQuest Library May 28, 2004, from http://www.mergentonline.com/EdgarSearchResults.asp?rdTextType=3Dname&t= extCompName=3Daol&textTicker=3D&textText=3D&textCIK=3D&text= FilingDate=3D&rdDate=3D90days&textInRangeFrom=3D&textInRangeTo= =3D&optFilingType=3DAll&textFilingType=3D&Page=3D0&Search= =3DSearch.

Weber, R.A., Camerer, C.F. (2003). Cultural conflict and merger failure: An experi= mental approach. Management Science. 4= 9, 4.

 [SLB1]= Does this need to be blue and underline? What about Wal-Mart in next line?

 [SLB2]= Cynics to think??? Check the quote.

 [SLB3]= Why are the company names in red? Should they be changed to black?

 [SLB4]= Was the company name wrong in his quote? Or should it be Online?

 [SLB5]= This is an awkward sentence

 [SLB6]= Similar?

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