M&A: the triumph of hope over experience
11 December 2009
There’s an intriguing symmetry between two announcements this month. Comcast, the cable company, has acquired 51% of NBC Universal, and Time Warner has finally managed to sell off AOL, with which it so disastrously merged nine years ago. The latest deal may not challenge the earlier one for the title of most catastrophic coupling of the century, but it is surely yet another triumph of hope over experience. How many successful mergers can you think of between businesses in radically different industries?
No, I can’t either – perhaps I’ve been dazzled by the disasters. Comcast picked up some of the wreckage from one of these in 2002 when it took over the cable businesses whose acquisition had virtually destroyed the old AT&T. That was at least a business Comcast understood and where it might have been able to achieve some efficiency savings. (Though nothing like enough to justify the $72 billion it then paid.) Nothing so humdrum as efficiency is on its mind now – it believes that getting into content will save it from commoditization, hence the $30 billion valuation of the new joint venture.
It’s nearly always the vendor who’s the winner in these deals, because the buyer becomes so intent on seizing the exotic new prize that it raises its bid way above what could produce a decent return. You can be sure that GE knew exactly how much NBCU was worth and was delighted to get so much for it. Mergers within the same industry at least have a chance of being based on informed calculations of possible savings and synergies.
AOL-Time Warner was a notable exception to the general rule about vendors winning. In this case the company being acquired was so bedazzled by the apparent glamour of its seducer that it gave away the crown jewels. Nobody in the Internet world thought Steve Case and AOL glamorous, even in 1999 when its market cap soared to $175 billion. It had a temporary monopoly in Internet advertising and a ruthless hold over dot.com start-ups, thanks to its then enormous captive customer base, but it was not the model new media business it claimed to be.
To Jerry Levin, mortified by Time Warner’s expensive Internet flops, the cyber cockroach, valued almost twice as highly as TW’s mere $90 billion, looked like a superstar. Maybe it could give the group the ‘digital construction’ he thought it needed. One of Levin’s core beliefs was that ‘the deal’ was the defining moment in business, and he was all ears when Case came a-courting. He was right that this one would transform his resolutely analogue old media business, but not quite in the way he had dreamed.
Case was well aware that AOL’s stratospheric valuation could not last and that even its recently acquired profitability and market domination were fragile – a merger would be a brilliant way of cashing his chips. (He preferred to call it capital preservation’. Despite the fact that Time Warner’s revenues were four times AOL’s and that it had $6 billion of cash flow, AOL shareholders got 55% of the stock in the new group, and Time Warner’s 45% – this was extremely nifty financial engineering. But there was no arguing with such an enormous disparity in share price – capital markets couldn’t get valuations that wrong, could they?
What mattered to Levin more than whether this was good value for his shareholders was his personal position – the crucial thing was that he should be the CEO of the new group. In fact he soon found himself shackled by Case’s role as executive chairman and only survived for a year after the deal was finalized. When it was revealed that AOL’s earlier numbers owed not a little to creative accounting and extortionate sales tactics, Case too was forced out a year later. Broadband was drawing dial-up subscribers away in their millions and it became clear that Time Warner might be more valuable without the cockroach at all. Having struck the hated name from its title, it agonized for seven years as to how to divest itself of its toxic asset, finally demerging on 9 December. The stock market then valued the new AOL at a measly $2.5 billion and Time Warner at a miserable $36 billion, 60% down on the $90 billion that had so chagrined Levin ten years ago.
The only winner from this sorry tale is Steve Case and his cronies, assuming that they managed to sell their Time Warner shares before they too collapsed. The biggest losers were Time Warner’s shareholders, and the saddest its employees, with holes in their pensions.
In terms of rationale, Comcast’s venture is more comparable to an earlier tragic-comic saga: in 1989 Sony blew almost $6 billion to buy an almost worthless Columbia studio and obtain the services of a couple of Hollywood hucksters. Ever since its defeat in the VCR wars Sony had believed that content was critical to the success of its hardware, but what really counted was Akio Morita’s dream of owning a Hollywood studio.
Maybe Comcast’s chief executive doesn’t have stars in has eyes, but the idea that there is a business benefit from combining content with technology in the same organization is contradicted by all the evidence. Content owners are happy to sell their products to any distributor with the money to pay, so it’s infinitely cheaper to buy programming on the open market than to have your own factory. Consumers couldn’t care less about viewing Sony films on Sony equipment and vertical integration almost never works well. If Comcast was worried about commoditization, it might have done better to build on the assets it already had and tried to extend its capabilities.
But who wants to spend time improving the business you have, when there are new worlds to conquer and an empire to build?