Grand Fireworks for Merged Values, but What About Profits?
By Philip Bowring International Herald Tribune.
HONG KONG - Merger of Time Warner and AOL? Everyone is talking about values but no one about profits.
Grandiose claims are made that the deal represents the new global industrial logic of the Internet age. In reality, it has been driven by Wall Street financial logic. The absence of all but the vaguest claims of tangible earnings benefits from the combination has been striking.
Instead of earnings forecasts, the public is treated to vague statements about combined revenues. Brokers enthuse about ''return'' as defined by the stock price performance, not by the underlying profitability of the company.
These ''new values'' of the ''new economy'' are especially striking to observers in Asia, which during the recent crisis was lectured by the West to put earnings ahead of size.
Those hailing this deal as an epoch-making made-in-heaven marriage said similar things when Time Inc. merged with Warner and CNN. That created a deeply indebted company which has generated very modest earnings for its shareholders despite being a supposedly leading-edge, global media company in a buoyant economy.
As Time Warner was selling on 140 times earnings even before the merger announcement, it is hardly surprising that the market prefers not to focus on how the merged one will justify a price-earnings ratio of 250.
The notion that the merger proves the power and importance of the Internet is hype. The deal merely demonstrates the power of the AOL share price. There may be some industrial logic in it, but do media companies need to own Internet providers any more than newspapers need to own forests?
Why stop here? If Time Warner needs an Internet service provider, AOL needs content. Combined, they surely need a telephone company too! The theoretical scope for vertical integration is endless - and vertical integration seldom increases profits.
The fact is that this deal is driven by the financial logic of share prices. It is good for Time Warner shareholders, who can get a slice of the Internet share price bonanza and pay off the $17 billion debt on their balance sheet. It is especially good for Time Warner executives such as Chairman Gerald Levin. At the stock prices prevailing just after the deal was announced, the value of Mr. Levin's stock options was estimated to have hit $400 million - not bad for the chief executive of a company whose net income in the three years 1996 to 1998 totaled just $223 million
As for AOL, its sky high share price has provided it with the ability to buy the security of a broader product base. AOL is just a service provider that owns a browser. The Internet is here to stay, but the future for intermediaries is less certain. They are especially vulnerable to further technological or commercial change. So AOL's desire to merge is not industrial logic. It is managerial interest logic.
The bottom line is that the combined company has a stock market valuation equal to more than 10 times its projected gross revenues in 2000 and 200 times likely net profits.
On Monday, before falling, the AOL-Time Warner market valuation of around $350 billion was at least 40 percent more than the market capitalization of the stock market of Australia, Taiwan, Hong Kong, Spain or Sweden. The deal will go down in history, but not as the triumph of the Internet. It will be the crowning example of a mania which gripped Wall Street at the turn of the millennium.