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Survivor!

When the merger with Time Warner was announced, we all thought high-flying AOL was getting shafted; now it looks like the smartest move a dot-com ever made.

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How many people can be fooled by one merger? If you are talking about the merger between America Online and Time Warner, the answer may be just about everybody. Except the executives of America Online. They look smarter and smarter every day.

I know I fell for it. I can still feel the rush of adrenaline that January morning when the news broke. "It's brilliant, it's an instant must-own," I gushed to my colleagues. "Take it, take the stock to $90, this is the big one."

But I didn't have to worry about getting America Online stock in. There were willing sellers well below my buy price -- so willing, in fact, that by the time I entered how excited I was about the combination in my online diary on TheStreet.com, the egg had already dried and crusted all over my face. If you take a look at the chart of America Online in the year 2000, you can see what looks to be the North Face of Everest, around $83, that quickly plummets into a crevasse. That high was the final ascent made by Cramer Berkowitz, shortly before the avalanche of sales buried us alive down to the $50 level.

The willing dumpers, those not dazzled by the entertainment synergies, bolted furiously, but for what turned out to be the wrong reasons. They sold because they didn't want to exchange America Online's red-hot growth stock for the staid, slower-growing, and hopelessly leveraged Time Warner. They wanted an "Internet multiple," not a "traditional entertainment multiple," and AOL Time Warner, as the new company would be called, didn't have the Internet juice.

Time Warner executives, on the other hand, stymied by every attempt to crack the Net, were all too eager to step into cyberspace and link up with one of the hottest stocks in the frenzied dot-com world. If you can't beat them, why not join them, and get them to pay up to boot? Having one and a half shares of a known highflier sure beats having one of a company that nobody cared that much about and that pretty much sat out the go-go growth era of the stock market.

I can imagine that if Time Warner had struck up talks with AOL after the just-reported quarter, AOL's name wouldn't be going first in the new moniker. But it's too late for that regret now.

The only guys who looked like losers were the two so-called geniuses behind America Online, Steve Case and Bob Pittman. What the heck were they thinking? Why did they hitch this ballast to their fast-moving ship? Why did they choose, out of nowhere, to lower their own growth rate at a time when the dot-com future looked so bright and the prospects for cracking into the top five highly valued companies in the Standard & Poor's seemed so within reach? What were plodding behemoths Merck and IBM and Pfizer doing being valued greater than fast-growing AOL, let alone Intel and Cisco? And why were Pittman and Case throwing in the towel now?

Eight months later, it looks like the only guys who got it right were the two towel-throwers themselves. Eight months later, it seems pretty laughable, frankly, that Time Warner is hooking up with a company from the now scorned Net world. The dot-com universe has fallen apart, with average declines of roughly 65 percent for almost every dot-com, good or bad, profitable or unprofitable, smart or stupid.

That would have put America Online in the high $30s instead of the $50s, where it is now. In fact, I think that AOL trades as highly as it does because of its claim on the now more valuable Time Warner. While arbitrageurs who are short the stock would probably rush to cover it if the deal were to fall apart, I would wager that AOL would actually go down substantially soon after if this deal were to fall apart now. That would have been just plain stupid to argue eight months ago. During the weeks after the deal was announced, traders could get AOL jumping three or four points on whispers that the deal might be in trouble. Even a direct-mail promotional piece for Inside.com that featured a fake headline about the breakdown of the deal caused AOL to rally nearly three points the day the mailing arrived in New York homes! Everybody who was long AOL wanted this deal dead.

These days, however, only AOL's call on Time Warner keeps it out of the dot-com dead pool. Meanwhile, internally at Time Warner, they must be scratching their heads about what they did and how they got all caught up in the final innings of the dot-com mania. For several years, we had heard that a bricks-and-mortar company like Time Warner should have bought an America Online or an Excite or a Yahoo! much earlier. By last year, any old-world company would have had to settle for a merger of equals. Going into this year, however, in a period when Time magazine had just made Jeff Bezos Man of the Year (a real merchant, like Sam Walton, must have been rolling over in his grave at that nod!), AOL was worth much more than Time Warner.

So it was only natural that Time Warner was willing to take 45 percent of the combined company, which is how things will shake out when the merger closes. While AOL continues to put decent numbers on the board, last month it reported its first-ever revenue disappointment. Oh, sure, earnings were "better than expected," one of those happenstances that are barely happenstance -- companies create their own earnings estimates, and then the Street laps them up. But its revenues were so naggingly "in-line" that my team blew out of the stock while I was sunning in Amagansett, without even clearing it with me.

Good move! The stock took an immediate hit in reaction to the news; the slowdown for dot-coms had at last arrived at AOL's door. Remember, we growth-stock hounds don't care nearly as much about earnings as we do about raw sales growth. That's what spurs stocks like Intel and Cisco and Sun Microsystems and Nortel, some of the current rapid revenuers with the largest market caps.

And how about Time Warner's stock? I can make a case that it would have traded up here on its own, and gone a lot higher, given the incredibly strong recent showing of traditional media conglomerates Disney, CBS and Viacom (now one company), and even Murdoch's News Corporation, which has stumbled at the box office and on the tube but not on Wall Street. Fortunately, Time Warner held out for a huge premium in the merger. If it hadn't, Time Warner execs would right now be secretly feeding documents about Web and music-industry dominance to the folks at Disney, who are still trying to break up the merger on anti-competitive grounds. If Time Warner hadn't bargained for such a great price, its shareholders would surely be up in arms as they got sucked down into the dot-com vortex.

I can imagine that if Time Warner had struck up talks with AOL after the just-reported quarter, AOL's name wouldn't be going first in the new moniker, and the ownership percentages for "Newco," as we call prospective merged entities on Wall Street, would look a lot more like what Steve Ross created and a lot less like those Steve Case would want. But it's too late for that regret now.

Up until January of this year, every company on earth wanted that ethereal Internet multiple. Except America Online. I guess you needed to be the biggest dot-com of all to see the unraveling coming. Case and Pittman turned out to be truer visionaries than anyone ever imagined. They were the only two never fooled by the whole mania. They got out at the top. Congratulations. Nice call!

TheStreet.com
This week's "10 Questions" will be a Q&A with tech specialist Robert Loest, portfolio manager of the IPS Millennium fund. Available for free at www.thestreet.com.

James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had positions in America Online, Cisco, IBM, Intel, Nortel, Sun Microsystems, TheStreet.com, Viacom, and Yahoo! His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites comments at
jjcletters@thestreet.com


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