Vanishing Value: America Online
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SPOKESPERSON: Welcome. You’ve got mail.
PAUL SOLMAN: You’ve got mail. This became a cliché of the early Internet age. Though, despite their though despite their anonymous e-mail romance via America Online in the 1998 film “you’ve got mail,” Tom Hanks of the behemoth bookseller, fox books, was about to put Meg Ryan’s little shop around the corner out of business.
PAUL SOLMAN: Reporter: Because, in corporate America, bigger was better. Or at least, unstoppable.
ACTRESS: A Fox books superstore.
ACTRESS: Quelle nightmare.
ACTRESS: It has nothing to do with us. It’s big, impersonal, overstocked, and full of ignorant salespeople.
ACTOR: But they discount.
PAUL SOLMAN: It was happening in books, and also on the books. That is, companies were doing everything they could to grow fast. Exhibit A– O.L.: America Online itself and its $166 billion purchase of media giant Time Warner in the year 2000. The stated purposed was to create what were called synergies between the firms. That is, the new merged entity would be worth more than the sum of the old parts.
STEVE CASE: The merger of the number-one Internet company with the number-one media company will bring together the best of both worlds, and create one of the most respected and most valuable companies in the world with strengths in every link of the media value chain.
MICHAEL KELLY: The synergies will be approximately $1 billion, really reflecting the value and the combination that these… this enterprise will have overall.
PAUL SOLMAN: And that would be just in the first year alone, with far greater synergies to come. Now synergy is invoked in most mergers, usually to justify their high cost– in this case, nearly double Time Warner’s stock price just before the deal was announced. Here, for instance, synergy would come from what AOL consumers would see when they logged on: Ads for Time Warner products, and then they’d supposedly by the products themselves. The combined company figured to sell more than enough ads and products to justify the price of the deal.
GERALD LEVIN: Think back to the Warner Brothers movie “You’ve Got Mail,” nicely promoted jointly with AOL
ROBERT PITTMAN: This is the perfect one-plus- one-equal-three opportunity. We are the missing piece of each other’s puzzle.
PAUL SOLMAN: Unfortunately, pieces of the AOL-Time Warner puzzle are still missing three years later, as it so happens, are the men you just heard: AOL’s three top executives, and Time Warner’s former chairman and CEO, and now even vice chairman Ted Turner– all victims of the vanishing value of the combined company. Witness this week’s write-down of $45 billion in the value of assets, on top of the $54 billion write-down earlier in the year. Grand total: $99 billion, the largest recorded write-down in U.S. corporate history. So where did all that supposed synergy go?
Well, to answer that question, return with us now to the 2001 annual report to shareholders, published last spring. AOL-Time Warner was still putting its best faces forward, still selling synergy. “We are singularly well positioned to cross promote our products and services and offer our partners unequalled advertising opportunities.” The company’s stock, however, had by then dropped to less than half its price at merger time. One plus one was now equal to about .79. Check out the fine print deep inside the report: “AOL Time Warner expects to record a one-time noncash charge of approximately $54 billion…in the first quarter of 2002.” We tracked the lost billions with accounting Prof. Paul Healy, examining AOL’S balance sheet.
PAUL HEALY: The balance sheet shows the firm’s assets, the resources that it owns. It shows its obligations to creditors and banks, called liabilities. And it shows the residual, what’s left over for shareholders.
PAUL SOLMAN: And it’s a balance sheet because what the company owns has to balance where the money came from.
PAUL HEALY: Correct.
PAUL SOLMAN: And so synergy?
PAUL HEALY: Synergy shows up on the asset side. You can see assets include cash, and they include receivables from customers, and property, plant and equipment. But the synergy shows up in this item called goodwill.
PAUL SOLMAN: Goodwill, right. And goodwill is?
PAUL HEALY: A large part of the goodwill is the value that the company places on the synergy that justifies the price it paid for Time Warner.
PAUL SOLMAN: Now “Goodwill” is a catch-all category on the balance sheet designed for intangibles: The supposed value of a brand name, like AOL say– the synergy of a deal like this one. We went goodwill hunting–trying out a fanciful merger synergy idea on Paul Healy’s Harvard colleague, Krishna Palepu.
PAUL SOLMAN: So let’s say Pottery Barn, the home furnishings chain, buys Barnes and Noble, the bookselling chain, and becomes Pottery Barnes and Noble.
KRISHNA PALEPU: Clever idea.
PAUL SOLMAN: Because we’ll get synergy.
KRISHNA PALEPU: Yeah, we’ll get synergy. Because we can cross sell books in Pottery Barn Stores, and maybe we can put more couches in Barnes and Noble and thereby we can increase sales in both chains.
PAUL SOLMAN: In addition to using books to sell couches and vice versa, there would also be synergy through lower costs: Just one Web site instead of two, one computer department, one headquarters, one logo– synergy through sign-ergy, if you will.
PAUL SOLMAN: And how would we account for all the synergies?
KRISHNA PALEPU: Well, let’s assume that Pottery Barn paid a premium or going market price for Barnes and Noble. The difference between the two will be booked in the balance sheet as goodwill, assuming that there are going to be gains from increased sales and therefore more profits.
PAUL SOLMAN: And if there aren’t?
KRISHNA PALEPU: If there aren’t, then we’ll have to say, “oops, it isn’t goodwill, it’s bad judgment,” and we have to write that off.
PAUL SOLMAN: In fact, says Palepu, two-thirds or more of all takeovers don’t justify the purchase price. So if you wind up with stock in the merged firm, you’re usually out of luck. And in AOL-Time Warner’s case, the lack of synergy was hugely compounded by the bubble- inflated value of the AOL brand name. That’s another reason the combined stock has gone down. Add failed synergies, and there’s a lot of lost goodwill to account for and write down.
PAUL HEALY: To a stockholder, this means that AOL has essentially acknowledged that its rationale for the merger hasn’t worked. The company’s lost a lot of value in its assets, and its shareholders have been penalized dramatically. The stock price has plummeted for AOL.
PAUL SOLMAN: So does this mean there is no such thing as synergy — that this merger, and most others, are doomed? Well, says Wall Street analyst John Tinker, not necessarily.
JOHN TINKER: Synergy is totally out of fashion now because over the short-term, it has totally failed. Over the longer term, it’s a more interesting question because a lot of large companies don’t come together easily, but take time to meld, deal with the “personality issues,” i.e., someone has to get fired. At which point, the assets have an opportunity to work together.
PAUL SOLMAN: And in this case they would work together how?
JOHN TINKER: In AOL-Time Warner’s case, for instance, the magazines, where readership slips every year because fewer people want to read, might have their content information ideas sold via the Internet in a different form of distribution where people still want to get the idea, but not by picking up a newspaper or magazine.
PAUL SOLMAN: All companies, says Tinker, from Fox Books and the little shop around the corner– which in some sense merged happily ever after– to AOL and Time Warner, are under pressure to get big enough to roll with the tides of time and technology, finance new initiatives, foreign ventures and the like. To Tinker, then, synergy is often a code word for growth.
JOHN TINKER: Synergy is a great sound bite. It’s succinct, it sells the idea that this deal benefits everybody and everything.
PAUL SOLMAN: And there’s some explanation as to how it does so.
JOHN TINKER: It’s a magical coming together of these assets from which great new products, whatever will come out. And what companies are really saying, which is a less palatable message, is we need to be big and we need to have muscle. And people don’t always react well when they hear that, but that in reality is what synergy is.
PAUL SOLMAN: That’s what happened, many would argue, with the merger of Time and Warner to create Time Warner itself — something that has happened in industry after industry throughout the history of corporate America. On the other hand, size alone does not guarantee success. The data suggest, as we’ve already said, that most mergers don’t pay off, because synergy is pretty much like anything else: If you pay too much for it, you may find out that you got nailed.