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AOL Time Warner Merger

AOL Time Warner Merger. examine a famous merger case describe the unique valuation issues surrounding mergers/acquisitions describe some unique accounting issues surrounding mergers/acquisitions answer the Zen question: what is the value of an overvalued stock?. AOL Time Warner Merger.

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AOL Time Warner Merger

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  1. AOL Time Warner Merger • examine a famous merger case • describe the unique valuation issues surrounding mergers/acquisitions • describe some unique accounting issues surrounding mergers/acquisitions • answer the Zen question: what is the value of an overvalued stock?

  2. AOL Time Warner Merger • what business is each company in? • what are the synergies between them? • other motives for mergers in general?

  3. Who brought what to the table?

  4. AmericaOnline TimeWarner

  5. “Merger Facts” • for each share of TW stock, get 1.5 shares of new AOL stock. This much is clear! • pre-merger and pre-announcement • TW has 1301.5M shares, trading at $64.75 • AOL has 2255M shares, trading at $72.88 • The premium to TW shareholder • Value to TW shareholder= $72.88x1.5 = 109.32. 109.32 – 64.75 = 44.57 premium, or 68.8% increase

  6. market’s reaction to announcement • TW stock increases from $64.75 to $90 • AOL stock decreases from $72.88 to $72 • Is this a common reaction? • Target price increase from one month prior to delisting ranges averages from 53% in 1989 to 72% in 1993. • Hostile takeovers have premiums 30% larger than friendly mergers. • Acquirers’ stock price declines 4%.

  7. Should the stock price change when a firm issues new shares of stock? • Firm’s assets etc. worth $20 and 1 share outstanding. • Issue 1 additional share for $20. beforeafter $20 of assets/1share ($20 of assets + $20cash)/2 shares But is the $20 of cash still worth $20?

  8. Salomon Smith Barney evaluation of 1.5 exchange ratio Estimate that TW plus synergies is worth $109.32/shr. 109x(1301.5M) = $142,280M needed in value for TW. Divide by $72.88/AOL shr = 1952M shares to issue. 1952/1301.5 = 1.5.

  9. creating value by issuing over-valued stock • Suppose intrinsic value of AOL was $35.43/share • 78020 MktVal /2201.8 shares in eVal = $35.43/share • If TW is worth $142,000M, and can get it for 1301.5M x 1.5 shares of AOL stock, then new intrinsic value is (78020 + 142000)/(2201.8 + 1301.5x1.5) = $52.97/share

  10. EPS growth through acquisition • A stock acquisition generally improves EPS if the P/E of acquirer is greater than the P/E of target. • butbeware of takeover premia, goodwill amortization and merger-related costs.

  11. EPS growth through acquisition – an example • Acquirer has $100 NI and 50 shares, so EPS=$2/share. Price/share = $40, so P/E = 20. • Target also has $100 NI and 50 shares. But Price/share = $20, so P/E = 10. • Acquirer buys Target by issuing 25 new shares to target shareholders. (50 x 20)/40 = 25 • New Firm has $200 NI and 75 shares, so New Firm EPS = $2.67/share. • But what if paid $44 per share for target, so had to issue (50x44)/40 = 55 new shares? New Firm EPS = $1.90/share.

  12. What is the EPS effect of the Merger? • AOL P/E ratio = $72.88/.37 = 197 • using 6/30/99 basic EPS • TW P/E ratio = $64.75/1.51 = 43 • using 12/31/99 basic EPS • At TW premium price of 109.32, • P/E = 109.32/1.51 = 72 • So why is AOL Time Warner pro forma EPS still lower than AOL’s EPS?

  13. Pro Forma AOL- Time Warner Income Statement 6/30/99

  14. Deal closes on January 11, 2001

  15. Regulatory Constraints on Deal -- Instant Messaging: Option 1: AOL can't offer advanced services, such as video streaming and voice communications, over its Instant Messenger until it grants access to at least one IM rival. Within six months, AOL would have to open up Instant Messenger to at least two more rivals, or shut down advanced services. -- ISPs: AOL and Time Warner mustn't restrict Time Warner's cable subscribers from choosing an Internet-service provider other than AOL. -- Interactive TV: No restrictions on interactive TV, the system that allows viewers to access digital information in real time with television programming. But the FCC said it would begin an inquiry into ways to ensure competition. -- AT&T: AOL-Time Warner and AT&T can't enter into exclusive agreements with each other that will affect rival ISPs' access and terms of access to AOL-Time Warner and AT&T's cable systems. Source: FCC

  16. Deal finally closed on Jan. 11, 2001. Value went from $162B to $106B. What Happened?

  17. AOL Time Warner Lost $1.82 Billion; Dismal 4th-Quarter Result, While Expected, Sends Stock to 3-Year LowThe Washington Post; Washington, D.C.; Jan 31, 2002; Alec Klein; • 2001 EPS = $-1.11 • Revenue per subscriber at AOL declined for the first time in its history in 2001. • $60B writedown of goodwill from the TW acquisition • Changed name to Time Warner in October 2003 • AOL has 10% reduction in subscriber base in 2003 • Case, Levin under investigation by SEC

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