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Will Google Bid on AOL?
Analysts suggest the possibility
Recent rumors of a potential Microsoft MSN/AOL merger may lead Internet search engine giant Google into making a 'pre-emptive strike' to protect its financial interests. "Google, which receives 12 percent of its sales from advertising and other fees generated by America Online, may make a bid to preserve that income, Merrill's Lauren Rich Fine wrote in a note to clients Friday," stated in a Houston Chronicle article. This will certainly be something to watch as it unfolds, who do you think will come out on top? Microsoft or Google?

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jaquer0
join:2000-07-09
Decatur, GA

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jaquer0

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AOL TW background

People should remember that "Time Warner" is the company formerly known as "AOL Time Warner," which was the result of the acquisition of Time Warner by AOL, which was announced at the beginning of 2000 and took place in Jan. 2001.

That was the one deal that more than any other punctured the dot-com stock bubble. As long as it was one dot com buying another, with their overvalued monopoly money stock as the means of purchase, no one really cared how many phony extra zeros were tacked on to the stock market valuation of something like pets.com. But when people with real assets were actually stupid enough to take AOL stock as real money, then the whole thing collapsed, and it collapsed most of all on AOLTW.

Since the deal officially closed, I read in a story yesterday, some $200 billion in the stock market valuation of this one conglomerate has been wiped out. And AOL stock (and therefore also TW) had ALREADY dropped in value by nearly half in the year between the announcement and the closing.

The deal closed with the stock at something like $45 or $48 dollars. Later, when it started to come out that (the old) AOL had cooked its books, it went down to something like $8. For the last year or to it has been stuck at around $18, and nothing can move it, even though, for example, TW has greatly reduced its debt load and got rid of TW music, which was doing terribly.

Part of the reason are the legal problems inherited from the old AOL. Although the company is really the continuation of the old TW in terms of businesses and so on with AOL tacked on, technically, this company IS the old AOL which acquired the old Time Warner, and fully liable for AOL's misdeeds.

There are also a bunch of shareholder lawsuits by former TW shareholders who say they were swindled. Since the old AOL did, apparently, cook its books, these don't appear to be just nuisance actions.

On the face of it, the deal was crazy. TW was about five or more times the size of AOL. It was based on TW boss Gerald Levin's vain hope that as a result of calling his motley collection of media properties a dot-com, the entire thing would become as insanely overvalued as AOL itself was.

Supposedly this merger was going to generate real new value, and it was going to be created from the "synergies" of this fusion. What actually happened is that all sectors of the business became paralyzed, there were no "synergies," quite the contrary.

AOL had been leading the fight to force the cable and phone monopolies to allow other ISP's on their infrastructure on a common-carrier-type basis. When they joined up with TW, they became corporate kin to the second biggest cable company in the country and reversed course, sabotaging that fight.

But! Time Warner Cable already HAD its own broadband ISP, Roadrunner, and really had no use for the more expensive AOL training-wheel service, especially in those early-adopter days. So AOL found itself frozen out of broadband. Because even if a Comcast or a BellSouth was willing to let some other ISP on their lines, the LAST one they would choose is the one that's part of the same corporation as one of their main direct competitors, Time Warner Cable.

You can go through all the divisions and see a similar thing. Ted Turner in the late 80's and early 90's used to launch one or two new cable networks a year. Since becoming part of TW in the late 90's, what's happened is that TBS has had to shut down networks -- the CNN sports network and the CNN financial network, to name two.

With its stable of cable channels (CNN, TBS, HBO etc.) TW would be in an ideal position to group negotiate very high fees and would have no problem getting its own channels carried in preference to others. But of course that's just taking money from one corporate bank account to another. No real value created there. And the combination of both the content and distribution under a single corporate house makes both have to behave very unaggressively in fear of anti-monopoly regulators coming down on them like a ton of bricks.

An *obvious* move that should have been done a long time ago is to put channels like CNN on the internet. I mean the actual main feeds from Atlanta: there are about a half dozen, national and international, including one in Spanish.

That is something people would probably be willing to pay a few dollars a month for, but it would require CNN renegotiating the "exclusivity" deals it has with the cable companies. In the late 90's, and perhaps even today, Turner Broadcasting has sufficient market power to get that change -- but the corporate bosses aren't about to let that happen if that means possibly damaging TW cable.

Instead, CNN got itself into one of these deals where people have to pay to access the video. It lasted a couple of years, they just abandoned it and went back to streaming their reports for free with advertising. They also said at the time they'd be putting some sort of ongoing CNN paid service on the Internet that is coming this fall.

Similarly, TW Cable has started some local all-news stations, like New York One. You'd think with the CNN brand, infrastructure and know-how, they'd have let their corporate sister fill that niche. But TW Cable execs don't get bonuses for how well CNN does, nor vice-versa. From CNN's point of view, NY One is just one more competitor for the narrow news-and-information junkies audience.

Another example, in a very different field, is gnutella, the first really pure p-2-p file sharing app. It was developed by Justin Frankel, creator of Winamp, and put out on the web site of the winamp company (called Nullsoft), which had been acquired by AOL. When he put it out in the spring of 2000, TW screamed bloody murder (because it still owned Warner Music and they were all trying to shut down Napster) and AOL told Nullsoft (which AOL had paid something like $100 million for, even if it was dot-com stock funny money) to abandon it.

The main post-Napster p-2-p apps were all initially based on gnutella. Fast Track (Kazaa) was really a gnutella-type network of supernodes, with tons of regular nodes hanging off the supernodes in gnutella sub-nets. Frankel thought it was a klutzy kludge and said he had a better idea for how to scale p-2-p but wasn't allowed to work on it.

AOL could have *owned* p-2-p file sharing, AOL would have been the ideal company --in terms of size and clout-- to lead a fight for a grand compromise with the record companies where people would be allowed to share music over the internet for a set fee -- a universal license.

They could have incorporated that into their walled garden service, paying a dollar or two of copyright bribes a month to the music monopolies per user, or tried to get it legislated so everyone could just do it generally.

If they had gone to bat for this disruptive new technology, the record companies would have had to adapt by now (eventually they will have to adapt, or die).

The other ISP's would have joined them, everyone knows that's what's driving broadband adoption, just look at the adds about how much faster you can download a movie or music.

But AOL couldn't because by "acquiring" Time Warner, it itself became a captive of the copyright cartels. Worse, it made it impossible for the other ISP's to wage the fight, because the largest of them all --AOL-- was bound to take the party line position of this copyright-hoarding conglomerate, that p-2-p was a devil-spawned abomination.

Eventually a couple of years ago Frankel came out with an encrypted group collaboration software (WASTE) that TW put the kabosh on and told him he wasn't allowed to continue freelancing like that, he could only do corporately-blessed projects. So he walked out a few months later, I guess when his contract ran out.

Losing people like that tells you that this is a conglomerate that is dominated by a culture that is incapable of adapting to the present, never mind the future. And remember, just a few years earlier, AOL had paid a hundred million dollars just to get him and his little music player in the corporate door.

So do CNN, AOL and so on at least use Winamp and its technology? Nope. Because of these corporate mega-deals, in which conglomerates try to share our eyeballs with each other, they're in bed with Real.

Justin Frankel is just one of a long series of people pushed overboard by the conglomerate. Probably the first was Ted Turner, when AOL and Time Warner announced their future corporate structure in mid-2000, Turner was named vice-chairman, but removed from control of Turner Broadcasting, which is like being Prince of Wales except that you don't have the right to succeed to the throne.

One of the two or three people responsible for creating the multi-billion dollar cable industry, for seeing the value in the old film libraries that the studios didn't know what to do with, the guy who invented CNN. And they put some corporate flunky who had been in charge of the fledgling WB as head of turner broadcasting. He lasted about a year.

Another example is Warren Lieberfarb, the father of the DVD. Some time after the merger he was fired for being "disruptive". One of the issues is that the disastrous merger completely wiped out the stock options he'd been given for having played a central role in creating a new multi-billion dollar industry, and he thought this was a crock. And remember, this company is the legal continuation of the old AOL, which engaged in accounting irregularities which. had they been admitted in a timely fashion, would have deplated its stock price and blown up the merger, which means Lieberfarb's stock options would still have been worth something.

Of course Liberfarb was disruptive, just like Turner and Justin Frankel and, yes, in his own way, Steve Case, and lots of others. That's what it takes when a field is rapidly changing and evolving as technology advances. It shakes things up, as a result there are winners and losers.

Ted Turner ran CNN at a loss for something like seven or eight years. Then it went into the black, and it's been printing money every since. Under a corporate bean counter regime, it would never have been launched, and if by accident it had been launched, it would have been closed after three years.

The bottom line is that you have a bunch of businesses that in a variety of ways compete against each other with the management of each constrained by the fact that they're fighting with another part of the same corporation and that overall, they're not judged by how brilliantly the initiative or risk they took three years ago panned out, but by quarterly results.

But most of all what is required is that no one rock the boat, overstep their bounds, disrupt the business of some other part of the conglomerate. But as technology changes things, that's precisely what has to take place, Internet distribution starts competing with cable, with traditional music distribution, with dead-tree publications. Time Warner's businesses are perfectly positioned to have everyone else eat their lunch, because they can't innovate and take risks, they can't evolve.

The corporate strategy now is supposedly something like content production, aggregation and distribution in "branded environments," i.e., controlled spaces. This runs counter to the main thrust of development of the Internet and media which is ever more horizontal distribution, mixing and mashing. The overwhelming majority of internet traffic is unpaid and unauthorized sharing of content, and I don't think that's going to change.

AOL still has a strong brand, a huge internet audience, and is a company that desperately needs to reinvent itself, but because it is in a straightjacket as part of Time Warner, that's not going to happen, not as long as it remains there.

But what is true of AOL is true of the rest of the businesses. They're all in the media field, which is being revolutionized and reinvented as technology advances.

So for Time Warner itself, the best thing that could happen to it is a complete de-merger into the constituent businesses. It even makes sense from a bean counter point of view, because as it stands, it is undervalued a great deal in the stock market. In pieces it is probably worth $25 or more a share, and it trades at around $18-$19.

It trades at that level because no one can figure out what the stock is, and what you get is a sum of risks that hold back demand for it.

The TW cable business is basically a utility, low immediate risk but with a very large fixed investment, probably limited upside, and long term in danger of being wiped out by satellite, which also has a high fixed investment, but it doesn't change with the number of subscribers, which means at some point the per-subscriber cost of the fixed infrastructure of the satellite distributors might become significantly lower than that of the cable companies.

And it is a wicked situation for cable. Every time a home changes from cable to satellite it increases the cable company's per-subscriber amortization of their fixed investment AND lowers the satellite company's.

Of course, cable can provide phone service and internet access also, which is why their strategy is to "bundle" it. (In my area, the cost of Comcast internet without cable TV, and the cost of Comcast internet WITH cable delivery of local channels is exactly the same. But that means the "basic cable" package of 70-something channels involves an additional cost of only $25 or so).

But the flip side to that is that the phone company also has a wire into the house and that wire potentially may be able to deliver both internet and digital video, "cable TV" to all intents and purposes. So for now cable delivery is a good business but it has long term risk.

Turner Broadcasting is (now) a fairly staid but large TV company, some risk, because programming is expensive, public tastes change, a lot depends on the talent of the people involved, but not much as it is well diversified in its business. It used to have a big upside, but with Ted Turner gone, that's history.

WB is a regular also-ran TV network with a couple of hits, an okay business, but it was based on a fundamentally flawed premise, that you had to have production (studios) and distribution under the same corporate roof, otherwise you'd get frozen out. This was the same calculation Turner made, in agreeing to merge with Time Warner, that Turner Broadcasting needed to be qualitatively bigger to survive. It was the common, accepted wisdom in the 90's, that's how we wound up with these hugely dysfunctional dinosaur media conglomerates, and along come new players like Google whose leadership is close enough to a real, concrete, immediate business to smell opportunities and take advantage of them. And so we're talking about Google taking a piece of TW rather than the other way around. But with a breakout hit, WB has great upside potential. And the downside risk is limited.

The studios are a dice-rolling business, and TW was lucky to have two pre-merger deals pay off afterward, the LOTR series (which no one but a Ted Turner would have green-lighted, all the big studios turned it down and it got the go-ahead when New Line was part of Turner Broadcasting and Turner was still independent), and the Harry Potter movies. This is high risk, potentially high reward, too.

Time, Inc., is into dead tree magazine and book publishing, a declining if still profitable business. It is a cash cow but there's no sign of a turnaround from the decline of the sector.

AOL is a premium dial up internet provider trying to figure out how to become something like cable (pay TV) or advertiser supported TV in the broadband internet world, a content conglomerator/organizer.

It's a complete crap shoot, but almost certainly there are giziillions of dollars that are going to be made from the Internet in the future and --if given the chance-- AOL might just be one of the companies that figure out how to get a nice slice of that.

And then there's odd bits and pieces, there was a music label (but they got rid of it) a baseball team, a record club, home video, and so on.

If you look at all the different sorts of opportunities and risks, you'll see why the stock trades well below its breakup value. There are just too many imponderables. Movies are high risk, high reward, cable (both networks and delivery) are steady but delivery itself has this long term cloud over it. The WB is low risk with a small chance of real big upside. Magazines and book publishing, well run, are cash cows but in decline. And then there's AOL.

So it is hard to figure out just how this particular stock fits into investment strategies. It gets bought because its the biggest media company and if you're just buying "the market" in general, it's going to be in there.

But if you're stock picking, for example betting on the Internet, you're going to buy Google, not Time Warner, because AOL is too small a component of it. If you're betting on movies and tv and entertainment, again, you have this utility distribution component that is a huge part of the company and makes it not a very suitable entertainment bet. If you want a good utility, though, you have all these other volatile sectors in the company that carry risk that other utilities don't have.

That's apart from the fact that the businesses are ALL in segments undergoing rapid transformation due to computers and the Internet and changes in electronic media generally, and they are all prevented from innovating and taking risks and being disruptive by being part of such a huge conglomerate, which is something that is only just now beginning to be considered and isn't generally understood.

There's another problem with Time Warner. Conglomerates like that, the only way they can be run is by bean counters. The top execs don't have time to really get into issues like, should Turner Broadcasting launch a Spanish-language cartoon channel in the U.S. (they have one in Latin America). Top management can't really "manage" any businesses at all, there are dozens and dozens of them in widely disparate fields, niches, and even countries. What they can do is administer budgets and allocate funds for investments.

And that requires a whole corporate superstructure, which is also a financial drag on the individual businesses. The individual businesses have to pay a "tax" to the corporation for the corporation as a whole to cover its overhead, like that palace Time-Warner built itself in New York, which I think in the future will be regarded as a monument to corporate hubris.

And dealing with things like tax, legal and regulatory issues, lobbying and so on has to be done centrally also, you can't have AOL lobbying for one thing and Time Warner Cable for its opposite. So you get this bureaucracy of highly paid accountants and lawyers and so on. And then each of the component companies has to have a bigger management team so they have people to relate to the corporate higher ups, give them the information they need, attend their meetings, etc.

And this unbridled corporate gigantism even drives other costs in unsuspected ways. CNN is one of TW's corporate jewels. So of course at its New York Taj Mahal, TW has to have CNN studios, tremendously, monstrously expensive studios, in the most expensive possible place. Literally unnecessary millions and tens of millions get sunk into things like that.

But at the same time, there are scores of businesses and sectors and niches that the corporation is into, and the three top people who have to make the decision when it comes time to take a risk or gamble are in no position to do that, they can't really get that intimately involved in any one individual niche to see whether a risk makes sense, to smell an opportunity others haven't seen yet.

The irony is this talk of Google buying AOL. If AOL had stuck to its own business, it probably would have acquired Google --or a big slice of it-- instead.

But unless I miss my guess momentum is mounting towards taking apart these useless conglomerates. The same thing happened in the late 60's and 70's, there was a rush to create conglomerates, the rationale then was to isolate corporate returns from the up and down cycles of different businesses. But the result was the same, the businesses of the conglomerates were no longer being run as real businesses, and it was followed then by a whole epoch of takeovers and leveraged buyouts where tons of money was made taking apart all those conglomerates, because a) you saved on the conglomerate's overhead, layer upon layer of completely useless management and b) the individual businesses themselves were likely to be better run.

Dick Parsons, the head of Time Warner, is old enough to remember what happened back then, and if he's smart he'll do it himself rather than letting someone else do it to him.