Marketwatch’s David Callaway suggests that a MSFT acquisition of Yahoo! will be awfully reminiscent of the Time Warner AOL merger, which has left AOL confused and searching for a strategy, as we outlined earlier today. He says:
Microsoft’s bold, $44 billion bid for Yahoo bears many similarities to Time Warner and AOL. Yahoo is a sought-after portal, perhaps the most famous and certainly the sexiest of the mighty three, which include AOL and MSN.com. Microsoft, despite its MSN service, is a mature company; not quite old media, but close. Any combination would involve thousands, if not tens of thousands, of layoffs as the dreaded “cost synergies” were hunted down. For these types of deals only work, to the extent that they ever do, with ruthless cost-cutting.
The big difference is that when Time Warner bought AOL, the Web portal was at the top of its game. Yahoo was also at the top of its game back in 2000, while Google was only just getting started, two years out of Stanford and a full four years before its massive IPO. Now Google trumps both Microsoft and Yahoo, and Yahoo has been looking for direction for most of the last four years.
On a superficial level, Time Warner + AOL is indeed similar to Microsoft + Yahoo!
But the instant you dive into the matter, you realize they’re not identical at all. The outcome might be the same, it might be very different, but going into the deal, the differences far outweigh the similarities:
1) Tech & Media = Oil & Vinegar
Time Warner’s sale to AOL was a big bet on the promise of synergies between technology and old media. In theory we all expect that to work, but between cultures and DNA, it does not always bode well.
Tech and media do make an interesting mix, but they don’t really blend well together, causing problems.
In MSFT’s bid to acquire Yahoo!, a technology-company with a legacy of prowess on the desktop is attempting to acquire a technology cum media company with prowess in online advertising and the Internet. Sure, in many levels, MSFT and Yahoo! are very different, but juxtaposed to Time Warner and AOL, MSFT and Yahoo! are eerily identical (one-time technology giants undergoing some kind of innovator’s dilemma).
2) Deal Structure
More importantly, and this is key to remember:
AOL (a company founded in the 1980s) bought Time Warner (Warner Bros.’ lineage goes back to 1912). That in itself is meaningless, fine, but ultimately, AOL bought Time Warner with an inflated stock as a hedge against the impending dot com bubble bursting.
Steve Case hedged himself using Time Warner: a mature and stable enterprise with much more revenue. In doing the deal (in the 2000 mindset of growth over income), he pummeled his stock overnight but secured his company because the dial-up business would be dying as broadband prevailed.
You might be thinking: so what? The stock market is always right. All right, well, numbers don’t lie:
Before the merger, TW was valued at 20x its annual cash flow. If you applied this to AOL, it would have been worth $30B. Even by today’s standards this would be rich (Yahoo! was worth less than $30B before MSFT’s unsolicited offer), but AOL was being valued at $150B!
To put things into context, today Google is worth $157B (down from its $225 high back in Q4 2007).
When AOL bought Time Warner, it was a $164B merger, created out of thin air, built on sand… and like a house of cards, the whole thing went tumbling down once the Nasdaq market crashed and fell from 5,000 to 1,200 in a few years.
AOL leveraged its balance sheet to acquire Time Warner to spruce up its income statement.
Indeed, Rupert Murdoch said of Steve Case’s deal: “It was brilliant, he bought something with $6B in annual cash flow”.
The problem was the main asset that was leveraged was goodwill. Before long, AOL would have none left, both with analysts, investors, but most importantly, with Time Warner brass.
3) Climate
2008 has gotten off to a shaky start, but broadly speaking, it’s nothing like 2000, which was the tail end of:
a) a 19-year old Bull Run (briefly interrupted by Black Monday in 1987)
b) a torrid 6-year technology boom (the famous “irrational exuberance” call came from Alan Greenspan in December 2006, the valuations of firms like MSFT, Cisco, Dell, and the Web companies continued undeterred all the way until 2000)
c) a bubble era launched by the world wide web’s explosive and speculative growth, driven largely by Yahoo!, Amazon.com, eBay and of course, AOL.
In 2000, we were way beyond irrational exuberance and well into madness. For example, on the day of its IPO, Priceline had a greater market capitalization than the sum of the market cap of United Airlines, Continental Airlines and NorthWest Airlines. On IPO day, Priceline was losing $3 for every $1 it earned! Today, Priceline is worth $4B but it generates well over $1B in revenue and nets $100M in profits.
But no need to get into the outliers like Pets.com and Webvan, AOL had no business being valued at $150B, but it was, and invariably, Steve Case showed his shrewdness by buying Time Warner.
The climate is vastly different because online advertising is a global $40B business expected to grow to an estimated $80B size within a few years. Online advertising is not a gimmick anymore, global marketers and Fortune 500 advertisers understand that online (digital/interactive) advertising will be leading all marketing initiatives and Microsoft does not plan to let Google become a bigger business than it the way that MSFT surpassed IBM and all startups eventually take over the incumbents.
4) Culture
If Steve Case was shrewd, then many felt that his counterpart at Time Warner, Gerry Levin, was plain dumb. Of course he wasn’t. While many media moguls like Rupert Murdoch stayed on the sidelines, players like Levin envied the multiples and media attention the Internet companies got, and eventually gave in to temptation by merging their shops with Web giants.
And make no mistake about it: in 2000, AOL was a giant. But within months, it became vulnerable with the stock market crash. Eventually, Time Warner AOL dropped AOL from the corporate namesake, and took a $99 Billion charge. Time Warner shareholders lost $100B in value. Today TW is worth $55B. The merger pegged the value at $164B. That kind of animosity does not go away.
Even if MSFT/YHOO becomes 1/10th of what the planners are thinking it might be, neither MSFT nor YHOO will lose $100B in market cap. Given the climate, the technology pedigree and the deal structure, it’s hard for this union not to work, especially when both companies are being kicked in the rear end by Google.
This is probably an under-estimated nuance. If MSFT prevails in buying Yahoo!, some staffers will be laid off, many will be reassigned, but anyway you dice it, the stronger company with more revenues, profits, execution track record, etc. is buying the weaker company.
To conclude, Yahoo! has no one to blame but themselves. They are being taken over by a stronger company, mainly because that is how the stock market works. This is as much of a case study on stock market mechanics and dynamics than it is about technology and media, software and advertising.
In that sense, yes, this does remind us a bit of AOL, that was also a manifestation of financial engineering, but apart from that little similarity, the difference far outweigh the commonalities.
As I said, this is all going into the deal, a deal that has yet to be approved.
I think given where online advertising is today, how badly Yahoo!’s management has fared over the past 5 years, Yahoo! should be welcoming this interest from Microsoft. Incidentally, this is one more difference between the two cases. When Time Warner agreed to sell, I suspect a lot of the TW brass was into AOL. In Yahoo!’s case, the board, management and employees seem to be giving the acquiring party the cold shoulder. Maybe that is the best omen yet.
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