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AOL-Time Warner merger validates Internet euphoria

The deal marks the point where Net stock valuations were legitimised
Written by Larry Barrett, Contributor

America Online's $190bn (£117.8bn) purchase of media giant Time Warner Monday not only marks the largest merger in history but a deal that years hence will be viewed as the point at which leading Internet stock valuations were legitimised.

The ramifications of this landmark merger go far beyond the prospects of the two companies involved.

Sure, chip and software stocks have been on an incredible run for much of the past decade, but the unbelievable growth experienced in the past two years has mainly been a product of the high-flying Internet stocks.

The idea of a single stock doubling or tripling in a two-month period was inconceivable before the dawn of the Internet age.

All the so-called experts who lauded the Internet as the medium to revolutionise the modern economy were often the same people who mocked the incredible stock run-ups made by the likes of AOL, Yahoo! and Amazon.com.

The long-running argument that Internet companies would be unable to make the seamless transition to the "mainstream" or "traditional" economy no longer holds water.

This isn't to say every publicly traded .com operation will find the success or validation that AOL now enjoys. Most won't. But the fact that AOL has miraculously evolved from a problematic Internet service provider to a leading global media juggernaut in less than three years validates what Internet investors and analysts have known all along: you're buying the potential of these companies regardless of their profits or lack thereof.

Time Warner shares closed up 25, or 39 percent, to a 52-week high of 89 3/4. AOL shares actually closed off 2 3/4 to 71after jumping more than $13 a share.

Monday's deal gives the combined company a market capitalisation of more than $360bn. Leading Internet content providers all saw their stocks make significant jumps in the wake of the announcement.

The fact that AOL would be in a position to buy a company with the extensive television, print and music resources and reach that Time Warner holds shows just how far the Internet and its leading companies have come in such a short time.

Now, Wall Street has been forced to accept these Internet companies as legitimate powerhouses even if the bulk of their value is viewed as paper money. "When I started covering AOL 10 years ago, I would have never dreamed this was possible," said Abishek Gami, an analyst at William Blair in the US. "It validates the concept that offline and online will merge."

The bar has now been raised not only for the Internet companies trying to capture eyeballs and market share, but also for the traditional media players that have only begun to dabble in the online world. Undoubtedly, other media companies will be busying looking to make their own moves to keep up with the companies that had the conviction to jump in with both feet.

"If Time Warner played its hand well from day one it would have been AOL," Gami said. "Now the Internet guys could acquire media properties and use currency if necessary."

Gabi said he now expects the likes of Microsoft, Yahoo! and AT&T and Excite@Home to make similar moves down the road. While he doesn't expect someone like Yahoo! to buy a company like Fox, he envisions those companies stepping up their plans to acquire proprietary content.

From a managerial standpoint, AOL will have the best of both worlds. AOL CEO Steve Case will serve as chairman of the combined company while Time Warner chairman and CEO Gerald Levin will serve as CEO of the new firm.

AOL now will be able to expand its reach across traditional and new media, allowing the delivery of programming from Time Warner's stable of brands onto the Web and giving AOL access to Time Warner's US cable television network to offer high-speed Internet access.

The new company will bring together Time Warner's Time, CNN, Warner Bros., People, HBO (Home Box Office), Sports Illustrated, Cartoon Network, Warner Music Group, Fortune, Entertainment Weekly, and Looney Tunes with America Online's AOL, CompuServe, Netscape, ICQ instant messaging, Digital City, and AOL Moviefone.

"We're kicking off the new century with a unique new company that has unparalleled assets and the ability to have a profoundly positive impact on society," Case said in a prepared release. "By joining forces with Time Warner, we will fundamentally change the way people get information, communicate with others, buy products and are entertained -- providing far-reaching benefits to our customers and shareholders."

Under terms of the deal, AOL stock will be converted to AOL Time Warner stock at fixed exchange ratios. Time Warner shareholders will receive 1.5 shares of AOL Time Warner for each share of Time Warner stock they own while AOL shareholders will receive one share of AOL Time Warner stock for each share of AOL they own. AOL shareholders will hold 55 percent of the merged company, while Time Warner shareholders will hold 45 percent, even though AOL's market capitalisation prior to the deal was nearly twice that of Time Warner.

Time Warner has about 1.5 billion fully diluted shares outstanding; AOL has some 2.58 billion shares outstanding.

Because AOL's venturing into the traditional media space, it's unlikely to see the geometric sales growth it's enjoyed in the past three or four years. It's a bittersweet position to be in because it will now have more reach and clout, but will also be viewed more as a traditional stock. Simply improving sales by 10 or 20 percent a quarter will have to satisfy investors used to explosions of more than 50 percent.

"People who own AOL are used to a very rapid growth rate," Michael Wallace, an analyst UBS Warburg, told Reuters. "It puts AOL and Time Warner leaps and bounds ahead of anyone that's trying to compete with them."

The transaction, which is subject to certain closing conditions, including regulatory approvals and approval by America Online and Time Warner shareholders, is expected to close by the end of 2000.

Company officials also announced new marketing, commerce, programming and promotional agreements that will immediately expand various relationships already in place between the two companies.

These agreements include plans to include AOL software disks in Time Warner promotional mailings and product shipments, extending the "carpet bombing" marketing that helped fuel AOL's growth in the mid-1990s. In addition, Time Warner's RoadRunner Internet service will begin carry AOL services on its high-speed cable network while Warner Bros. stories will distribute AOL disks to shoppers.

What does Time Warner get out of this? After lagging behind the likes of Disney, NBC, ABC and CBS, Time Warner finally gets an Internet strategy.

Time Warner Vice Chairman Ted Turner put it best: "We could have built it ourselves, but this is infinitely preferable."

Time Warner had the right idea but was unable to execute as its Pathfinder portal was among the first on the Internet. But so far, it has been unable to monetise its key brands on the Web.

It's also nice to merge with a company that has more than 18 million registered users just dying to get their hands on new entertainment and news content.

"It's damn hard on the Net," said Richard Parsons, president of Time Warner. "We could have worked a decade and may not have been competitive. We would never recapture that first mover advantage."

Now that the gauntlet has been thrown down, perhaps those nay-sayers who compared Internet stocks to tulips have finally gotten the message.

Instead of asking if AOL or Yahoo! is the next IBM, maybe it's time to start asking if IBM or any of the other traditional cannons of industry have what it takes to compete with these emerging Internet/economic leaders.

Reuters contributed to this report.

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