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AOL Time Warner: Will it fly on Wall Street?

Though the combined company needed the government's approval to be created, the newly combined entity needs Wall Street's support to thrive.

Though the combined America Online and Time Warner needed the government's approval to be created, the newly combined entity needs Wall Street's support to thrive.

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Did AOL Time Warner burst the Internet bubble?
Don Luskin, CEO
After receiving approval from the Federal Communications Commission on Thursday, investors can officially value the company as a single entity. They seem to be optimistic about its prospects--at least for now.

Under the deal, Time Warner shareholders will receive 1.5 shares in the combined company for each share they hold, while AOL shareholders will receive one share. How are investors defining their new holding?

"We do not view America Online Time Warner as an Internet company; it's a media company that is well-positioned to take advantage of digital delivery of information and entertainment," said Christopher Dixon, an analyst with UBS Warburg.

Although two weeks after the Nasdaq Stock Market's worst-performing year in history may not seem the best time to showcase a newly merged behemoth, many investors and analysts are bullish on the company and hopeful for its future prospects.

Fourteen analysts have "strong buy" ratings on Time Warner, while 22 have rated AOL a "strong buy." Only one analyst has put a "hold" rating on Time Warner, and 4 have given "hold" ratings to AOL.

Bad times may be good sign
Ironically, the stock market slump may actually have helped analysts better determine how to value the combined company.

When the merger was announced a year ago, investors weren't sure how to value AOL Time Warner--as an Internet stock, a media company or some sort of hybrid. Today, however, the crushing decline in technology shares has forced investors to judge all companies by similar standards.

In the high-flying days of the Internet economy, executives, analysts and investors focused on revenue growth and market share to determine the value of many Internet companies. However, the stock market plunge in April and the steady slide since then has forced people to look at boring Old Economy metrics such as earnings.

"Today, I don't think there's that much of a mystery of how it will be valued," said Scott Davis, a media analyst with First Union Securities. "It's really gone the media way because (investor concern) has gone to EBIDTA" (earnings before interest, taxes, depreciation and amortization).

Most analysts say they view AOL Time Warner as a media company, to be judged by its enterprise value EBITDA multiple compared with its long-term growth rate. Even using this guideline, however, the company remains attractive, they say.

According to First Union Securities analyst Scott Davis, AOL Time Warner is trading at a 19 EBITDA multiple against a 30 percent projected rate of growth for 2001. The long-term growth rate is expected to be 20 percent to 25 percent. "That's looking pretty cheap looking at traditional valuations," Davis said.

AOL Time Warner
at a glance

Chairman: Steve Case, America Online  
CEO: Gerald Levin, Time Warner  
Employees: more than 80,000 combined  
Combined revenue: $35.8 billion*  
Market capitalization: approximately $205 billion  
Ticker: AOL

*Represents revenue for the four quarters ended Sept. 30  
Sources: Bloomberg News, Reuters

By comparison, Walt Disney, which might be considered a similar company because of its vast content and ownership of ABC Television Network and the ABC Radio Networks, is trading at a 13 multiple compared with 10 percent growth. Viacom, also a diversified media company, is trading at a 16 multiple with 15 percent to 16 percent long-term growth.

Dan Cook, a portfolio manager with Stone Ridge Investment Partners, said these numbers look good to him. For the time being, his firm plans to stick tight with its holdings--about 400,000 shares of AOL and about 200,000 shares of Time Warner. Cook said he will also continue to watch the company's quarterly earnings-per-share numbers.

"I'm looking at it from the positive standpoint of more stable growth vs. the growth rate," Cook said. "I also like the cross-selling opportunities."

Executives expect to reap $1 billion in synergies from the deal, based on cross-promotional marketing campaigns and bulk advertising buys.

Shares rise on expected OK
As an indication that investors are optimistic about the combined entity, AOL Time
Warner package Time Warner shares gained $4.19, or about 6 percent, to close at $71.19 Thursday on anticipation of regulatory approval. Since the merger was announced Jan. 10, 2000, the stock has fallen about 27 percent.

AOL shares, which have fallen some 40 percent since the merger was announced, gained about 5 percent Thursday to close at $47.23.

Meanwhile, the new company faces some daunting challenges that could keep some investors on the sidelines: The economy is slowing, and merging two large corporations is a daunting task that is frequently botched.

According to a November study by KPMG, 83 percent of the largest corporate mergers between 1996 and 1998 failed to increase shareholder value because of "poor planning or execution or both."

The question is whether AOL and Time Warner executives will manage to be part of the 17 percent that get it right.