• by Diane Mermigas , May 4, 2009

When Time Warner agreed to merge with AOL, it had an equity value of $95 billion and annual earnings of about $8 billion on revenues of $33 billion. Its portfolio of cable, publishing and movies aimed at achieving $1 billion in synergies with AOL, which generated $3 billion annual earnings on $11 billion in revenues and was valued at about $100 billion. That was nearly a decade ago.

The media and advertising worlds were very different then. The integration risks, the advent of broadband and powerful tech-savvy consumers threw the world's biggest media company and its peers for a loop. Financial projections and values turned out to be different than originally assumed. Media and Internet multiples have dropped as fast as ad revenues. Virtually nothing has turned out as planned.

Were the companies' principals unrealistically optimistic or just too naïve?

At the time, Wall Street and the press generally gushed over the prospect. The initial analyst reports were unparalleled in their superlative-laced assessments: "The next generation media powerhouse," and "the driving force behind the next wave of online consumer usage, and the convergence of new and old media."

Even the skeptics considered the combination bold, even brilliant. Merging the second-largest cable operator and the leading Internet portal would provide a competitive edge in a domestic market of 34 million households subscribing 83% to dial-up, 10% to cable modems and 7% to residential DSL.

So many of the merger assumptions for a successful AOL Time Warner turned out to be wrong, in part, because the evolution of the Internet, digital mobile technology and the connected consumer was (and still is) wildly unpredictable. The misrepresentation by former AOL CEO Steve Case and others of synergistic and financial potential didn't help. Now, it's complicated by a volatile and dire economy.

Time Warner's decision to jettison AOL (after buying back Google's 5% stake) is not only a dramatic admission that the merger failed, but a warning to the broad media universe. That also goes for pure-play content providers -- which Time Warner, sans its cable systems, is positioned to become.

Great content rules (even if user-generated) but may be more easily pirated than monetized. Even the most sure content distribution models -- theatrical, television and downloads -- are in flux. Content successes, even on a fragmented spectrum, are cyclical and unpredictable. Bottom line: Time Warner has no more reason to excel as a content player now than in 2000. The key will be to create efficient production models that allow for innovation and creativity, take advantage of emerging distribution revenues and shed legacy processes.

Time Warner management, and some industry analysts, have suggested that axing its storied publishing unit is necessary to achieve "streamlined" nirvana. Nonsense. If you fancy being a content giant, why fling the proven brands that need more skilled Net nurturing? There was a time that Sports illustrated could have been more of a multimedia rival to ESPN, People to TMZ and Time and CNN to The New York Times Digital. They were led by a myopic Time Warner management -- some of whom are the same executives who turned the AOL brand into a toxic idiom.

Look no further than Time Warner's latest quarterly results. Difficult year-earlier comps in home video and theatrical contributed to a 7% decline in filmed entertainment revenues. Advertising revenues fell 2% at the cable networks and 30% at publishing, where top-line revenues declined 23% and earnings plummeted 92%. The fluctuations had as much to do with managing for growth as the recession.

The newly formed content group that includes Time Warner's dominant TV networks, filmed entertainment and publishing is expected to generate $5.7 billion in earnings on $26.7 billion in revenues in 2009. AOL constitutes the remainder of Time Warner's overall anticipated $6.6 billion in earnings on $29 billion in overall revenues this year.

Although content is the lion's share of Time Warner's $26 billion market cap, it's also the company's most unmanageable big bet. It makes you more vulnerable to inherent risks, such as the volatility of theatrical revenues that comprise about 28% of the company's overall base, or the continued contraction of DVD sales. While original production on Turner cable networks and occasional film standouts have tipped the scales, Time Warner is searching for a new gold mine extending mobile access for pay TV and premium cable subscribers it calls "TV Everywhere."

The new status quo is Internet and digital interactivity; AOL is not the only "broken" Internet property. There is no solid evidence that Time Warner can maneuver content's treacherous waters better in the future. And jettisoning AOL will not be all that simple.

The difference between selling AOL outright rather than spinning it off could be $6 billion in synergies to the buyer, according to Citigroup analyst Jason Bazinet. With an estimated annual earnings of $1.15 billion on $3.4 billion in revenues (down double-digits in recent years), AOL's valuation has fallen to around $3.6 billion to a $5.5 billion valuation per Credit Suisse analyst Spencer Wang. Just a year ago, some analysts estimated AOL could sell for between $15 billion and $20 billion. Depending on the way AOL is disposed, Time Warner would be worth between $22 billion and $23 billion. Time Warner Cable's stand-alone market cap is about $12 billion.

The squandering of value over a decade is astounding, and the future growth prospects for an acquired AOL and a stand-alone Time Warner are not assured. Time Warner has billions at its disposal as a result of its cable spinoff. Bits and pieces of AOL could go to Yahoo, Microsoft, InterActiveCorp. and EarthLink. But if the Time Warner AOL debacle has taught us anything, it's that just moving pieces around the chess board isn't enough. The goals are to reshape strategy and reinvigorate execution in order to stay a step ahead of consumers' connected demands.