There Must Be a Pony in Here Somewhere

by Kara Swisher

  That was good news for Levin, since Time Warner’s cable assets were strong and its media assets top-notch. But in the rush toward the Internet space, Time Warner still lagged badly, with few initiatives and little indication of any true strategy. The disastrous experience of both the Full Service Network and Pathfinder had proved debilitating. Though individual divisions, such as the film studios, pursued their own experiments, Levin seemed to have all but abandoned the grand interactive plans that had long occupied him.

  It seemed unusual to me that Time Warner executives were almost nowhere to be found in the Internet space during this frothy period of the late 1990s. One would hear stories of their occasional visits to Silicon Valley, and they seemed to take particular interest in possibly acquiring one of the many Web-centric publications that had sprung up in the boom and seemed to be minting money. Sometimes they would talk to a small dot-com about a partnership or even an acquisition. But with all the money scattered around for anyone who bent down to pick it up, it was hard to compete. The stories I heard from both inside and outside the company usually ended with some Time Warner functionary lecturing the dot-commers about their insane valuations and jetting back empty-handed to New York. They were right about the mania, which they also wanted to be part of, but still got dinged as dinosaurs for not benefiting from the Internet boom.

  Other media companies were less circumspect about entering the fast-moving digital stream. In the summer of 1998, Disney made a major move by purchasing a large stake in a second-tier portal called InfoSeek, and then moving quickly to remake it into a major Web site called the Go Network to compete in the big Web leagues ruled by AOL and Yahoo. General Electric’s NBC bought CNET’s Snap portal, while both Viacom and News Corp. made a series of moves to beef up their Internet assets.

  Perhaps the most audacious attempt was made in early 1999 by USA Networks’ Barry Diller, in a stillborn deal that would turn out to be a kind of precursor to the AOL Time Warner merger. Diller, who had been one of the earliest and savviest among the media moguls to enter the Internet space, sought to purchase the Lycos portal. When the agreement was first announced in February, it was valued at $18 billion. It was also touted as a critical merging of old and new media to create the first e-commerce and entertainment powerhouse. The deal was scotched by May, though, by its largest shareholder—Internet-holding company CMGI—which thought the price USA wanted to pay for Lycos was too low. Diller, a wily businessman hardened by innumerable Hollywood scams, didn’t concur and walked away. Interestingly enough, Time Warner was soon suggested as a possible new suitor for Lycos and held many talks with the company about a possible acquisition or investment deal. But Lycos’s high valuation prevented a deal that properly valued Time Warner’s digital contents.

  Thus, nothing came of it, despite a new unit Levin created in June 1999 called Time Warner Digital Media, which was intended to give new energy to Time Warner’s Internet strategy. It was headed by Richard Bressler, who had been the company’s CFO and who would later play a critical role in the AOL Time Warner merger even though he had little Web experience or expertise. He began his Web efforts in earnest by sniffing around the portal space, after the company nearly completed a deal to buy the AltaVista portal, in a deal so close to signing that the St. Regis ballroom in New York was rented to announce the acquisition. (Before the formal announcement, though, Time Warner canceled the deal, due to company infighting over who would be in charge.) The company also considered spinning off and taking public some of its vertical Web assets, especially popular ones like those created at CNN more for the stock pop than for business reasons—but those plans also came to naught. The company then began to focus on creating topic-specific “hubs” that linked in with e-commerce, even as it was in the process of shuttering Pathfinder.

  But all this was clearly not enough for Time Warner or for Jerry Levin. As Internet stocks shot up even further in mid-1999, some media companies became increasingly worried that rather than being an acquirer, they might find themselves in the crosshairs of these increasingly muscular Web companies. With no special controlling stock that might prevent such a move, many felt vulnerable.

  Many close to him at this time said Levin even became concerned about AOL after hearing rumors that it was considering plans to go hostile on Time Warner. Every top-ranking AOL executive has told me this wasn’t true, mostly due to issues around losing talent and angering big shareholders. In addition, they feared it might prompt a wholesale reevaluation of what Internet companies were actually worth. But it remained a possibility. “It was a red hot time for Internet companies and I think it laid one on Jerry that in the real world that AOL could do that,” said John Malone, who noted it seemed unbelievable that even Time Warner wasn’t large enough to face down the soaring Internet valuations.

  Levin was also facing some serious cash-flow problems at his heavily indebted company. While the cable business had rebounded, there was considerable weakness in the once cash-spewing music division. And things were only going to get worse in that arena, considering the damage that the explosive growth of Internet music-swapping services like Napster was having on sales. No matter how hard the media companies fought back, Levin was certain that the Web posed a threat to a lot more than just the music business over the next decade. All of Time Warner, he surmised, would sooner or later be under siege by the Internet.

  Levin told me in 2003 that to counter that fear, he’d become even more convinced that Time Warner needed another major transforming transaction, because the spark to make huge changes was not present inside the company. “I thought that you have to change the culture, or you were going to be in real trouble because of what was coming,” he said.

  One Levin adviser agreed that the Time Warner CEO was tired of doing nothing and wanted in on the Internet game. “In a way, it was capitulation, since Time Warner had been vilified as a dinosaur because it sat on the sidelines of the Web’s ascendancy,” this person said. “It did not believe in the Web, did not believe it, did not believe it. Then it finally believed it.”

  After three years of the Internet boom, the adviser added, “Time Warner just lost its ability to say no to the Net and that was exactly the moment when Jerry Levin met Steve Case.”

  Climb High, Climb Far—Oh, Just Climb!

  Steve Case seemed to have been ready for him well before late 1999. In a December 23, 1998, email to his major executives—including Novack, Gilburne, Pittman, and public policy head George Vradenburg—Case advised them to think big, even as he appeared nervous about AOL’s growing valuation. AOL now needed, he insisted, something much more stable.

  “I like the idea of buying fallen stars that have real assets versus chasing the highfliers that are fluffy and inevitably will come crashing back to earth,” Case wrote, noting he was amazed that the online auctioneer eBay was worth $12 billion at that point. “Given the Internet zaniness, I also like the idea of looking beyond the so-called Internet and identifying companies that have a profound impact on how people get information, communicate with others, buy products, are entertained. . . . They tend to be suffering from the Internet momentum.” Case ended the email with a hokey poem often featured on inspirational business posters: “Climb high/Climb far/Our aim, the sky/Our goal, the stars.”

  Case’s point, said one AOL executive, was that “everything was going to be profoundly changed. We could do either more Internet or media buys to transform.” Or do both.

  And although Case was already higher than anyone had thought he could be, sitting atop a company that looked like it could do no wrong, he was also worried. While the company’s momentum was soaring in terms of both business and valuation, he and others at AOL were nervous about coming changes in the interactive market that could badly damage the online service. These included a possible shift to non-PC devices such as more powerful cell phones and handheld organizers, the coming saturation of the dial-up audience, and the inevitable shift of users to high-speed broadband connect
ions. Where these changes would leave AOL was anybody’s guess—especially if the company couldn’t make the transitions smoothly.

  The Netscape deal had provided some short-term revenues and added luster to AOL, but it hadn’t done much of anything else. Badly managed and relatively ignored by AOL, Netscape suffered from a mass exodus of talent (including Marc Andreessen in 1999), no real progress in its enterprise efforts to reach the business market, and negligible development of its famed browser. AOL’s short attention span—coupled with its long history of mangling rather than managing acquisitions—made it ill-suited to really get in the trenches and make something of Netscape.

  Instead, it did more deals, a favorite tactic for pasting over past failures in acquisitions. To AOL and a lot of other tech companies, making deals was another addiction, mostly because it was a lot more exciting than using its energy to manage what they already had. In a manic series of placing its bets all over the table, AOL seemed to touch on every new trend of the moment. Since AOL’s stock was so high, it was capable of buying just about anything, and in a very frantic 1999, AOL launched its AOL Anywhere push. This included a plan for AOL TV and investments in several digital video recorder companies; deals with Palm Computing on small handhelds; a $1.5 billion investment in General Motors’s Hughes Electronics satellite in hopes of spurring a high-speed satellite Internet service; and an $800 million stake in Gateway Computers, to push the development of new computing devices and get more subscribers. And that wasn’t all. There were also multiple phone-company deals related to high-speed DSL services and cell phones, and a plan to deliver AOL over BlackBerry paging devices. The company even considered buying one of the big broadcast networks and making a $250 million investment in the radio broadcaster Chancellor Media.

  One of the most intriguing and important developments occurred in the spring. It had to do with potential AOL involvement in a bid by cable operator Comcast to beat out AT&T in acquiring the MediaOne Group. While AOL ultimately was not needed by Comcast and shoved aside, it had made sense for AOL to consider such a move, since executives were increasingly worried about their inability to get any of the cable companies to open up their lines to AOL. More worrisome were the exclusive agreements that several major cable companies had with their jointly owned high-speed Web service called Excite@Home. In fact, when the Excite portal merged with @Home in early 1999, a panicked Steve Case instructed lobbyist George Vradenburg and others to hit hard at the cable industry to force them to provide open access.

  “Although we thought broadband was coming on much more slowly than others did, we knew we needed to get access to high-speed access systems, especially cable,” said Vradenburg. “But the cable companies were not willing to do deals, because they thought they could leapfrog us. Why do any deal with AOL when you thought you had the upper hand?”

  AOL quickly backed an open-access lobbying organization, agitated in various cities to prompt cable companies to do a deal with AOL, and even took its arguments to federal regulators. Cable companies (including Time Warner cable executives), long used to little government intervention, despised AOL for the move. They had all seen how AOL rode the phone lines to glory while phone companies got little of the benefit, and they weren’t going to let it happen to their prized cable lines. They were not, as Excite@Home head Tom Jermoluk often told me at the time, going to become “dumb pipes.”

  One of Case’s biggest opponents in the open-access battle turned out to be John Doerr of Kleiner Perkins, the venture capital firm that was one of AOL’s early investors in the 1980s. At a party to raise money for Silicon Valley’s Tech Museum, the wiry and jumpy Doerr wouldn’t let me leave as he ranted about AOL’s behavior. “They don’t have a product anyone wants to buy anymore if they have to pay for it and access too,” complained Doerr, in an agitated rant that I got to hear many times. “Steve Case is in big trouble and he knows it, which is why he’s attacking us.” Doerr was right, but Excite@Home later turned out to be a flameout of a company and went bankrupt, done in by sheer incompetence on the part of its owners and management. But the challenges that broadband access presented to AOL—specifically that high-speed users churned off of the dial-up service forever—scared it a lot.

  And Case wasn’t attacking only the “cable cabal,” as AOL lobbyists called it: As always, there was a continuing omnipresent fear of Microsoft. With Microsoft’s big cable investments and rumors that it might even drop the price of MSN dramatically, AOL was on tenterhooks over just what the software giant would do next. Both Colburn and Case testified against Microsoft in its antitrust trial in Washington—a battle that got even juicier after AOL bought Microsoft’s alleged victim, Netscape. “I’m trying to get everyone to understand that Microsoft is the real enemy,” joked Vradenburg to me when I saw AOL’s lobbyist at a congressional event in D.C. in 1999. “And not us.”

  Hovering above it all was Case’s deepening worry about unstable Internet valuations, those close to him said—most especially his own. Wall Street had boosted AOL’s value compared to its performance, forcing it to garner impossible-to-reach results. Thus, AOL clearly needed to put a very big and stable business underneath itself in order to keep from slipping off the valuation treadmill.

  Subscriber growth was sure to slow before AOL could make up the difference with much-less-lucrative high-speed customers once it created a viable broadband service. And too many of the ad deals that were coming in relied much too heavily on financially questionable dot-coms. AOL had made an art form of reinvention, and many at the company thought the jig was just about up once again. “We all knew we were living on borrowed time and had to buy something of substance by using that huge currency,” AOL’s investor relations head Richard Hanlon told me. “We definitely needed to trade up, and fast.”

  Others agreed. “I think he looked at the prices the shares were selling for and thought it was time to do something to keep AOL as the frontrunner in the Internet space,” observed John Sidgmore, the former WorldCom executive who knew Case well.

  Another executive spoke even more urgently. “The bottom line is that there was always going to be a deal, since we felt the market was overvalued and that there was a kind of craziness,” he said. “And, believe me, we knew an Internet nuclear winter was coming.”

  AOL needed to heat up its efforts immediately, especially because of concerns about the possibility of a diminishing currency. “If we fail to capitalize on this market,” Steve Case’s closest adviser, Ken Novack, told him, according to others who were present, “it will be the biggest missed opportunity in history.”

  It Takes Two to Tango

  AOL needed a grand strategy, one unlike any they had ever considered or anything they had ever done. Enter, once again, Miles Gilburne, the brainy deal maker who had taken to coming and going at AOL on his own schedule. He had collected around him a small group of mostly young Harvard MBAs, who started formulating—with the help of bankers from Salomon Smith Barney—an analysis of what AOL should do. The strategy was to address the basic problem of finding future growth and diversifying AOL’s business from a single dynamic industry.

  According to internal documents generated by Salomon bankers and AOL analysts, the possible directions settled into four major areas. The options were:

  1.

  To double their bet on the Internet sector, with “tuck-in” purchase—adding it to existing AOL units—of smaller Web or tech companies. The companies AOL was considering for this included Yahoo, Amazon, eBay, Intuit, Lycos, Electronic Arts, RealNetworks, and even Apple Computer.

  2.

  To diversify in the business-to-business arena, by doing a major deal with a company like IBM to sell online software and services specifically targeting small businesses nationwide.

  3.

  To diversify “downstream” to the telecommunications sector, looking especially at wireless assets. Here AOL hoped for some kind of deal with AT&T, WorldCom, or Bell Atlantic/GTE.

  4.


  To diversify “upstream” in media. It was a strong belief that content and destination sites would yield valuable cross-promotion opportunities, as well as the longed-for Holy Grail of the single ad buy. Here the main targets were Time Warner, Bertelsmann, NBC, and Walt Disney.

  The business-to-business option was quickly discarded, since AOL had a long history of mucking up all its attempts to break into the enterprise space. Its Netscape fiasco only underscored the fact that AOL was more of a consumer brand, much in the same way that Microsoft operated better in the corporate realm than in attracting consumers to MSN.

  Telecom also elicited groans from AOLers, because of the then-high prices and also the unhappy prospects of owning massive amounts of costly infrastructure in a market of diminishing margins. AOL had sold off its network once in the CompuServe deal and had little competence in the sector. The company had engaged in off-and-on-again discussions with AT&T in both 1998 and then again in 1999. The talks included the idea of AOL taking over AT&T’s troubled long-distance business and getting carriage on its cable systems. But each time, the discussions got caught up in a series of complex issues about control and price, made worse by an ego clash between Case and AT&T CEO Michael Armstrong.

  The Internet and tech sectors were more appealing to AOL executives, since it was clear that consolidation here was inevitable. But the company thinkers were still nervous about the elevated Web stock prices and worried that acquisitions in the arena wouldn’t be enough to materially impact AOL’s business. Individually, each Web company had issues: Yahoo was an unlikely partner because the combination of the two biggest Web companies would likely create a regulatory thicket; Amazon was coming under increasing scrutiny for its high debt and risky sales prospects; Lycos was a less attractive, second-string property of dubious popularity; Apple meant a very heavy bet on hardware; and AOL worried that RealNetworks faced too much competition from Microsoft’s Media Player in the streaming media market and might become another Netscape. Only financial software maker Intuit, eBay, and games maker Electronic Arts really intrigued AOL, although all seemed small. “You do not get to the end game with another Internet company,” Gilburne told his staff many times, given AOL needed to solve its broadband infrastructure challenge.