M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Saturday, May 30, 2009

The Art of Leaving in High Time

Robert F. Bruner has graciously sent his thoughts on the recent announced spin-off of AOL from Time Warner.  Dr. Bruner is Dean and Charles C. Abbott Professor of Business Administration and Distinguished Professor of Business Administration at the Darden Graduate School of Business AdministrationUniversity of Virginia where he teaches M&A courses in the MBA program.  He is also the auithor of multiple books, articles and case studies on M&A.     


If you have made a mistake, cut your losses as quickly as possible” -- Bernard Baruch


 Late last week, Time Warner announced that it would spin off its AOL division.  This ends one of the most notorious stories in M&A history.  In my book, Deals from Hell, I dubbed the AOL/Time Warner merger one of the worst in business history, a genuine nightmare for almost everyone involved.   The announcement of the merger in 2000 pitched it as a deal from heaven, converging old and new media, content and distribution.  But it turned out otherwise.   While AOL’s shareholders did very well in the deal, Time Warner’s did not.  The deal was closed in January 2001.  The transplanted organ was not accepted by the host; intramural fighting ensued.  Civil and criminal litigation sprouted.  Executives were sacked.  All of this occurred against the bursting Internet bubble, the recession of 2001, and the slow recovery.  AOL’s business withered.   By 2003 the rise of broadband and wireless connectivity and the demise of AOL’s dial-up business were clear.  AOL’s number of subscribers fell from about 27 million in 2002 to under 10 million at the end of 2007. 

 One wonders, why did they do this deal?—this is the subject of numerous books and articles.  But there is an equally compelling question that has received much less consideration: Why did it take so long to unwind the deal?  In contrast to Bernard Baruch’s advice, corporations generally seem slow to cut their losses quickly.  Perhaps Time Warner found a way to squeeze cash out of the business, and therefore tarried.  The illiquidity of a company’s assets is an obvious reason; under the best of circumstances, selling a business can take a while.  But there is more to the story of slow corporate divestitures:

1.       Measurement and information problems.  It is tough to identify the point of inflection where the acquired business begins to turn sour.  Five years ago, newspaper publishers had little clue that classified advertisers would begin to flock to Craigslist and other Internet marketplaces.  Those publishers today are taking a pounding from the Internet that would have been very hard to foresee in 2003.  Similarly, the demise of the dial-up Internet connectivity (in favor of wired broadband and WIFI) has been faster than many forecasters expected in 2000.  Monitoring the trends within the portfolio of a firm’s businesses is difficult to do and fraught with error. 

2.       Biased thinking.  This is what economists call “behavioral factors,” such as denial, loss aversion, and “sunk cost” mentality: “I can’t just sell a $100 billion investment for $50 billion”—even though it might be rational to do so if $50 billion is a fair value today.  Sunk cost thinking regards the business the way it used to be, not the way it is or will be. 

3.       Corporate governance practices and incentives.  There is a well-known correlation between firm size and CEO pay.  This can prompt management to think that bigger is better and that smaller is not better.   Boards of directors may not monitor and challenge the thinking of management as vigorously as they should.  And various kinds of takeover defenses or share voting restrictions may prevent shareholders from directly challenging the board and managers to sell ailing businesses.

4.       Barriers to exit.  The Federal Communications Commission took a year to approve the merger of Time Warner and AOL.  It might take that long to approve a divesture.  A small number of buyers or the existence of unusual liabilities very nearly scratched the sale of Bear Stearns.  A price tag in the billions of dollars along with the reluctance of banks to finance a purchase (that, as many private equity firms will tell you, is the situation today) could kill a sale.  Uncertain environmental clean-up costs or generous union agreements (think of the auto industry) can drive potential buyers away.

CEOs require strong will and strength of character to cut its losses in the face of these kinds of problems.  Plainly, it takes a bias for action, regard for opportunities, careful due diligence, and tough-minded concern for your investors’ return.  We want firms to exploit the flexibility to enter and exit from businesses because it promotes dynamism and growth in the global economy.  But the devil is in the details.  Economic discipline, timeliness of response, and focus on action are all vital.

 - Robert F. Bruner
   May 30, 2009



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