Tuesday, October 11, 2005

Wolf at the door

Time Warner

Oct 13th 2005 NEW YORK
From The Economist print edition

Pressure from Carl Icahn and other shareholders is just what Time Warner needs

FOR a short time this summer, Time Warner, the biggest media company in the world, thought it had moved on from its disastrous takeover in 2000 by AOL, an internet firm. In August it set aside $3 billion to settle legal claims over the merger. With that its managers expected to be left alone to concentrate on developing the company's assets, which include movie studios, cable-television channels, a cable system and magazines, as well as AOL. But now the company has to fend off Carl Icahn, a billionaire corporate raider. In August Mr Icahn announced he had taken a stake in Time Warner, alongside some hedge funds. This week he got personal. On October 11th in a long letter to shareholders he attacked the company's management and board members.

Even while Mr Icahn is circling, Time Warner's managers are receiving more- welcome overtures from two giants of the internet world—Google and the MSN division of Microsoft. The two companies are reported to be competing to take a stake in AOL, as a way of scooping up internet users. Any such deal might generate some cash to help appease Mr Icahn. But it would not address the corporate raider's broader critique of the company.

Mr Icahn initially said that Time Warner should sell its cable division, which in 2004 accounted for a fifth of revenues, and use the money to buy back $20 billion worth of its own shares. That would quickly narrow the gap between the price of Time Warner's shares and the potential value of its assets, he said. Before he made his demands the firm had already announced plans to buy back $5 billion of its shares and spin off 16% of its cable operation. With a total market capitalisation of $82 billion, the firm is still the world's largest media company. But at around $18, the company's share price has fallen by a total of 76% since before its merger with AOL. Dick Parsons became chief executive in May 2002 and started trying to repair the damage. But the share price has still fallen by 5% since he took over.

This week Mr Icahn accused the firm's top managers of “paralysis of inaction” and argued that they have sold assets far too cheaply since the merger. In 2002 the company was heavily in debt and needed cash. Mr Parsons sold Warner Music to private-equity investors for $2.6 billion. Mr Icahn points out that Warner Music, which was floated on the stockmarket this year, is now worth $4.7 billion. Time Warner's board, he complains, still contains most of the Time Warner members who made the terrible decision to sell the company to AOL, as well as former AOL board directors. Time Warner's new headquarters at Columbus Circle in Manhattan are excessively lavish, he complains.

Much of what Mr Icahn says is right. It is true that the company has sold assets for prices that were far too low—at least with the benefit of hindsight. Many of the firm's top managers must surely resent the continued presence on the board of Steve Case, the man who wooed them into one of the worst mergers in history. And Time Warner's corporate culture is certainly not known for leanness.

With his allies, however, Mr Icahn controls only 2.8% of Time Warner's shares. Although it has no controlling shareholder like News Corporation or Viacom, two other giant media conglomerates, the company's fragmented shareholder base (the biggest owns 5.3%) gives it protection. That means Mr Icahn would have to muster support from other shareholders if he wanted, for instance, to try and oust management. He is highly unlikely to get backing for anything so drastic. Other institutional fund managers distrust him as a short-term investor, and Time Warner's top managers have kept on good terms with shareholders, despite the company's lagging share price.

Time Raider 2

Shareholders are nevertheless very happy to use Mr Icahn as a spur to get the firm's top managers to think more aggressively about how to increase its share price. Mr Icahn has spoken to fellow shareholders, says Jessica Reif Cohen, the media analyst at Merrill Lynch, and his letter this week is in effect “a collection of their individual miseries.” His demand that Time Warner buy back more shares especially strikes a chord with other investors. Big traditional media firms are finding it hard to grow, and their record on mergers and acquisitions has been poor. So many of them are under pressure to return money to shareholders.

Mr Parsons' response is that Time Warner will increase its share buyback and possibly spin off more of its cable concerns. He also argues that it is AOL that will drive the firm's share price in the immediate future, more than share buybacks or cable. The attentions of Google (in alliance with Comcast, a big cable television company) and Microsoft certainly suggest that AOL is far from moribund. It contributed a fifth of Time Warner's revenues last year, mostly from selling premium dial-up access to the internet. But the dial-up business has been in decline for years because people are shifting to broadband web access. So the new strategy is to diversify away from subscription towards internet advertising. This summer it launched a portal, AOL.com, to attract more visitors and ad revenue, offering free content previously reserved for AOL subscribers.

So far the strategy seems to be working: ad revenue is growing quickly and in July millions of people tuned in to AOL.com for a webcast of the Live 8 concerts. “We're not far off Yahoo! for number of visitors,” says Don Logan, who oversees AOL for Time Warner, “but we're not getting recognition from Wall Street yet.” A link-up with either Microsoft or Google would secure more traffic and advertising for AOL, as well as a big cash infusion for the company that might be handed back to shareholders.

“We're asking ourselves whether we have all the partnerships we need to grow in online advertising and we're exploring all our options,” says Mr Parsons. But the problem with AOL, says Michael Nathanson, an analyst at Sanford Bernstein, is that its declining subscriber business still accounts for far more of its revenues than its growing advertising business.
Many shareholders, Mr Icahn included, are also worried about Time Warner's cable business.

Once Time Warner completes its acquisition of Adelphia, a bankrupt cable operator with a valuable franchise, roughly half of Time Warner's profits will come from this division. The industry faces new competition from phone companies, which will soon offer video products as well as voice and broadband, and a price war could ruin profitability. For the moment, Mr Parsons says that cable is still an excellent business, and that Time Warner's content assets benefit from having distribution to back them up.

Changes in Time Warner's management are on the way. Mr Parsons was appointed to clear up after the merger. He is a conservative lawyer and banker, who unlike other top executives at Time Warner has not built a media business. Under Mr Parsons, says Peter Kreisky, chairman of the Kreisky Media Consultancy, “there's an appropriate sense of steady-as-she-goes.” His successor, in the next few years, is expected to be Jeffrey Bewkes, the man who built Time Warner's crown jewel, HBO, a cable-television company. Mr Bewkes has more appetite for risk, and next year could take over management of AOL, Time Warner Cable and the magazine division from Mr Logan, who is expected to retire. At some point in the next few years Mr Bewkes will probably become CEO—a change which could help drive the company forward.

For now, all Mr Icahn wants is a new, independent shareholder representative on Time Warner's board, which could be himself or someone else. It is hard to see how that could do anything but help the firm make rigorous decisions on what businesses to be in for the long term.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

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