Finally, theyve got a deal

AOL-Time Warner merger gets the FCC's approval; now the tricky part is to make it work

For a year and a day Steve Case and Jerry Levin battled bureaucrats, competitors, and Internet advocates on both sides of the Atlantic. But the chiefs of America Online and Time Warner last week finally created the world's largest media conglomerate after clearing their last regulatory hurdle.

That was the easy part. Now they've got to make it work.

That's because when AOL Chairman Steve Case agreed to take over Time Warner last January the dotcom world had not yet melted down, advertisers had not started fleeing AOLs Web sites, Turner Broadcasting's cable networks and Time Inc.'s magazines, and heavy spending on developing businesses was still considered a good thing.

When the AOL merger of Time Warner was announced the deal was valued at $183 billion. Today, it's worth $128 billion.

"This is the first day of the rest of your life," said Sanford Bernstein media analyst Tom Wolzien. "They've got to perform."

Time Warner employees are bracing themselves, nervously pondering the $1 billion in cash flow savings Case has promised investors this year. CNN could cut as many as 1,000 workers. (See page 12.) Other Turner Broadcasting System employees are worried that they could be next.

"A year ago all you saw were the opportunities," said an executive at one Time Warner division. "Now you see all kinds of downside."

For the cable industry as whole, the merger also leaves a worrisome wake. Thanks to the regulatory hoops through which regulators forced AOL Time Warner to jump, other cable companies now face an unwelcome model for Internet open access that could force rival ISPs onto all their broadband networks. The FCC also is mulling restrictions for cable operators' interactive TV businesses.

"This will give everyone a chance to review the potential for technical discrimination and to determine how to make sure the playing field remains competitive," said Preston Padden, the Walt Disney lobbyist to who made the push for merger conditions a personal crusade.

The cable industry is already sounding the alarm. "To commence a rulemaking-one that could bind hundreds of companies that have nothing to do with this merger-is totally unwarranted by the facts," said Robert Sachs, president of the National Cable Television Association. "Interactive television has yet to take form as a business."

FCC Chairman William Kennard and several other commissioners insisted their action has no bearing on industrywide proceedings and that the conditions were imposed because AOL is the largest Internet provider with 24 million subscribers and Time Warner is the second-largest cable company, serving 12.7 million customers. Further more, they said, Time Warner's vast holdings in cable programming, movies, music and publishing give it unprecedented power to dominate both supply and delivery of media content.

But others say the open-access conditions imposed by both the FCC and the FTC will be models as the next FCC chairman (Kennard announced he will step down to make room for the Bush administration's pick Friday, Jan. 19.) takes over the agency's ongoing review of possible cable broadband regulations.

"I really think open access should be the way to go for this country," FTC chairman Robert Pitofsky declared when his agency approved the merger last month.

Also, FCC Commissioner Michael Powell, who opposed the FCC's conditions but voted for the merger, noted that the open-access conditions would "distort discussion about what, if any, rules are necessary to promote the availability of multiple ISPs on cable." Powell, who opposed the open-access and instant-messaging restrictions his colleagues imposed, nevertheless backed the pending rulemaking on ITV. Powell's comments are critical, because he is widely expected to follow Kennard into the chairmanship.

The FCC voted to approve the companies' merger a year and a day after company chairmen Steve Case of AOL and Gerald Levin predicted that the first merger of a traditional-entertainment giant and an Internet-age leader would sail past regulators. Since that time the dotcom shakeout has battered even the most successful Internet companies.

Caught off guard by the intense pressure levied by consumer advocates and industry rivals, AOL and Time Warner were forced to accept a series of conditions laid down by the FCC, the Federal Trade Commission and the European Union. On Jan. 11 the FCC's three Democratic commissioners voted to impose strict conditions on the merged company's high-speed modem and instant-messaging services.

As a further condition, Time Warner would be forced to sever its financial ties to AT&T, the country's largest cable company.

"I took a hard, careful look at this merger to make sure that this historic marriage would benefit consumers," Kennard said. "I balanced the need to protect the public from the danger that any one company will be able to dominate the marketplace against the need to guard against intrusive regulation that could stifle investment and innovation."

The Federal Trade Commission approved the merger in December with wide-ranging restrictions.

Powell and Furchtgott-Roth decried the FCC conditions, both for imposing restrictions for as-yet undeveloped problems and for over-reaching agency authority. "I believe the majority has given in too much to their collective imaginations, rather than sound reasoning based on the record." Powell said.

Furchtgott-Roth charged that the agency and FTC cooperated in an improper way by sharing merger documents and by not making those deliberations public.

The strong FCC requirements were a victory for Commissioner Gloria Tristani, who said the FTC's conditions and simple requirement that instant messaging be opened to one rival, urged by FCC staff, didn't go far enough.

"This is far more than a narrowband text-messaging service," she said.

Powell countered that advanced IM high-speed services, which staffers dubbed AIHS, does not yet exist and suggested the agency concocted it from its collective imagination. "When a regulatory agency has to make up its own acronym to describe a product or service it intends to regulate, one should be concerned," he said.

Specifically the FCC's conditions are:

Open access. Going beyond the FTC order, the FCC mandated that AOL Time Warner cannot control the "first screen" seen by subscribers of rival ISPs when accessing service over Time Warner cable. Also, direct billing between unaffiliated ISPs and their customers must be allowed. Third, unaffiliated ISPs must have access to the same technical quality as AOL in areas such as content caching. Finally, the FCC reserved the right to review contracts between AOL Time Warner and unaffiliated ISPs.

Instant messaging.
AOL Time Warner faces no restrictions on its current text-messaging services but has two options if it decides to offer advanced services such as IM video. One, it can demonstrate that its service relies on technical standards open to all services. Or two, it can open its platform to three rival services. AOL can, however, petition the FCC to have the instant-messaging restrictions lifted if a change in the marketplace warrants.

AT&T/Time Warner link.
AT&T must sell its 25% stake in Time Warner Entertainment, eliminating financial ties between the No. 1 and No. 2 cable companies.