Wall St. and Business Wednesdays: Advantage, Icahn (Dec. 21 - 26, 2005)

For several weeks, I have been paying attention to the controversy surrounding shareholder activist and ‘corporate raider’ Carl Icahn’s public criticism of Time Warner CEO Richard Parsons’ management of the multi-billion dollar media company. That criticism is attached to the billionaire Mr. Icahn’s desire to take control of the board of directors of Time Warner.

Essentially, Mr. Icahn believes that Mr. Parsons has made critical mistakes and errors that have caused the company’s stock price to remain mired at disappointing errors. He argues that Mr. Parsons made a critical error in the sale of the Warner Music Group and 50% of Comedy Central and he believes that Time Warner needs to break up the company in order to unlock shareholder value. Some, like Gabelli and Co., estimate that Time Warner’s current market capitalization (stock price times the number of shares outstanding) represents a close to $50 billion discount to the break –up value of the company. The break up value represents the estimated aggregate value of the company, if its major divisions and holdings were sold. According to Gabelli and Co. Time Warner’s networks (HBO, WB, Turner) would be worth $44.5 billion; its publishing (Time, Inc.) would be worth $11.5 billion; its cable TV unit worth $44.5 billion; its AOL would be worth $17 billion – all for a total break up value of $134 billion. Mr. Icahn wants the company to sell some of these units.

On the other hand, Mr. Parsons, though admittedly disappointed with his company’s stock price, which currently languishes around $17, believes that Time Warner is just mired in a temporary funk. He believes that the company just needs to wait out the current slump, while making a few new moves, without doing anything dramatic or radical. Mr. Parsons believes that his company is better positioned than other media giants to weather the storm, because of the diversity of its holdings that uniquely include an Internet company like AOL, for example.

Analysts believe that the next months are critical with a showdown coming at the company’s Spring 2006 meeting.

I find myself sympathetic to some of the points made by both men. I think that Mr. Parsons is correct to point to some unique aspects of his company which do differentiate it from its competitors in an industry which has seen stock prices fall and remain sluggish. But I also think that Mr. Icahn has made a valuable contribution – as anybody’s worst critic can – by placing a spotlight on Time Warner management’s decision-making process; whether its infrastructure is too expensive; and asking the most fundamental question any business can ask – ‘what business are we really in?’

And I also think both men’s narrow self-interest obscures much and leaves a lot to be desired.

In the case of Mr. Parsons, I find his disposition and response to Icahn’s challenge to border on lethargic. And I even think he is still shell-shocked in the aftermath of the devastation that was the Time Warner-AOL merger. His vision for the company appears unexciting, if not unimaginative. He represents, perhaps, conservative corporate management to an extreme.

On the other hand, Mr. Icahn, though depicting himself as a saviour of ‘shareholder value,’ appears to be more interested in what the numbers tell him about the break-up value of Time Warner than he is in dealing with the reality of how the company will work after it sells what he desires. His attacks on Mr. Parsons do seem personal and his interest, as is always the criticism of ‘corporate raiders’, appears to very short-sighted and designed to produce a short term capital gain, alone, rather than that, and a thriving company that is built to last. Lastly, he has never run a human capital-laden entertainment company, and I wonder about how his cold cost-cutting measures will affect a company whose greatest assets are human beings who go up and down the elevator everyday. He, in my view, represents radical corporate investor activism to an extreme.

As is quite often the case, I consulted with my friend and perhaps the best business economist in the world, Mr. Reuven Brenner – a man who not only teaches economics and finance to students; but a person who is also an expert on analyzing business models, and company valuations -frequently advising billionaire investors and money managers on investments, and corporations and entrepreneurs on business plans.

Here is Mr. Brenner’s take on the matter, provided this weekend:

My view on Time Warner: it's simple. I think Icahn in an interview put it right: that he does not understand the digital business, and he does not think Parson does. The difference is that he admits not understanding.

I think Icahn is right, and his strategy is right. Complex business plans can never be executed. All those synergies may sound nice, but when it comes to execution they often fail. When technology is changing so quickly, one has to simplify and decentralize. That's the only way one can do experiments - and hopefully some of these experiments will bear fruit. Entrenched managements do not like to hear or admit this.

Note why the talks between Microsoft and AOL fail - because Microsoft apparently insisted on some complex conditions. Google came with something simpler: AOL salespeople selling ads on the Google network (with AOL having advertising channels everywhere); and Google infusing cash. Microsoft wanted to integrate Internet functions within its Windows and Office software - that's way too complex, and backward looking. And those programs are already way too complex (look at Microsoft’s delays and then the patching up they frequently have to do).

In a nutshell that's the way I see it.

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Reuven Brenner’s point is a good one and both Mr. Parsons and Mr. Icahn would be wise to listen. Mr. Parsons could use the advice to focus his drifting gaze, and Mr. Icahn, who does not necessarily share Mr. Brenner’s view of the Google deal, could use the wisdom to temper his break-up strategy, broadening his narrow focus on shareholder value with a viable business strategy.

The news that Google has invested $1 billion in AOL, for a 5% stake in the company, is of course, being interpreted differently by many, including Mssrs. Ichan and Parsons. Mr.Ichan, in an open letter expressed his displeasure with the deal, writing the following to the board of directors of Time Warner:

Like all shareholders, I am not opposed to Time Warner entering into an AOL transaction that creates long-term value. However, I am deeply concerned that the Time Warner board may be on the verge of making a disastrous decision concerning an agreement with Google if this agreement would make it more difficult in any way or effectively preclude a merger or other type of transaction with companies such as IAC/InterActive, eBay, Yahoo, or Microsoft etc.

I believe there are and will be major opportunities to enhance Time Warner's value in future combinations. However these transactions might not be achievable if Time Warner enters into long-term arrangements that preclude future flexibility such as an agreement regarding search functionality. I also question whether Google is the best partner for unlocking the value of the AOL asset. Indeed, a recent Goldman Sachs report concludes, "In contrast to the conventional perspective, we believe that eBay, followed by InterActive Corp., would provide greater incremental benefits to AOL's option value with fewer conflicts of interest than Yahoo! while MSN and Google would provide the least incremental benefits."

On the eve of a proxy contest, I believe it would be a blatant breach of fiduciary duty to enter into an agreement with Google that would either foreclose the possibility of entering into a transaction that would be more beneficial for Time Warner shareholders or make such a transaction more difficult to achieve. If, as is my belief, other suitors interested in transactions predicated on receipt of control of AOL have been foreclosed from entering into negotiations, the board's actions would be even more questionable.

The real risk for Time Warner shareholders is that a Google joint venture may be short-sighted in nature and may preclude any consideration of a broader set of alternatives that would better maximize value and ensure a bright future for AOL.

Once again, I am not opposed to the board using its business judgment to enter into a transaction with Google or another suitor so long as the transaction does not destroy or impede Time Warner's flexibility to unlock shareholder value in the near and long term. However, I want this letter to serve as notice to Time Warner's directors that if they enter into a transaction that has that effect, shareholders will seek to hold directors responsible.

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While Mr. Icahn strongly makes his case, many Wall St. observers believe that Mr. Parsons scored a mini coup with the AOL-Google deal by 1) getting a cash infusion that it hopes will boost its company valuation, and 2) sealing a deal that many believe will attract sufficient advertising revenue to AOL, making up for the steady decline in subscribers.

So far, Wall Street's investors don’t appear to agree.

Time Warner shares fell 21 cents to $17.74 in 4 p.m. composite trading on the New York Stock Exchange, yesterday (Tuesday). Google shares rose $5.14 to $429.74 in 4 p.m. composite trading on the Nasdaq Stock Market. In after-hours trading, Time Warner edged up to $17.79, and Google rose to $430.90. The deal was announced after the market closed but there is no mistaking by watching the stock price movements, that Wall St. thinks a good deal for Google is not necessarily one for Time Warner.

As Alan Murray put it in The Wall St. Journal, "The 'do no evil' computer search company agrees to buy a big stake in Time Warner's America Online at a price significantly higher than what most analysts think it is worth. The result? Google's stock soars. Meanwhile, Time Warner's Richard Parsons pulls off a coup. He will bring in a billion dollars, increase the perceived market value of AOL and give the struggling company, which is losing its dial-up subscribers at a dizzying pace, a new lease on life. His reward? A lackluster stock price and another angry letter from Carl Icahn."

Advantage, Icahn - with the clock ticking on Parsons.

Cedric Muhammad

Wednesday, December 21, 2005