The doomed partnership

W hen business historians get round to documenting the late-1990s Internet boom, the defining moment might well turn out to be the merger of America Online and Time Warner. Few other events captured the absurdities of that period quite so graphically.

Television stations still delight in showing clips of the merger press conference, with Steve Case, AOL�s youthful chairman and chief executive, hugging an embarrassed-looking Gerald Levin, his counterpart at Time Warner. Significantly, Case, the dress-down dot.commer, put on a tie for the occasion, while Levin, suppressing his better instincts, appeared with open collar. Wall Street analysts muttered that Levin had �gone Internet�.

Rounding things off, we had that grizzled veteran Ted Turner, a key Time Warner shareholder, sounding off about how he was more excited than when he first hopped into bed with a girl all those years ago.

Case, now 44, became chairman of AOL Time Warner, with Levin as chief executive.

Back then, in January 2000, it was a deal that made perfect sense. Internet stocks were on an unstoppable climb, attracting ludicrous valuations from star-struck pundits. What an Internet provider like AOL lacked was content - films, music videos and TV newscasts. Combine it with a media giant like Time Warner and you had a marriage made in heaven. In the parlance of the day, it was the ultimate example of �convergence� between old and new media.

In all the excitement, some glaring discrepancies were overlooked. Time Warner, with its solid �old economy� portfolio, made almost $27bn in revenues in 1999, compared with just $5bn for AOL. Despite this, the valuation put on AOL�s shares meant the company was worth twice as much Time Warner. Inequitably, AOL shareholders were given 55% of the merged company. This, in the mood of the time, was about pricing for the future, today. Rather than worrying about the absence of underlying revenues, analysts were more concerned that Time Warner would act as a drag on the needle-shaped AOL. As with other stock market �bubbles� down the years, normally rational people had become gripped by a collective madness.

Three years on, the colossal folly of the deal has been laid bare for all to see. By late January 2003, the original architects of the merger had bowed out in disgrace, muttering about broken dreams and shattered ambitions.

AOL Time Warner duly announced that its losses in 2002 came to $100bn - the biggest corporate loss in history. This is equivalent to the total wealth of Ireland and only slightly less than the European Union�s proposed budget for 2003.

Back in January 2000, suggestions of losses on this scale would have been greeted with derision. Case had built AOL into the world�s largest Internet company, introducing millions of homeowners to e-mail and instant messaging. Time Warner, forged a decade earlier from the merger of Time Inc and Warner Communications, brought together household names like Time magazine, CNN, Warner Bros and Warner Music.

The merged AOL Time Warner described itself as �the world�s first fully integrated media and communications company for the Internet century�. It was built on a vision of consumers routinely downloading films, TV programmes and music, using AOL technology. Case enthused: �We will fundamentally change the way people get information, communicate with each other, buy products and are entertained.�

It is worth remembering that this was just three years ago. By now, we were all supposed to be routinely sending photographs to each other using mobile phones, downloading video on computers and using digital interactive TV in our living rooms. The intervening period brought the horrific events of 11 September, US corporate scandals, and the admission from technology providers that they had been somewhat optimistic in their forecasts.

AOL Time Warner was worth $260bn in May 2001. By January 2003, plunging share prices had cut its value to just $66bn. The shares lost half their value in 2002 alone.

Flaws in structure

Financial pressures inevitably exposed the flaws in AOL Time Warner�s management structure. Tensions between the two camps - chalk and cheese, effectively - boiled over in a series of divisive rows.

Levin was the first high-profile casualty. He resigned as chief executive in May 2002. The next to go was Bob Pittman, the former AOL executive who was given the thankless task of crunching the two entities together.

Shareholders then turned their anger on Case. It did not help his cause that he had made $127m exercising share options just after the merger was completed. His position became even more difficult when federal investigators began re-examining AOL�s accounting policies in the run-up to the merger. Analysts began referring to the �Case discount�, arguing that his departure would herald an immediate lift in the AOL Time Warner share price.

Finally, in mid-January, Case announced his resignation. He steps down as chairman in May, at the annual shareholders� meeting, but intends to remain on the board. The company, he said, did not need distractions at such a critical time.

Case went on: �Given that some shareholders continue to focus their disappointment with the company�s post-merger performance on me personally, I have concluded that we should take steps now to avoid the possibility of that effort hindering our ability to pull together as a team and focus fully on our businesses.�

There was some sympathy for Case. His elder brother, Dan, an investment banker, was terminally ill, and died in June 2002. Sadly for Case, Wall Street was looking for scalps, and his was the biggest one available.

If shareholders thought that was the end of the saga, they were wrong. Barely a fortnight later, Ted Turner announced that he was stepping down as vice chairman. His enthusiasm had long since waned.

The AOL Time Warner story is a work in progress, and it will be a while before historians can write the definitive piece. Dick Parsons, the chief executive, has some tough decisions to take in cutting through the company�s $26bn debt mountain. The music publishing business looks a likely candidate for a sale. It has been speculated that the division might merge with EMI, although the inevitable regulatory scrutiny makes this less attractive an option for a company that needs cash - fast.

The film division will find it hard to improve on 2002, when revenues were fuelled by blockbusters like Harry Potter and The Lord of the Rings. It is not beyond the realms of possibility that the company will drop AOL from its name and cast the Internet division adrift as an independent company. Three years ago such a move would have been considered blasphemous. But, for now at least, �old media� is in the ascendancy. Analysts like to see real earnings underpinning share prices.

The dissection of AOL Time Warner is not wholly dissimilar to events at Vivendi Universal, where executives are rapidly unravelling Jean-Marie Messier�s empire.

Case remains as evangelical as ever about the Internet, and he might well have the last laugh. It may take years longer than anticipated, but the Internet will inevitably change the way we live. The problem with the AOL Time Warner merger was that it was way ahead of its time. Like so much from that era, it was a grand idea that simply did not match the reality.

Jon Ashworth is business features editor at The Times.