One for The Books

By John Greenwald

For two hours last Friday morning, more than 40 lawyers, reporters and Wall Street speculators camped outside a quiet office in the Delaware Court of Chancery in Wilmington. They were anxiously awaiting the outcome of one of the most intensely watched corporate takeover fights in the 197-year history of the court. When clerks appeared at 10:30 with copies of Chancellor William Allen's 79-page ruling, the aggressive crowd tore the documents from the court officials' hands. Dialing their offices, moneymen shouted into their cellular phones, "The Time-Warner merger is on!"

The hectic scene marked the latest and most dramatic stage of a three-way battle that has captured the attention of everyone from billion-dollar money & managers to Hollywood movie directors. At issue before Judge Allen was an effort by Paramount Communications to block Time Inc. from acquiring Warner Communications in a $14 billion friendly merger that would create the world's largest information and entertainment company. If the judge had granted Paramount's motion, which was joined by several major Time shareholders, Paramount could have pressed ahead with its hostile bid to acquire Time for $12 billion. But after 5 1/2 hours of hearings last week, Allen denied Paramount's request for an injunction to halt the Time-Warner deal.

Beyond its impact on the opposing sides, the case tested a crucial aspect of the takeover binge that has raged through U.S. industry during the 1980s. By originally bidding $175 a share for Time and then raising the price to $200, Paramount contended that it was offering Time shareholders a rich reward for selling their stock. But Time insisted it was not for sale and that it could eventually boost the value of its shares well above $200 after acquiring Warner. The battle pitted against each other two contradictory interests that have been at war throughout the takeover era: the short-term enrichment of shareholders vs. longer-term growth and value. Declared the New York Times last month in its reporting on the landmark battle: "The outcome of the legal contest is of critical importance to corporate America."

In his ruling Allen affirmed the right of directors to manage a company's strategy. Among other arguments, Paramount had claimed that Time's directors breached their responsibility to company shareholders by converting the Time- Warner deal from the originally proposed stock swap, which required shareholder approval, into a two-stage leveraged takeover, which needed no such vote. The change gave Time shareholders no opportunity to choose between the Warner merger and Paramount's cash. But Allen found that the board's moves were consistent with Time's long-term plan to merge with Warner. He wrote, "The corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm."

The judge did grant Paramount's motion for a ten-day stay of the Time-Warner merger while Paramount appeals to the Delaware Supreme Court, which agreed to consider briefs throughout this week and hear the final arguments in the case ! on July 24. The appeal prevented Time from purchasing 100 million of Warner's nearly 200 million shares in a $70-per-share tender that had been scheduled to expire this week. Time would acquire the remaining Warner shares later for cash and securities.

The Delaware Supreme Court will have the final say in the matter, but a number of legal experts said they doubted that Allen's ruling would be overturned. The Supreme Court, they noted, has generally upheld Delaware's "business judgment rule," and has been even more forceful than the Chancery Court in giving corporate directors broad freedom to set long-range policy for their companies. Stanford University law professor Ronald Gilson disagrees with the ruling because he feels shareholders should have more rights in takeover battles, but he doubts the decision will be overturned: "If the Paramount arguments were not persuasive to Allen, one would not expect them to be persuasive to the Supreme Court."

Wall Street had anticipated the Delaware ruling, sending Time's share price tumbling for several weeks on growing speculation that the company would stave off the Paramount bid. Time stock finished trading Friday at 145 1/4, down 6 1/4 points for the week but at the general level where analysts expect it to settle, at least briefly, if the Time-Warner deal goes through. Warner stock closed at 64 1/2, up 2 3/4, on the increased likelihood that Time would be able to carry out its tender offer. Paramount, which has been rumored to be a possible takeover target itself, closed at 57 1/2, up 1/2.

In reaching an almost unequivocal decision in the complex case, Allen dismissed a key Paramount claim, that Time's directors had put the company up for sale in March when they originally agreed to acquire Warner. If that had been found to be true, Time would have been obligated under Delaware law to seek the maximum immediate return to shareholders by auctioning the company to the highest bidder. Paramount's argument that Time's directors were selling the company to Warner rested partly on the fact that the exchange ratio of the proposed stock swap would have given Warner stockholders 62% of the shares of the combined company. In Paramount's view, that situation amounted to a transfer of corporate control.

Time disagreed on the ground that Warner shareholders would not be voting as a controlling group in the corporation. Allen concurred: "I am entirely persuaded of the soundness of the view that it is irrelevant for purposes of such determination that 62% of Time-Warner stock would have been held by former Warner shareholders." In fact, he added, "neither corporation could be said to be acquiring the other. Control of both remained in a large, fluid, changeable and changing market."

On another major point, Allen rejected Paramount's claim that Time acted improperly in revamping its Warner deal after the Paramount offer was made. The precedent in judging such tactics is a 1985 Delaware case involving an effort by the California oil company Unocal to escape a raid by takeover artist T. Boone Pickens. In that case, the court decided that companies may take defensive moves only if they are "reasonable," as Unocal's were deemed to be. Paramount argued that Time's decision to launch the tender offer for Warner was excessive in proportion to the takeover threat and thus failed to meet the Unocal standard. But Allen rebuffed that claim, holding that the Time board "did only what was necessary to carry forward a pre-existing transaction in an altered form."

As one of its reasons for rejecting the Paramount bid, Time had asserted the necessity of preserving its corporate culture to ensure the editorial independence and freedom of its publications. While Allen stopped short of endorsing that concern as a primary basis for blocking a takeover bid, he indicated that the preservation of such ideals does carry weight. Wrote Allen: "This culture appears in part to be pride in the history of the firm -- notably TIME magazine and its role in American life -- and in part a managerial philosophy and distinctive structure that is intended to protect journalistic integrity from pressures from the business side of the enterprise."

Allen noted that Paramount dismisses "this claim of 'culture' as being nothing more than a desire to perpetuate or entrench existing ((Time)) management disguised in a pompous, highfalutin' claim." Wrote he: "I understand the argument . . . But I am not persuaded that there may not be instances in which the law might recognize as valid a perceived threat to a 'corporate culture' that is shown to be palpable (for lack of a better word), distinctive and advantageous."

The judge also rejected Paramount's contention that Time executives were using the editorial-independence argument simply to entrench their positions. Wrote Allen: "There may be at work here a force more subtle than a desire to maintain a title or office. Many people commit a huge portion of their lives to a single large-scale business organization. They derive their identity in part from the organization and feel that they contribute to the identity of the firm. The mission of the firm is not seen by those involved with it as wholly economic, nor the continued existence of its distinctive identity as a matter of indifference."

Amid the arguments in the bitter struggle, court documents filed in Delaware gave a vivid picture of the two-year merger talks between Time and Warner. A Time brief showed that the two partners broke off negotiations in August 1988 over Time's insistence that Warner Chairman Steven Ross set a date for stepping down as co-chief executive of the merged company to make way for Time President N.J. Nicholas to hold the chief executive's job alone. Not until Ross agreed last January to step aside five years after the merger were the talks able to proceed.

While the courtroom was the main battleground in the Paramount-vs.-Time struggle, some unexpected lobbyists emerged to tout the Time-Warner combination. Director-producer Steven Spielberg, a close friend of Ross's, expressed his support in a telephone talk with the Warner chairman and Nicholas. Spielberg collaborator George Lucas, who distributes their Indiana Jones films through Paramount, wrote a column in the Wall Street Journal last week that praised the Time-Warner deal for promising "steadily increasing values" and attacked Paramount for "contributing to the further destabilization of the entertainment industry and the U.S. economy."

Although Wall Streeters had generally come around to the expectation that Allen's decision would go in favor of Time, many did not agree with his philosophy when the ruling was announced. They suspected the Delaware court of siding with corporate management to preserve the state's lucrative role as a corporate haven. Most major U.S. companies, including more than half of the 1,671 firms listed on the New York Stock Exchange, are incorporated in Delaware. Said a Wall Street analyst: "What was really at stake was the kingdom of Delaware as the guardian for directors against shareholder rights."

Yet the merged Time Warner Inc. will still have to generate the rising stock values that the two companies have promised, or the communications giant, for all its size, could face a new takeover threat. Says Alfred Rappaport, chairman of Chicago's Alcar Group, a management-consulting firm that champions shareholder value: "What Time must now do is not celebrate the decision, but convince the marketplace that the new company can still deliver." For now, however, Time must keep one eye on the marketplace and the other on a courtroom in Wilmington, where its freedom to purchase Warner will finally be decided.

With reporting by William McWhirter/Chicago and Frederick Ungeheuer/New York