AOL, Time Warner Face Many Merger Obstacles

And now, the morning after.

The business world’s euphoria over the proposed merger of America Online Inc. and Time Warner Inc. began to dissipate Tuesday, if modestly, as the scale of the deal--and of its potential obstacles--grew clearer.

Those obstacles include the melding of two large corporate bureaucracies with sharply different cultures, the reconciliation of two very different financial structures and the hard work of figuring out what exactly it means for one company to own both a world-class stable of entertainment and news brands and the world’s leading pipeline to the Internet.

“It’s going to be difficult to pull this off,” said Josh Bernoff, an Internet analyst for consulting firm Forrester Research. “Time Warner is very slow-moving and has had a lot of difficulties with the Internet, and America Online is very aggressive.”

Those concerns, compounded by the realization by investors that the financial structure of a combined AOL Time Warner may depress profit for as long as 20 years, helped trim the stock prices of both companies.

In late trading Tuesday, AOL was off $8.63 to $64, and Time Warner was down $6.25 to $86 after soaring $27.50 on Monday on news of the deal.

The losses trimmed about $18 billion from the peak value of the merger, which reached $170 billion on Monday night as computed from the after-hours trading price of AOL shares.

Few industry experts expect the deal to run into serious regulatory opposition in Washington or elsewhere, although the paperwork will be daunting. For one thing, hundreds of municipalities will have to rule on the change of control of Time Warner cable franchises in their areas. Some are likely to insist on promises that the company would open its cable lines to Internet service providers competing with AOL, which the companies already have agreed to do in principle.

Industry experts were divided about whether the deal’s great benefit for America Online lies in its access to the high-speed, or “broadband,” cable network owned by Time Warner and marketed to cable TV subscribers under the brand name Road Runner, or in its access to Time Warner’s news and entertainment properties. Those include Time, People, and Sports Illustrated magazines as well as CNN, HBO, Warner Bros. movies and the WB broadcast network.

Expressing the latter view was David Londoner, a media analyst for Schroder Securities.

“The most important part is content and the cross-promotional potential,” he said. “All the Time Warner publications, the WB and cable will be promoting AOL and getting them new subscriptions. Then when you go to AOL’s home page, it will be leading you to CNN.com, Entertaindom.com, and all the other Time Warner sites. I see them as enhancing each other.”

That’s the theory. The question is how well the combined firm can execute the plan. Managing a media-technology-marketing enterprise of such size--by market value one of the world’s largest companies--is formidable even under ideal conditions.

AOL and Time Warner will have to navigate among a web of marketing and licensing deals and corporate alliances both companies have already made. Many of these will limit the way they can redeploy their own content or lead to troublesome conflicts of interest.

On Tuesday, for example, Thomas Middelhoff, chairman and chief executive of Bertelsmann, the German entertainment conglomerate that owns half of AOL Europe and a small stake in the parent company, said he would resign from the AOL board because Time Warner is a major Bertelsmann competitor.

“People keep forgetting that these are companies with a huge set of marketing partnerships,” said Michael J. Wolf, an entertainment industry consultant at management consulting firm Booz, Allen & Hamilton Inc. “We keep hearing that we’ll be watching Warner programming on AOL, but a lot of that programming is encumbered” by alternative deals.

The companies will also have to decide whether some Warner content should be available exclusively to AOL subscribers. Streaming or downloading Warner Bros. movies to AOL subscribers over the Web--a technology that will become accessible as more users sign up for broadband access--might enhance AOL’s allure as a service, but only at the expense of limiting the movies’ availability to a mass audience.

“If they make content available on AOL and not anywhere else, that would be shortsighted,” Londoner said.

It might also cause friction with Time Warner artists and producers who would prefer that their properties be made available to the widest possible audience.

“I think they will try to pull something exclusively for AOL users to entice people to be subscribers,” said Lewis C. Henderson, head of new media at William Morris Agency. “But how specifically they try to handle it would definitely be a deal point for me.”

Early indications are that the company would try to straddle that fence. Asked Monday how AOL Time Warner would handle Entertaindom.com, a Time Warner Web site that offers specially produced shorts as well as vintage TV clips and Warner Bros. Looney Tunes cartoons, Time Warner Chairman Gerald M. Levin said, “Entertaindom is going to be on AOL, but Entertaindom is also going to be doing other things.”

Possibly the most immediate issue for investors is the finances behind the merger.

The financial burdens of many mega-mergers can cripple the offspring for years. Among the best examples of that, as it happens, was the merger that created Time Warner itself: the combination of Time Inc. and Warner Communications that was completed 10 years and one day ago. That deal saddled Time Warner with a mountain of debt that depressed earnings and left shareholders with a stock that barely budged in price for eight years until 1997.

Although the AOL merger won’t have the same debt-producing outcome, it does carry its own financial cloud: the conjectural value of America Online stock, which is the currency paying for the merger. Like most other Internet stocks, AOL’s has gyrated wildly. Holders doubled their money over the year leading to Jan. 7, the last trading day before the merger announcement, but in the process they had to endure some heart-dropping downdrafts, including one that pared 20% from the price between Dec. 10 and Jan. 7.

In accounting terms, the price AOL is paying for Time Warner is far above the latter company’s tangible value. The nearly $150-billion excess, which is known as “goodwill,” is to be charged against profit over 20 years.

What remains after all these obstacles are cleared are the imponderables of cultural dynamics.

In the biggest deals, management and merger experts say, the pure complexity of blending different organizations is a huge stumbling block.

“Complexity is always a challenge,” USC management professor Warren Bennis said. “As you become bigger and have more and more bureaucratic levels, you risk squeezing out the creativity of human imagination.”

Combining a young Internet company such as AOL with a diversified, media giant with a rich history such as Time Warner, experts say, could prove particularly tricky.

Bennis said he expected tumult at AOL Time Warner. “I wouldn’t put a lot of money on the management structure lasting more than a year,” he said. “Executive search firms are all like vultures now, wheeling around looking at how this plays out and to see who isn’t where they think they should be.”

Management experts warn that investors should not be misled by the enthusiastic rhetoric that invariably accompanies news of big deals, as it did Monday’s AOL Time Warner announcement. One of the worst merger fiascoes involved AT&T; Corp.’s acquisition of NCR Corp. in 1991 after a nasty takeover battle. Initially, the $7-billion deal was touted as a natural convergence of the global telecommunications and computer industries. But after piling up losses at NCR that eventually totaled $4 billion, AT&T; decided in 1995 to spin off the Dayton, Ohio-based cash register and computer systems concern at a huge loss.

Among other missteps, AT&T; antagonized NCR staffers by installing one of its own executives to run the company. Likewise, NCR staffers chafed when AT&T; changed the company’s name to AT&T; Global Information Solutions. The name was changed back to NCR only after AT&T; gave up and spun off NCR.

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WHO’S NEXT?

Analysts expect a wave of new-media/old-media alliances. C1

* STOCKS DIVE

Shares of America Online and Time Warner plunged. C4

* PRIDE AT AOL

Employees at once-derided America Online are feeling a sense of redemption. C1