One month after the announced merger of America Online (NYSE: AOL) and Time Warner (NYSE: TWX), it is still hard to get a fix on what it means. That's not surprising. The companies are unique, with no overlap between them. Each is also the largest company in its respective industry. Those industries touched and overlapped in certain areas. But the scale on which AOL and Time Warner operate is such that, more than a merger of two companies, their combination suggests a merger of two industries and, at least arguably, the creation of a new industry altogether.
That scale and sense of newness is what makes it difficult to think about the pros, cons, and implications of the merger. And because the two companies are easier to deal with separately, one of the most common reactions is that a merger just doesn't make sense. This shows up most often in the idea that an outright merger was unnecessary and that most of the deal's perceived benefits could be had through partnerships between AOL and Time Warner. Of course, that will depend on what you perceive those benefits to be.
Topping the list of merger benefits is that Time Warner's cable systems help AOL round out its broadband strategy, allowing it to offer high-speed Internet access to its subscribers. This makes some basic sense. However, Time Warner's cable system covers a relatively small portion of the country, and the nature of the cable infrastructure makes it difficult for that coverage to grow. It is thus not a comprehensive solution to AOL's broadband needs, much less its broadband "problem," and can't possibly justify a merger of this magnitude. While cable broadband is certainly playing a role in the merger, I think that role is being misinterpreted.
Offering and cross-promoting Time Warner's media properties to online subscribers is another benefit of the deal. This too makes some basic sense. But just as cable systems cover fixed and limited territories, not even Time Warner's vast content base can cover all appetites for information and entertainment. Effective content distribution and return on production costs virtually demands partnerships between otherwise rival companies. With the reach of its Internet properties, AOL did not have to buy Time Warner to offer its content. Similarly, the post-merger distribution of that content will not be limited to the properties of the combined company.
The limited coverage of Time Warner's cable system, and the inadvisability of limiting the distribution of content, are valid points. But all they do is state the obvious. As arguments against the AOL-Time Warner merger, they make sense only if we think those who put the deal together can't see the same obvious points. I figure the chances of that are zero. This doesn't mean the deal is a good one. I'm just saying that these are not the reasons it's a bad one.
Given the scale of the AOL-Time Warner merger and the accomplishments of those who engineered it, if the deal appears to make no sense, you want to try and find the sense. And it just makes sense to start looking in places where it appears to make the least sense of all.
The idea that AOL being able to offer cable Internet access is driving the Time Warner merger goes against AOL's historic practice of not owning its own network infrastructure and instead outsourcing those essential services. More than the cable system's limited coverage, I believe this is a clue to the sense of the deal. After all, no cable system can have complete coverage. Some areas may never have cable access. Some people might prefer other means of access.
AOL's practice of not owning its own network infrastructure reflects a view of the interactive medium that sees access more as a means to an end than an end in itself. In this view, general availability of access is assumed, rather than being a direct component of the business itself. Despite the Time Warner deal, I believe AOL still operates from within this point of view and that its long-term objectives do not include ownership of network infrastructure.
AOL will benefit from ownership of the Time Warner network. It can begin operating on the cable platform. No longer "locked out of cable," it should also give AOL some leverage in negotiating deals with others. However, access costs, including broadband, will continue towards commodity status and long term this is not a business AOL will want to remain in. The problem is, AOL currently gets about 70% of its revenues from subscriber fees, which need to be replaced with advertising, transaction, and other e-commerce revenues.
Paradoxical as it seems, I believe part of AOL's plan to replace subscription revenues involves intentionally driving down the cost of access to the consumer. This view is supported by the pricing for the recently launched AOL Plus DSL service, which is at the low-end for high-speed access after allowing for the initial set-up fees that can be easily rebated.
Further, the merger with Time Warner helps AOL in this goal since in addition to the cable network and content, the deal brings with it Time Warner's revenues, which are three times greater than AOL's alone. This eases AOL's ability to compete on price to grow its subscriber base and increase usage of AOL-owned services, the quantity, quality, and variety of which is vastly multiplied by the Time Warner merger.
Longer term we will see that the ownership of Time Warner's cable infrastructure was a stage AOL passed through as a means of discarding its subscription-based model. I think this is where we start to find the sense of the deal as part of AOL's strategy to deploy and commoditize interactive services.
-Nico Detourn
