There Must Be a Pony in Here Somewhere

by Kara Swisher

  Pittman knew that being the top dog had its benefits and he knew that he needed to sell the fact that AOL was the place you had to be if you wanted to reach online customers. That was the simple proposition he began to peddle to advertisers, most especially the legions of dot-com companies eager to make a name for themselves by doing a deal with AOL. Publicly, the AOL team sold potential partners on the idea that being on AOL would garner paying customers by pointing its massive subscriber base in their direction. In truth, no one had any real idea whether this would work or not, especially considering the high prices needed to grab those coveted AOL spots. Pittman’s team was able to make those deals mostly because while no one had substantial proof online advertising did work, no one had proof it did not. This strategy would have dire consequences later on, as many companies would abandon their expensive AOL deals.

  What did work for sure was the huge financial boost every company immediately got after signing a deal with AOL, which turned out to be the main reason many companies flocked to it. AOL was, for all intents and purposes, the dot-com IPO enabler of the highest order, followed by Yahoo and other major traffic sites on the Web. As a key part of allowing companies to go public and giving a giant boost to those already in the markets, the deals to be the exclusive advertiser in every category on AOL soon came in huge numbers.

  A constant barrage of press releases was also part of the game, which instantly sent shares of both AOL and its partners upward in the heady market atmosphere. The idea was to convince Wall Street that AOL had a legitimate momentum and that business was flowing to it en masse. The company had largely avoided working with powerful ad-placement agencies, preferring to deal directly with company brass to get deals done. That had slowed the flow of more traditional companies to AOL, since their ad-buying habits changed only glacially.

  Luckily, dot-coms were ready, willing, and able to jump in. So, after Tel-Save’s bet, by the end of 1997, AOL was in the online real estate business in a series of multiyear deals. Shopping service CUC International agreed to pay $50 million, online auto retailer Autobytel paid $6 million, travel service Preview Travel paid $32 million, and 1-800-Flowers paid $25 million. Sometimes AOL got major competitors to pony up. While Barnes & Noble’s online bookseller paid $40 million to be on the main AOL service, Amazon paid $19 million to get the paltry aol.com Web site spot. N2K forked over $18 million, more than twice the online music retailer’s annual revenue.

  By 1999, it got even more lucrative—Web auctioneer eBay paid $75 million in a four-year deal, while medical site Drkoop.com paid $89 million to provide health information on AOL. As part of that four-year deal, in a move that became increasingly common, AOL also got warrants to purchase shares in many of the companies that became its partners.

  This right to buy shares of ad partners became increasingly critical to all AOL transactions, because the stock of dot-com companies was soaring, due in large part to those same AOL ad deals. Drkoop’s shares, for example, initially jumped 56 percent on the announcement of its AOL transaction. AOL, in a practice known as round-tripping, or a boomerang, began making more direct investments in dot-coms, which often turned right around and invested that same cash in AOL ads. In addition, AOL pressed its vendors and other business partners to buy ads and also engaged in complex “barter” arrangements, where services were exchanged instead of cash.

  These seemingly virtuous circles soon became common practice throughout the industry and had embedded in them the seeds of worrisome conflicts of interest and potential opportunities for abuse, including the inflation of the costs of the deals. Later, even more disturbing issues surrounding the proper accounting of such unusual transactions would become hugely damaging to AOL. While AOL sold huge amounts of legitimate advertising, the mania to book any kind of revenue and dub it “advertising” became like a drug addiction at the company.

  The warning signs of this deal-making obsession and its repercussions came soon enough. In August of 1997, just six months after the Tel-Save deal was signed, AOL was forced by the SEC to change the way it accounted for the deal. Regulators determined that AOL had recognized too much of the $100 million deal as revenue in its earnings statements and booked that money well ahead of the introduction of the telephone service itself. The charges related to this SEC-mandated change meant that the only two quarters that had appeared to be profitable following AOL’s earlier accounting change (which had eliminated all of AOL’s historical profits) were also wiped out. Making identical excuses to those proffered during AOL’s earlier accounting woes, Case again blamed the problem on the relative immaturity of Internet industry, insisting that the accounting was subject to debate. He had previously promised “gold-standard accounting” in the marketing-expense accounting mess from 1996.

  But, few paid any attention to the Tel-Save snafu or Case’s broken vow, since it was hard to hear much of anything over the roar of companies lining up and loudly demanding to do a deal with AOL. But the seeds of the later accounting problems had taken root and were growing quickly into the AOL’s corporate culture. It was a pattern of accounting abuse that Time Warner would ignore until it was too late.

  If I Had a Hammer

  The way AOL conducted itself while doing deals would also come under increasing scrutiny by the industry and its players, given the proclivity of the team to beat up on many of the companies whose wallets they were busy emptying.

  Berlow was charged with reeling in the prospects, but Colburn and his team put on the real squeeze. He was aided in this by a passel of mostly narcissistic young men who copied his mannerisms right down to the boots and stubble. Colburn’s group, called Business Affairs, was infamous for its aggression against all comers. As AOL’s power grew, its potential partners increasingly began to feel that they were being subjected to an AOL shakedown, although AOL sold itself as partner-friendly. As the old saying goes, if you’re a hammer, everything looks like a nail. And AOL was a proficient carpenter. Colburn often joked to his colleagues about his rotten reputation: “I’d better make a lot of money at AOL, since I’ll never be able to get another job again.”

  Indeed, Colburn’s antics were legend in the industry, especially since they often verged on the absurd, and sometimes got blown out of proportion. And sometimes not, according to many sources. He would splay himself across tables to make a point. He’d stick his boots in the face of someone wanting a deal. He’d rant and call people names, and then just as suddenly compliment them effusively. He was even impertinent to Pittman, sitting next to him in meetings on Pittman’s glass-eye side and making faces he knew his boss couldn’t see. Others at AOL made similar jokes, but only Colburn was remembered for them.

  Some AOL deal-making tactics were less humorous, according to many sources. They included a proclivity to change deal terms at the last minute deep in the complicated wording of contracts; agreeing to a deal with one company and then keeping it off balance by threatening to do a similar deal with its competitors; putting attractive terms on the table, only to quickly remove them; and not honoring a raft of promises about aiding companies in attracting customers for their ad dollars. In addition, some of those who signed deals were later unhappy with the company’s follow-through, seeing little payoff from their big payouts to AOL.

  “With AOL on the other side, you always thought you were being screwed” was a sentiment I heard repeatedly from many who did deals with them—and yet the line of companies waiting to partner with AOL grew longer and longer. When I asked a few why they did it, most told me they needed to, desperately, for their next round of funding or their upcoming IPO, before asking me like some junkie if I could hook them up with AOL executives I knew well. I demurred, but it was hard after that to feel sorry for those who later complained after the deals went sour for one reason or another, since they had also sought to take advantage of their affiliation with AOL by lining their own pockets as their stocks rose.

  Berlow thought such stories were overblown. “It makes for a bet
ter story if we are crazy,” he said. “And in the context of the times, we were not that different than others.”

  Yet this was not so, since AOL was so powerful. “If everyone tells you that you walk on water, you usually get what you ask for,” said Mike Kelly, who had instituted a more formal system of signoffs to prevent abuses of the system that, in the end, were inevitable because many potential conflicts of interest loomed over most every deal. Even at the height of the boom, there were already worries inside AOL about potential problems. But few questioned a more troublesome aspect of the deal bonanza: The proper way to account for the many flavors of deals, since many of the gains made by AOL were not easy to characterize as traditional revenues. While many of their deals were commonplace throughout the industry, Colburn and his team’s aggressive nature only underscored the image of a too-powerful company that was willing to take things to the edge of the edge.

  Not everyone believed that all of AOL’s hard-hitting behavior was wrong. “I thought it was perfect—you squeeze anyone you can when you are in ascendancy,” said John Malone—the legendary cable titan and deal maker, who had watched AOL’s rise after passing on making a major investment in the company in the early 1990s—to me in 2003. “The problem, of course, comes when it is all over and you see those people on the way down.”

  Inside AOL, the celebration of toughness, in Business Affairs especially, was a major concern to some. “It was hard to call anyone on it, because of its success,” said Dan Prieto, a director of corporate development who was involved in more strategic acquisitions on the Gilburne team. “But the scorched-earth tactics made some of us worry that we were going to end up like Microsoft, successful but deeply resented by our peers and partners. We worried that if AOL ever found itself in a tough spot, no one would stand up for us and everyone would be against us.”

  But arrogance is the luxury of success, although many wondered why Pittman allowed such behavior. It would later prove corrosive. While he did frequently chastise his underlings for their more outrageous antics, he never actually stopped them. Neither did Case, who sometimes teased partners who complained. “Are you really scared of Colburn?” he once ribbed a major Internet executive who had told Case he was put off by the rough AOL style.

  Scary or not, that tone was encouraged. “The top guys and board of AOL wanted delivery, and they were loyal to their people,” said one executive, who noted they also wanted the money to keep rolling in. “We couldn’t stand up to Wall Street and say, ‘We sold enough,’ since we would get shish-kabobed.”

  In truth, both Pittman and Case needed people like Colburn—however distasteful some tactics might be, especially compared with AOL’s lofty corporate mission goals to make it the “most respected company.” Said one top executive succinctly, “He marshaled revenues for Bob and a war chest for Steve and that beat back all the complaints.” At the moment, when lucrative deals were plentiful, short-term gains made by Colburn beat out long-term concerns.

  By pulling in huge sums from the coffers of dot-coms, AOL also created an even bigger set of expectations and the skyrocketing stock soon gave the company an ability to do anything it pleased. Not surprisingly, AOL began a series of acquisitions, easily swallowing a range of online companies in a series of stock-for-stock deals. The biggest fish was the purchase of Internet icon Netscape for $4.2 billion in the late fall of 1998.

  This was another achingly complex deal, which included a critical side deal with Sun Microsystems with intricate back-and-forth revenue and operational agreements. Dreamed up by Gilburne, executed by Novack, blessed by Case, and handed over to Pittman to run, the deal was done for a range of reasons. They included a continued fear of Microsoft, a need for a Silicon Valley presence, and a desire to diversify the company’s business and increase its distribution ability. And it didn’t hurt that it would give the stock a huge lift, too.

  It was also a highly symbolic move, given that Netscape had set off the Internet boom in the first place. The idea of scooping up Netscape seemed so unreal that when a source I ran into at the premiere of Pixar’s A Bug’s Life told me about the acquisition talks, I responded immediately and inelegantly: “No way—you are a liar.” When the deal was finally struck, members of the Netscape team called me at home early in the morning—we had been reporting in the Wall Street Journal that a deal was imminent—with a new take on the famous AOL mail phrase. “They’ve got Netscape!” they chimed together. Yes, AOL did, right down to acquiring the Web’s golden boy, Marc Andreessen, who was also scooped up by the company as a new executive. CEO Jim Barksdale also joined AOL’s board.

  The Netscape deal, combined with AOL’s continuing ability to squeeze more and more money out of ad deals, gave AOL an air of invincibility. All the analysts’ reports from then on out were uniformly positive. In one report, for example, Goldman Sachs’s Michael Parekh gushed that AOL was now the “firstest with the mostest.” Such sentiments helped AOL stock rise even higher. And it was further turbocharged when AOL joined the Standard & Poor’s 500 at the start of 1999, becoming the first Internet company to be added to the benchmark index.

  AOL’s market cap, which had been hovering around $14 billion in the early spring of 1998, hit almost $65 billion the day it debuted on the S&P. Such gigantic leaps in market cap yielded huge fortunes to the major executives at AOL—and, in fact, to many hundreds of employees throughout the company. As did so many tech executives in this period, the AOL executives took full advantage of the share rise and regularly sold off their stock for ever-larger amounts. Steve Case made about $20 million from 1991 to 1996, but in one transaction in 1998 alone, he netted $61 million by trading in stock options he had gotten for pennies.

  Others, including Pittman, Berlow, and Schuler, also cashed out and quickly bought private planes, luxurious homes, and other accoutrements of wealth. Ted Leonsis used his gains to grab big stakes in two local sports teams—the Washington Wizards basketball team and the Washington Capitals hockey team. Everyone seemed riveted by what AOL’s executives were up to. At a speech I gave in 1999 to a local business group in Washington, D.C.—the locus of AOL power—one major grocery chain executive I had known for years asked me if I thought he had been really stupid for not getting in on the action and whether he should jump now. I was obviously the wrong person to ask.

  “Don’t you wish you’d taken my job offer?” Leonsis kidded me in 1999, when I met him at the National Press Club in D.C. I saw him right after a meeting he’d had with his new hockey team, where he gave each player a new and very expensive laptop computer to introduce them to the new world order. By now, I was not sure what to tell him.

  A Moment of Reflection

  While AOL was finally soaring in the late 1990s, life for Jerry Levin in these heady days wasn’t good at all, either professionally or personally. While he’d managed to come out on top after the power struggle that the contentious $14 billion merger of Time and Warner created, he seemed perpetually in trouble.

  He had been attacked in a much talked-about 1996 Forbes article as presiding over a “beached whale” of a company, and soon there were betting pools on Wall Street about when Levin would be ousted. A combination of bad Internet investments and overpriced cable acquisitions, along with crippling debt, had depressed Time Warner stock. From December 1993 to 1996, while the S&P was up 59 percent, Time Warner was down 15 percent. Worse still, the bitterness of the Time and Warner merger continued to linger.

  Levin was undaunted. “You have to have a strong inner core. The press is very often too high or too low on a CEO or on his or her strategy,” wrote Levin to me in an email, recalling the difficult time. “On the other hand, you have to have responsible leadership that is respected within and outside the company. So your public image is important.”

  But Levin’s life took an even more tragic turn in June of 1997, when his eldest son, Jonathan, was found dead in his New York City apartment. Tragically, the 31-year-old teacher at a low-income Bronx high school had been k
illed by a former student.

  Levin was shattered by the news, and his grief had many layers. His son was not only dead, but he’d been cruelly murdered. Compounding Levin’s agony was the fact that in recent years, he had not spent a lot of time with his son. He also seemed haunted by the fact that Jonathan, unlike Levin himself, had chosen to devote his professional life to helping others. In my conversations with him in 2002 and 2003, Levin often talked about this. It is no exaggeration to say that his son’s death created a personal crisis that would forever change Levin.

  I was astonished that many people, after the merger fell apart, charged that Levin made too much of his grief and used it to shield himself from other criticism. But this is sniping that Levin does not deserve. News clips taken of Levin at Jonathan’s funeral show a man in a daze. With fellow mourners supporting him, he appears barely able to stand; his face is creased with pain. Levin’s anguish ran so deep that some colleagues wondered if he’d have the strength to ever fully reengage in his work again.

  The tragedy most definitely provoked Levin’s restless mind to wonder if anything he was doing really mattered. He’d spent his entire life fighting his way to the top of the corporate hill. His was a world where people lived and died according to box office figures, record album sales, and magazine circulation numbers. How was it possible to care about any of that now? “I think I started to see everything differently from that moment, although I did not realize it at the time,” Levin told me. Others at the company also began to treat Levin better, too, startled by his son’s death into realizing that perhaps their CEO was more of a human being than they had thought. “It gave Jerry a lot of humanity, because he became more approachable,” said former Warner Bros. head Terry Semel.

  Oddly, the beginnings of the forces that would soon improve Time Warner’s prospects came only a week after Levin’s son’s death. Microsoft’s Bill Gates invested $1 billion in Comcast in an effort to jumpstart the digital rollout of information services. Gates followed this with a $425 million investment to buy WebTV and made other cable investments. His overall aim was obvious: To speed the development of high-speed Internet services to open new markets for Microsoft software. Microsoft’s other founder, Paul Allen, was also on a cable-buying spree, which further heated up once moribund cable market valuations.