Score One For AOLTW

By FRANK GIBNEY JR.

Steve Case and Jerry Levin are so confident in the future of AOL Time Warner that they just aren't going to let powerful competitors, wary consumers or, especially, the Federal Government stop them. That's why for more than six months they directed their top executives to endure hundreds of hours of interrogation in Room No. 385 of the Federal Trade Commission building in Washington, and why they showered thousands of proprietary documents on their inquisitors. And it's exactly why they faxed, on the eve of last week's FTC vote, the final written concession that led to unanimous approval of the $112 billion marriage between Case's America Online and Levin's Time Warner.

The combination will be, for better or worse, the world's biggest media conglomerate. (Of which TIME will be a part.) It's a vast empire of broadcasting, music, movies and publishing assets, complemented by AOL's dominant Internet presence, all fed to consumers, ultimately, through Time Warner's cable network. Think of it as AOL Time Warner Anywhere, Anytime, Anyhow.

In the world of the near future, all manner of content--magazines, movies, music, books, shopping--will be pouring into your home through your cable television line. The cable is now known as broadband because, even though it looks the same, technology has made it fatter and faster. When broadband access fuses the new and old economies with a bang, consumers will have a simple concern: If the broadband world is ruled by one company, will we have to pay more? Will we have a choice of what we watch? And if we don't stop them now, will we be able to later?

Nobody knows. And that put the FTC in the ungainly position of regulating the future. The FTC's solution was to ensure that the pipes, just like federal highways, were open to everyone, making "open access" to the two companies' cable and Internet services the price of approval. Case and Levin agreed to allow at least three other Internet service providers access to Time Warner cable lines and decreed that AOL would continue to invest in slower, phone-based DSL service.

But Case and Levin wouldn't budge when the FTC demanded the right to regulate the placement of AOL Time Warner content, fearing they would lose control of their own products. It was a make-or-break issue. In their 11th-hour concession, signed off on at 5:30 last Wednesday afternoon, they agreed to report any complaints from competitors who believe they've been denied AOL Time Warner content.

If there's a reason analysts are so bullish, competitors so fearful and regulators so confused, it's that even now very few people understand the future scope or reach of a company as big and diverse as AOL Time Warner. Time Warner is in the traditional media business; AOL is an Internet company. Because the two didn't overlap, antitrust lawyers saw no need for concern. But the more people looked, the more they thought this was not just a marriage of two companies in different arenas. It was potentially game changing.

The very thought occurred to Microsoft, a company whose domination of the software business made it one of the world's most valuable entities--and the target of a federal antitrust suit. Yet even the Micro-monopolists went running to the FTC to complain. "I never had a problem with the merger," Disney chairman Michael Eisner insisted to TIME this fall. "I have a problem with the fact that there might be a single entity that decides what intellectual property goes into the house."

Eisner is, of course, the guy who led the charge against AOL Time Warner at the FTC. And ironically, his case would not have had nearly as much resonance if Time Warner had not committed what one of its own executives calls "the stupidest business decision of the year." On May 1, after months of wrangling with Disney over a new retransmission contract for Disney's ABC television stations, Time Warner Cable shut the network off its system in New York City, Houston and Los Angeles.

Newspaper editorials decried the move as Orwellian. From Disney and Microsoft to a lowly Internet service provider in Oshkosh, Wis., competitors began turning up the heat. Separately, press accounts of AOL's take-no-prisoners approach to its business partners made the Internet entrepreneurs seem as predatory as the cable guys. By this fall, even the American Civil Liberties Union was claiming that the new company could be dangerous.

From the start, Case and Levin not unreasonably insisted that open access was integral to their companies' success. Why would Time Warner, which controls 20% of the nation's cable subscribers, close off competitors' access to its cable resources and risk its own access to the other 80% of the market? But after the Disney debacle, that sort of logic carried no weight.

FTC chairman Robert Pitofsky now had a hand to play, a sudden and broad public mandate to go after both companies. "In January you couldn't have found a lawyer in Washington who would have questioned this deal," says Richard Parsons, Time Warner's president. "It turned into an unbelievable and frustrating course for us."

Initially, the concern was that Time Warner would give AOL preferential or exclusive access to its cable network. That would disadvantage other Internet service providers, all of whom are looking to cable as the most versatile broadband delivery alternative. Companies like Disney complained that in addition to limiting open access, the new company might restrict interactive TV (ITV) services over TW cable. Then a roster of instant-messaging companies charged that AOL was preventing any competitor's messages from penetrating AOL's proprietary IM architecture. By the fall, when AOL Time Warner had initially estimated they would close the deal, "the FTC was hitting us with a new issue every week," says an insider.

In the end, Pitofsky could claim victory in that the FTC had established a template for regulation in the Internet age and had avoided the risk of losing control over the deal had he decided to sue to block the merger and lost. The new company was forced to relinquish its advantage in high-speed Internet service by agreeing to a deal that gives equal access to EarthLink, its largest competitor.

While Washington weighed the merger's fate, AOL and Time Warner confidently, or arrogantly, carried on one of history's most extensive premerger integration efforts. The same week that the ABC controversy erupted, Levin and Case announced a new corporate structure, with Case as chairman; Levin as CEO; and Parsons and Robert Pittman, a veteran of AOL (and Time Warner), as co-chief operating officers.

Pittman has emerged as the battlefield commander, with what many view as an insurmountable goal: to shape Time Warner's disparate, shark-infested corporate divisions and AOL's single-minded Internet entrepreneurs into a lean, mean conquering force. Although Levin insisted that the new headquarters be in New York, the cost was the defenestration of much of Time Warner's corporate staff. Many of the top executive roles have gone to AOL. Middle managers from the two companies have clashed over, among other things, ad-sales strategies and Time Warner's compensation structure. "A lot of [AOL executives] came in thinking they were going to tell us how to run our businesses," says a top Time Warner executive, a veteran of that company's internecine wars. "Then they began to realize that movies, publishing and cable are a lot more complex than just being online." Admits Pittman: "There are people at AOL who have been a bit naive, but I'm working to change that."

Indeed Pittman is beginning to win the grudging respect of early doubters. He has formed a series of committees across divisions and a council of capos at which top executives meet every three weeks to weigh integration progress. They are gradually enforcing a new plan for action that encourages division managers to think and act more corporately, as opposed to pursuing purely their unit's interests.

As an incentive to work together, the merged company's 2001 plan includes a provision for granting stock options to each of the combined company's 85,000 employees. Time Warner's compensation will probably shift too, from a salary and bonus system to one linked more closely to stock performance, not unlike AOL's.

As for synergy? The two companies have already found ways to boost growth by cross-selling subscriptions and advertising and running promotions for Time Warner content on AOL. Last summer a promotion on AOL is credited with boosting box-office returns for The Perfect Storm. Perhaps the best success so far has come from collaboration between Time Inc. president Don Logan and Pittman, who engineered a scheme to sell magazine subscriptions via AOL. So far, the combination has produced more than 500,000 orders.

AOL is relaunching Netscape next year, positioning the browser as the central clearinghouse for Time Warner's content. That's not prime Internet real estate, and there are some murmurs within Time Warner that AOL's quest for its own content is exceeded by its lust for rent-paying deals. Don't expect Time Inc.'s Money.com to replace CBS MarketWatch on AOL anytime soon.

The measure of success, of course, is whether AOL Time Warner can meet the stratospheric financial goals Case and Levin set a year ago, when they promised Wall Street that in 2001 the company's operating profit would grow by 30%, to $11 billion. Despite the Internet downturn, AOL's growth this year is still an impressive 23% (the company is adding about 1 million subscribers every six weeks). But Time Warner's growth is beginning to slow. The movie and music businesses are troubled. And if economic doldrums hit next year, ad revenues are likely to take a hit. "They've clearly made some promises that don't leave us any room for failure," says a top Time Warner executive. "In fact, the real question is, Are we just going to pull that $300 million to $400 million [the extra profit the company must generate to meet expectations] out of the air?"

The fear is that the AOL contingent will drive for growth too fast. There are rumors that the music or movie businesses might be sold, although Parsons denies this. And at Time Inc., the publishing division, there is concern that fledgling projects, including magazine start-ups, might be cut because the new regime is so short-term oriented. "The minute there is a case where we're being asked to cut into our core business because some other division didn't make its numbers, there's going to be trouble," says an executive. "If top people like Logan, [Jeff] Bewkes, [CEO of HBO] or Terry McGuirk [CEO of TBS] throw their hands up and leave, the AOL people won't have a clue how to fill those jobs."

Big mergers often fail (see DaimlerChrysler and AT&T/TCI). In a staff memo just days after the merger was announced, Case and Levin asserted that the new company would "fundamentally change the way people communicate." That's a tall order. And no matter how hot the paradigm or how far and fast the technology reaches, AOL Time Warner is still in the business of satisfying finicky consumers, who want content from everybody, for nothing if possible. It will take more than synergy for this new Internet-age media colossus to succeed. And as Case and Levin would be the first to suggest, there's no room for failure.

--With reporting by Adam Zagorin/Washington

With reporting by Adam Zagorin/Washington