The more high-flown the rhetoric surrounding a deal, the more suspicious we should be. I'm speaking, of course, about America Online's stunning takeover of Time Warner. This is being hailed endlessly as a visionary deal designed to launch a whole new era by combining AOL's Internet reach with Time Warner's old-line television, movie and magazine businesses. But it sure looks to me like this deal isn't about "content" or getting more people to read magazines. Rather, it's largely about AOL getting to use Time Warner's cable-TV wires to carry high-speed "broadband" services to millions of potential users. And then there are the standard motives: stock prices, Wall Street's manias and extra enrichment of already-rich corporate big shots. In this case, Time Warner Chairman Gerald Levin and AOL Chairman Steve Case both stand to get hundreds of millions of dollars of golden-parachute stock-option payments because both companies treat the transaction as if they're being sold. Pretty slick.
How can I be so skeptical about a deal that many people are hailing as the greatest thing since sliced bread? Because I've been watching takeovers for 30 years and I've learned to apply the Occam's-razor logic principle to them. For those of you who missed philosophy class, this means that the simplest explanation is most likely to be correct. And when the principle is applied to Wall Street, the most cynical explanation is usually the most correct, too. Before we proceed, disclosures. Time Warner's Time magazine is Newsweek's prime competitor, and Newsweek is owned by The Washington Post Co. I'm a former Time Inc. employee (Money magazine, 1982-84) and I've consistently said that AOL's stock is overvalued and the market has consistently disagreed.
So now let's get out our Occam's razor and slice through the deal. Until recently, AOL buying Time Warner was as likely as a flea buying an elephant. But the stock market made this takeover possible by valuing 15-year-old AOL at twice the value it accorded 76-year-old Time Warner. This despite the fact that Time Warner's businesses produce from four to six times (depending on who's counting) the operating profits of AOL's businesses. Thus, Wall Street says a dollar of AOL operating profits is worth eight to 12 times a dollar of Time Warner profit. New math?
If you apply the simplicity theory, Time Warner's cable wires stand out as the linchpin of the deal. For the past two years, Corporate America has embraced the idea that using cable-TV wires to carry high-speed services is the wave of the future. AT&T has bet its future on this, shelling out more than $100 billion to buy cable companies. AOL has been whining that AT&T's ownership of cable wires gives its partly owned Excite At Home Internet service unfair advantage over AOL and other Internetniks at peddling broadband-by-cable. AOL wants AT&T's wires opened to all comers. Buying Time Warner, the nation's biggest cable company, gets AOL into the cable game overnight.
AOL's chief financial officer, Mike Kelly, says that access to Time Warner's cable wires is one factor driving the deal but isn't the major one. "Time Warner's unique combination of content, great brands and cable assets are a perfect fit with AOL," he says. But now, a little subtlety. Even if, as Kelly says, AOL isn't obsessed with getting access to Time Warner's cable wires, Wall Street analysts fear that being locked out of cable is a big risk for AOL. And if Wall Street's worried, it means AOL has to do something. The company devotes great care and feeding to its stock price. When Wall Street wanted to see reported profits years ago, AOL used tortured bookkeeping to produce them. When the Street thought promotion expenses were excessive, AOL cut back. Now the Street wants more users, so AOL is promoting again. Why does AOL care so much about its stock price? Because its big shots are optioned to the eyeballs, stock options drive the AOL culture and AOL uses its shares to make acquisitions.
Time Warner's Gerry Levin says he doesn't buy the cable-wires-make-this-deal-go thesis, either. "To say [that] is what the deal is about misapprehends the deal," Levin told my colleague Johnnie L. Roberts. Then again, the old Time Inc. said I was wrong a decade ago when I mocked its premium-priced purchase of Warner Communications--a bizarre transaction that left Time, supposedly the acquiring company, under the control of Warner's Steve Ross.
Back to today's deal. Now, watch how Levin and Case both get to deploy golden parachutes. In most takeovers, employees of the acquired company--in this case, Time Warner--get their stock options vested immediately. Fine. But options of the acquiring company, AOL, will be vested early, too: a year after the purchase of Time Warner is completed. AOL says that's because Time Warner holders are getting a 45 percent stake in the combined company, and outsiders' getting 40 percent or more triggers change-of-control provisions. Even here, where AOL is doing the takeover. A classic case of double dipping.
Now let's play financial voyeur and count Levin's and Case's money. AOL is swapping 1.5 of its shares for each Time Warner share. The day before the deal was announced--the way you value such a deal-- AOL stock was $75, Time Warner was $64. Do the math and AOL is paying a bit above $110 a share, a fat $45 premium over the pre-deal price of Time Warner. You can see why Levin is hot for the deal on his shareholders' behalf. And his own. I'll spare you the details, which come from the companies' most recent SEC filings. (The companies declined to comment.) By my count, applying the $110 price increases the value of Levin's unvested options by $125 million and the value of his vested options by $240 million. Case's unvested options would be worth more than $600 million if he could cash them in at AOL's price Friday, and his vested options would be worth $775 million. I'm not saying this is why Levin and Case are doing the deal--but it sure doesn't hurt any. Wait, there's more. After cashing out their existing options, both Case (chairman of the new AOL Time Warner) and Levin (chief executive) would doubtless get huge new option grants. You've got to love it. You get to cash in your options early because of takeover provisions, and instead of losing your job you get more options.
Please note that I think some of the futuristic stuff that Levin and Case are spouting may actually come to pass someday. And that I'm not accusing Levin, Case, AOL or Time Warner of anything other than saying whatever it takes to get the takeover done.
In any event, this deal is probably better for Time Warner than the Warner deal was for Time. That deal bogged down the company with $14 billion of debt that it's still paying off. This deal doesn't involve debt. But it does involve believing that a company whose initial profits will be predominantly from Time Warner businesses will be valued as magically by the stock market as AOL has been. So for me, I'll watch the cable wires and tune out the rhetoric.
Sloan is Newsweek's Wall Street editor. His e-mail address is firstname.lastname@example.org.