_{THE WORST DEAL EVER MADE}

The Short Version

On January 10, 2000, America Online (AOL) announced it would acquire Time Warner in an all-stock deal valued at approximately $350 billion; the largest corporate merger in history.

AOL, a 15-year-old dial-up internet company with $5 billion in revenues and an absurdly inflated stock price, used that stock as currency to buy Time Warner, the largest media company in the world, which had $27 billion in revenues and owned HBO, CNN, Warner Bros., and half of America’s cable infrastructure.

The Nasdaq peaked fifty-nine days later. AOL’s stock fell 80% over the following two years. The synergies never materialized. The accounting turned out to be fraudulent. 

The combined company wrote off $99 billion in a single year and posted a net loss of $98.7 billion for fiscal year 2002, the largest annual corporate loss in American history. Both CEOs were gone within two years. AOL was eventually spun off in 2009 at a market cap of approximately $3.4 billion, down from $164 billion at the time of the merger.

Total value destroyed: roughly $200 billion.

That is the story. What follows is how it happened, why it happened, and why nobody stopped it.

_{PRESENTED BY DILIGENCESQUARED}

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_BACKGROUND

The Players

In January 2000, AOL had approximately 26 million dial-up internet subscribers, which made it the dominant internet company in America by reach. Its market capitalization was approximately $164 billion. It had revenues of roughly $5 billion and cash flow of approximately $1.5 billion.

That is a 109x cash flow multiple, at the peak of the biggest speculative bubble in stock market history, for a company whose primary product was the sound a modem makes when it connects to the internet. You know the one (maybe).

Your VP had an AOL account and thought it was the future. Your analyst was twelve. Both of them are now watching this story unfold from the same Bloomberg terminal (or your iPhone on the subway), which is the real convergence story of the era.

The stock had tripled in 18 months. AOL insiders knew it would not last. 

Time Warner, on the other hand, was the largest media and entertainment company in the world. It owned HBO, CNN, Warner Bros., Warner Music, Time magazine, People, Fortune, Sports Illustrated, and the second-largest cable system in the United States. It had revenues of approximately $27 billion, just five times AOL’s, and real, durable, cash-generating assets built over decades.

Its market cap was approximately $83 billion.

So a 15-year-old dial-up internet provider with $1.5 billion in cash flow and a $164 billion stock price was about to buy a century-old media conglomerate with $27 billion in revenues and an $83 billion market cap… using stock as currency. 

The company with the fake number bought the company with the real one.

This is what the bubble looked like from the inside.

_BACKGROUND

The Deal

The mega-deal was announced January 10, 2000 but took a year to close, ultimately closing on January 11, 2001.

The deal was all-stock, done at the peak of the dot-com bubble. 

AOL shareholders received 1 AOL share for 1 share in the new combined company. Time Warner shareholders received 1.5 shares of the new company for every Time Warner share.

AOL paid a 71% premium to Time Warner’s pre-announcement price.

The combined valuation at announcement was approximately $350 billion, making it the largest corporate merger in history.

AOL’s ownership stake was 55%. Time Warner’s was 45%. It was called a merger of equals.

Steve Case became Chairman. Jerry Levin became CEO. Both would be gone within two years, replaced by Richard Parsons, who had the unenviable task of explaining to shareholders how a deal misses even your most bearish downside scenarios.

The strategic rationale: AOL’s 26 million internet subscribers would access Time Warner’s content. Time Warner’s cable infrastructure would supercharge AOL’s broadband ambitions. Cross-selling, convergence, the future of media. Every investment banker in New York and San Francisco nodded along. The CD-ROMs practically mailed themselves.

The Nasdaq peaked on March 10, 2000. Fifty-nine days after the announcement.

_{THE FALLOUT}

What Went Wrong

Everything. But in a specific order.

(1) The currency evaporated. AOL’s stock was the consideration. Between announcement in January 2000 and close in January 2001, AOL’s share price fell roughly 50%. Time Warner shareholders who had agreed to receive AOL stock at a 71% premium watched that premium disappear before the ink was dry. The deal closed anyway because walking away would have been an admission that both boards had made a catastrophic mistake, and neither board was prepared to say that out loud.

(2) The synergies were fiction. Time Warner Cable refused to give AOL preferential broadband access on its systems. The two cultures were incompatible in ways that could have been identified before the merger if anyone had wanted to look. AOL was a scrappy, sales-driven internet company that used aggressive accounting.

Time Warner was a prestige media institution whose executives genuinely believed AOL was a fad. Putting them together was like your firm acquiring a WeWork. Everyone smiles at the press conference and then nobody knows whose desk is whose.

The accounting was fraudulent too. The SEC and DOJ investigated AOL for inflating its advertising revenue in the years before the merger. Time Warner ultimately paid $300 million to the SEC and $210 million to the DOJ to settle. Some of the growth that justified the deal’s valuation was not real. The CD-ROMs contained more value than the revenue figures.

(3) The goodwill writedown. When the company marked down the value of AOL’s assets to reflect reality, the result was a $99 billion goodwill impairment charge in 2002, the largest in corporate history at the time. AOL Time Warner reported a net loss of $98.7 billion for fiscal year 2002. In a single year. Larger than the GDP of most countries.

(4) Jerry Levin resigned in December 2001. Steve Case resigned as Chairman in January 2003. The company dropped “AOL” from its name the same year. That is how you know a merger has gone badly. In 2009, AOL was spun off as an independent company. Market cap at separation, approximately $3.4 billion. Down from $164 billion nine years earlier!

_{THE FALLOUT}

Why it Happened

The RJR Nabisco deal failed because leverage amplified a bad macro outcome. The AOL-Time Warner deal failed before it started, because the foundation it was built on was imaginary.

AOL’s management knew the stock was overvalued. A company that believes its stock is fairly valued does not rush to convert it into real assets. Case spent inflated internet currency to acquire durable media infrastructure before the market corrected. It was rational from AOL’s perspective. It was catastrophic for Time Warner’s shareholders, who traded their stake in HBO, CNN, and Warner Bros. for AOL stock that was about to fall 80%.

Levin’s decision is harder to explain. Time Warner’s assets were real. Its cash flows were real. It did not need to merge with anyone. The most generous reading is that Levin genuinely believed in the convergence thesis. The less generous reading is that he was flattered by the premium and excited by the idea of running the world’s largest media company, but neither instinct served his shareholders.

Both companies had advisors. Both advisors collected fees. Nobody told either board to stop.

_{THE FALLOUT}

Lessons Learned

A high stock price is not a competitive advantage. It is a liability looking for somewhere to land (SpaceX and Tesla merger could be similar, perhaps?)

AOL did not accidentally overpay for Time Warner. It deliberately converted an overvalued currency into a real asset before the market corrected.

The tragedy is that it worked, from AOL’s perspective. Case got out. It was Time Warner’s shareholders who held the bag.

The deal announced as the dawn of the internet age ultimately destroyed approximately $200 billion in shareholder value, produced the largest single-year corporate loss in American history, resulted in two federal settlements for accounting fraud, and ended both CEOs’ careers.

You've got mail. You destroyed $200 billion in shareholder value.