There Must Be a Pony in Here Somewhere

by Kara Swisher

  One change Levin made sure to complete as the restructuring commenced was replacing Ted Turner as head of his beloved CNN and other properties. Levin had long felt Turner was an erratic manager, and the merger finally gave him the opportunity to do something about it. Publicly, the decision to shift Turner didn’t attract a lot of notice, which was surprising given how major, and unexpected, a change it was. But in the May restructuring announcement, Turner received the vague title of “senior advisor” and the shared role, with AOL’s Ken Novack, of vice chairman of the combined company. Gone was Turner’s direct responsibility for running the Turner cable programming units, which was later given to Jamie Kellner, creator of the WB television network.

  Levin dumped Turner unceremoniously in a phone call, dispatching Parsons to Atlanta to explain the news, then later faxing the press release to Turner’s ranch in New Mexico as a fait accompli. Levin was annoyed with Turner, to be sure, but this was still shabby treatment for a man who’d long been a media visionary and an important icon at the company. John Malone, who was with Turner at the time in New Mexico, said the feisty entrepreneur was devastated by Levin’s actions and considered bringing a lawsuit, since the diminution of his role and responsibilities appeared, to Turner, to be a breach of his contract. Turner didn’t end up suing, but his wholesale removal would later prove to have been a dangerous act, one that enabled his uncontrollable anger to spark the rage of many others in the new company. He soon started to grumble privately about the deal to anyone who would listen, including other large investors.

  “Levin definitely wanted to empower management at the corporate level to drive growth and cross-division innovation,” said AOL lobbyist George Vradenburg. “Turner’s control over the Atlanta properties and his unpredictability ran counter to that strategy. Levin knew for sure he did not have control of him, but the problem was that corporate did not have operational control of any division.” To begin that shift to the center, Turner was out.

  “It was clear to Ted from that moment on that he had been tricked,” said Malone. “It was worse because he was probably the most hopeful of all at the start, thinking that AOL would finally be the thing that set Time Warner on fire.”

  But it was Turner who ended up burned.

  A Matter of Timing

  Igniting the combined company was precisely what AOL was supposed to do. By adding the magical digital element that had allowed it to grow so quickly over the years, AOL was supposed to be the key driver for the entire company to finally take off. Both Case and Levin envisioned AOL extending and morphing all the Time Warner businesses with its high-growth power. Levin had even dubbed the online unit “the crown jewel.”

  And yet the merger announcement was exactly when the Web-fueled rocket that had propelled AOL so high began to sputter—although few outside of AOL perceived it at the time. It was an irony that later would not be lost to those both inside and outside the company. Many believe that if Levin had simply delayed the deal talks even for a few months, as the dot-com valuations started to wane, he might have been in a position to completely control AOL rather than the other way around.

  In fact, the Web descent began on April 4, 2000, less than three months after the AOL Time Warner announcement. On that day, the NASDAQ dropped 575 points, losing more than 13 percent of its value, before recovering to finish the day down 75 points. Though the NASDAQ did recover that week, the plunge would turn out to be a harbinger of things to come; that day marked the beginnings of the Internet bust that would leave AOL—which had garnered 42 percent of its big ad deals from dot-coms in 1999 and 37 percent in 2000—deeply vulnerable.

  But the significance of the NASDAQ’s plunge was lost on most people, partly because the first quarter of 2000 marked the high water point of Internet venture funding, rollout of Web IPOs, and—mostly because of the AOL Time Warner deal—the headiest time for the celebration of all digital businesses. For these reasons, AOL’s business continued to look strong on the surface throughout the year and into the next—even though this time would later be regarded as the last great gasp of a bubble market.

  Just two days before the NASDAQ plunge, for example, AOL became the first Internet company to make the Fortune 500 list, debuting at number 337. And by April 18, AOL reported record earnings for its third quarter. Revenues were up 47 percent to $1.8 billion, advertising and commerce revenues had more than doubled, and the service had added another 1.7 million members. In fact, Pittman was so sure the positive trends would continue that in July he reportedly bragged at a joint meeting of the AOL and Time Warner boards that AOL’s annual ad revenue could reach $7 billion by 2005. This was a risky, rash prediction, and it had huge implications for AOL Time Warner, since the high margins from ad sales at AOL dropped straight to the bottom line as pure profit.

  Later, a two-part series in the Washington Post would raise doubts about the quality of these 2000 results—posing the question of whether AOL artificially inflated its revenues by striking dubious deals and accounting for them improperly in an effort to keep the merger from blowing apart. But already by May, an old accounting problem made the news again when AOL paid a $3.5 million SEC fine relating to its mid-1990s practice of counting marketing expenses as assets. Considered a relative slap on the wrist, the fine was generally ignored by Levin and Wall Street, seen by many as evidence of past problems rather than a troublesome pattern of behavior.

  The fact that this accounting incident and fine went largely unnoticed at Time Warner prompted some later to wonder why Levin didn’t press for more due diligence in the year it took to close the deal. “That was our real opportunity to look under the hood,” said one top Time Warner executive, “and we blew it.”

  It was not for lack of trying. In the early fall of 2000, as it became abundantly clear that Internet stocks were in a free fall, Parsons, Bressler, and others on the corporate staff went to Levin and advised that he consider not doing the deal. The reason was mostly due to the declining Web valuations and not about AOL in particular, although there was already a growing discomfort at the media company over the change in power and the brash style of the AOLers. Linking with an online company was a good idea, they argued, but did they need such a big deal to do so? There would have been several ways to accomplish reneging on the deal, the group suggested, including not going along with the many government requests for approval of the deal, paying a breakup fee that might apply or even risking an AOL lawsuit by dumping the deal and not forking over a dissolution fee.

  But Levin declined because he felt a deal was a deal and that AOL had not changed substantially even if the Internet market had. Other sources said, more important, Levin could not bear not doing a deal he considered revolutionary and critical to Time Warner’s future. And there was, it went unsaid, more than a little bit of ego involved. Later, Levin told me that he never thought there were serious questions about the deal at Time Warner before it was consummated, even though others say there was. “I think Levin saw such a cause of action as some kind of impugning of his integrity,” said one top executive who tried to warn his boss off the deal.

  And while the lack of collar and the possibility of a lawsuit and breakup fees—along with Levin’s stubborn insistence that the deal be completed—partly explain the reasons for this lack of action, in truth, no one at Time Warner pressed the issue strongly, because no one knew that things would get so bad so quickly. All through 2000, in fact, there was still a feeling that the strategic unification of AOL and Time Warner was still filled with possibilities and that the deal made sense, especially since AOL’s stock—on which the AOL Time Warner share value would be based—had held much stronger than other Web companies.

  While Time Warner executives later seemed to suffer collective amnesia on the subject, I recall their company’s employees speculating happily about what they’d do after retiring with their stock windfall. Many were worried about the Internet’s downturn, to be sure, but they also felt more anticipation of the benefits t
han they care to admit now. “There was not an us-versus-them mentality at first, even if it did end up that way,” said Walter Isaacson, Time Warner’s former head of Pathfinder. “A lot of people appreciated the idea of some centralization and finding ways to work together.”

  In any case, the boom still looked pretty healthy in 2000—so much so that the AOLers were still whooping it up. David Colburn made waves, for example, when he hired the boy band ’N Sync to play at his daughter Rachel’s bat mitzvah in June of 2000. Three hundred guests were treated to a set by the teenyboppers in Potomac, Maryland’s Beth Shalom Synagogue social hall, which had been decorated with a Venice Beach motif. It was another in a long line of dot-com excess stories that did not abate in 2000. I can tell you that no one in Silicon Valley thought the boom was going to end, even though everyone expected a correction and some had secretly hoped for one to calm things down.

  And the contraction began soon enough, as more and more Web companies that had been AOL’s cash cows began to openly warn about potential cash squeezes. As early as the end of March of 2000, for example, the most jarring warning came from the medical Web site Drkoop.com, which had promised AOL $89 million as part of a much-touted four-year deal in 1999. In a report to the SEC, the company noted that its “sustained losses and negative cash flow”—once considered a dot-com plus—put its future prospect in jeopardy. By the end of April, it had restructured its AOL deal by handing over 10 percent more of the company as compensation—an act of desperation that was a sign of later troubles.

  AOL deal makers punched back with another blockbuster announcement in May, trumpeting a deal with real estate Web site Homestore.com. AOL valued the arrangement at $200 million, even though it received only $20 million in cash and almost 4 million shares of Homestore stock. It was the terms of this deal, among others struck in this period that would later be investigated, though no one questioned it at the time and it was considered evidence of AOL’s strength.

  But by late summer of 2000, some within AOL were becoming acutely aware of the potential downside of any drop-off from the 80 percent annual advertising and commerce sales growth the company had enjoyed between 1997 and 1999. “AOL TW Strategy: Future Trends and Recommendations in the Advertising Sector,” an internal document prepared in July of 2000, noted ominously that any contraction in the ad market would drain billions of dollars from critical cash flow. “Although AOL has been able to maintain [ad rates] due to its market-leading share of eyeballs,” the report said, “some combination of these factors (even under moderate downside scenarios) could result in [cash flow] growth slowing from 25 percent to 23 percent and a cumulative AOL Time Warner [cash flow] shortfall (vs. Street estimates) of nearly $5 [billion] from [2001 to 2005].”

  The document offered several suggestions for finding incremental revenue for the online service, including increasing targeted ads, which had long been problematic considering AOL’s strict privacy rules; and forging better relationships with traditional ad agencies, which AOL had long attempted to bypass. It even floated the possibility of acquiring online ad serving and selling companies, such as DoubleClick, Avenue A, and 24/7.

  This kind of strategic reassessment became even more critical given that more than 100 dot-coms had failed by the fall of 2000. Hundreds of others were tottering, many of which had struck pricey AOL deals in the boom’s heyday. AOL deal makers, in fact, keep a running list of all their worrisome dot-com agreements, with scores tracking their viability and risk of nonpayment. Most were deemed troubled, and needed to be renegotiated from long-term contracts to short-term ones. By the end of the summer, renegotiations of these contracts became commonplace, as evidenced by the fact that AOL’s $3 billion ad revenue backlog—that is, the value of the future ad revenue expected from its many multiyear deals—remained flat. That was a clear sign that the growth years were over, and AOL’s executives were aware of the dangers looming. “We warned of trouble, but no one wanted to hear it,” said one high-ranking AOL executive. “It was like a distant bell to them, since the noise of the merger was so loud.”

  Still, AOL’s top brass maintained its euphoric outlook into the fall, even though Time Warner was also beginning to warn about the weakening ad market for its magazines and TV networks. In an October 2000 conference call in which AOL reported better-than-expected results, Steve Case inexplicably insisted that AOL was completely unaffected by the overall ad slump.

  “AOL’s advertising growth is right on target,” Case said, stressing AOL and Time Warner’s potential strengths as a unified company. “The current advertising environment benefits us, because it will drive a flight to quality.”

  Case was bolstered by Pittman, who pooh-poohed any ad woes in a quote that would later come to haunt him. “For this company, I don’t see it and I don’t buy it,” he declared definitively, in a memorable but dangerous line suggested by Ken Lerer. And AOL CFO Mike Kelly also continued to insist that the merged AOL Time Warner would be able to make the ambitious numbers laid out after the deal’s announcement. Still, some analysts were shaken when AOL also told them it would no longer report its ad backlog number. It had been the prime indicator of strength, but times were changing fast.

  At the time, I got only one real clue that AOL was troubled by any decline: A comment that I reported in my “Boom Town” column in October 2000. I had no idea how serious the falloff would become, but one high-ranking AOL executive was worried enough that he volunteered an enticing reason for wanting the deal to close quickly. “For all the deal does,” he told me in a near whisper, “the thing that makes me happiest is that it puts a floor under our stock.” It was clear AOL once again hoped to replace one declining business with a new, more promising one, something it had done so many times before. “They seemed to expect for the answer to fall out of the sky,” said one AOL observer. “It was management by wishing and hoping.”

  But from a peak of more than $90 a share in late 1999, AOL’s stock had fallen to below $50 by December 2000. That dropped the value of the combined companies from $319 billion in January to under $250 billion by the end of the year. The absence of a collar meant that no matter what happened with the two companies’ stocks, the deal would go forward on the terms originally negotiated. But the huge premium AOL had offered Time Warner was withering fast, and AOL executives pressed hard for the deal to settle, willing to be more amenable to government demands than Time Warner.

  Luckily for AOL, government opposition waned too. FTC attorneys informed the companies they’d have to make their cable lines available to competing online and entertainment companies, and appointed a “monitor trustee” to oversee the situation for five years. European authorities wanted Time Warner to cancel its planned $20 billion merger with the British music giant EMI. And the FCC would push AOL to open its Instant Messaging service to rivals, eventually requiring the company to do so when it deployed the service on Time Warner’s cable network, as a condition of approval.

  But ultimately the feds didn’t require anything the companies weren’t willing to concede. When the FCC voted to approve the merger on January 11, 2001, almost exactly a year after the merger announcement, the last hurdle had been cleared.

  It’s Show-Me Time!

  In the early-morning hours on the day of the close, workers took down the giant “Time Warner” sign above the company’s Rockefeller Plaza headquarters in Manhattan, replacing it with the name that would soon become ubiquitous in American media culture: “AOL Time Warner.”

  Angst ran high throughout the Time Warner side in January, as one AOL executive after another traveled up—often, annoyingly enough, via their own private planes—to the New York headquarters of the most powerful media company in the United States. The Time Warner side’s irritation was countered almost equally by the feeling of pleasure that coursed through the AOL staff at the very same prospect. Who wanted to stick around sleepy Dulles, Virginia—where even the Wal-Mart store across the road had closed down—when there was a chance to jet
triumphantly into glamorous Manhattan?

  Steve Case’s unlikely, longtime dream had finally been realized. He and his ragtag team had done the unimaginable, turning an anemic online video games company into a new media empire in just over 15 years. They had led the revolution of getting millions of ordinary Americans online. They held the upper hand in the largest merger in business history. And they had gotten where they were by continually ignoring the swipes of those who were sure they would fail. Who could blame them if they believed they were invincible?

  And the AOL executives seemed to believe that above everything else. Almost immediately they set out to show their Time Warner counterparts—who hadn’t thought much of them over the years—the right way of doing business, with little respect for the complexity of other industries. Soon, by intoning the Web industry’s arrogant mantra of “You just don’t get it,” AOLers would lose friends and influence no one. They would make huge changes across the Time Warner landscape or die trying. And the latter is precisely what happened.

  “AOL thought it was bringing a stodgy company into the Internet age, but everything we had was running solidly in place. Warner Bros. was doing a great job, so was HBO. Why tamper with that? I don’t think they understood how delicate it all was,” said one top Time Warner executive. “The concern we had was that this was a 15-year-old company or so, which is the life of a fruit fly. It was a single-product company. And it had been sitting on the top of a tidal wave. The range of its experience was limited.”

  Today, the AOL team’s belief that it could easily take over a company about whose businesses it knew so little seems massively naïve and deeply egomaniacal. One ace-in-the-hole they thought they had was Jerry Levin and his evangelical vision for the company. But that soon proved unreliable. “Since Jerry was so committed to it, we thought the various teams would line up and make it happen,” said Mike Kelly. “We underestimated how people at Time Warner felt about the merger.”