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You've Got Merger

AOL owns the Internet, has an absurd valuation (bigger than Viacom's!), and has media-company wannabes running the show. Guess what? Netscape's just an appetizer.

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The most recent chapter of America Online's remarkable adventure -- from near oblivion too many times to count (system overload brought it perilously close to collapse as recently as 24 months ago) to its present status as one of the most highly valued companies in the world -- is the agreement to purchase the Netscape Corporation for $4.2 billion in AOL stock. If you have not lived the twists and turns of the Internet industry -- as hairsplitting and convoluted as the rise and fall of international socialism -- it would be hard to truly appreciate the vastness of the irony here. Suffice it to say that the deal probably marks the beginning of the end of the economic and cultural dominance of the technology industry and announces a power shift from West Coast to East Coast and -- surprise -- the triumph of the marketers over the technologists.

As of this writing, the stock market believes that AOL combined with Netscape is worth $46 billion. It is a company, in other words, significantly more valuable than Murdoch's News Corp., Viacom, or CBS (indeed, AOL is worth more than Viacom and CBS combined), and almost as valuable, in the minds of investors, as Time Warner and Disney.

The problem, of course, is that it doesn't make very much money and has never really turned much of a profit. But then, perhaps this is not a problem. "It can't go on forever," or "I'm just along for the ride," or "I'm just waiting to trade my options for somebody else's paper" -- these have been the ways AOL staff members have explained to outsiders and to themselves the strange predicament of being part of a company that has continued to fail ever onward and upward. It's a new kind of business, one that never succeeds but, by moving fast enough, is successful at getting into a new business before it's apparent that the previous one has failed. Indeed, throughout AOL's nearly fourteen-year history, from its start as a little gaming company to its present colossus stature, the question has always been: How will it all end, or is this just the beginning?

Along with the purchase of Netscape, the new Tom Hanks-Meg Ryan movie You've Got Mail surely announces the next AOL era. Hanks as the head of America's largest bookstore chain stands in for the Riggio brothers, who own Barnes & Noble, and the Hanks-Ryan (she's the owner of an independent bookstore) e-mail exchanges stand in for AOL's real business of explicit sex talk (at no point does Hanks propose to act as Meg Ryan's strict parent, or maid).

You've Got Mail makes it official. At some point when Silicon Valley wasn't looking -- no doubt downloading some plug-in or other -- AOL became the Internet for America. In Silicon Valley the lowest form of life uses an AOL address, but in my house my 14-year-old daughter, Elizabeth, will have nothing else.

Still, now that they own the Internet, what do they do with it?

I think I know.

They buy a network. Voilà. Simple. Sublime.

The CBS network, which its new CEO, Mel Karmazin, keeps threatening to spin off from the more profitable station business, would be a good buy for AOL. Or the whole of NBC. Then there's AT&T's TCI (this merger not yet completed), which, as soon as it's embraced by AT&T, could be spun off again and merged with AOL, creating a media empire comprising cable network, programming arm, and high-speed-cable-access service, along with Web dominance. In other words, if you can zero in on a person via sitcoms, sports, news, browser, home page, e-mail, and chat session, you just might be able to get your message through.

Hmmm, there are the Time Warner cable properties, too. I see those spun off and combined with AOL, which almost inevitably reverse-merges back into TW, where, finally, AOL president Bob Pittman -- an ex-MTV exec -- realizes his old ambition to succeed Steve Ross as the head of Time Warner.

Even before Pittman (considered to be a real media executive rather than a "new media" executive) came to AOL in the fall of 1996, AOL Studios president Ted Leonsis (the vivid, intemperate proselytizer of AOL world dominance) was telling anyone who would listen that AOL was a media company -- famously, Leonsis said that on Thursday nights, AOL's competition was Seinfeld. Then came Pittman and flat pricing -- a cable visionary and a cable business model. AOL was suddenly no longer in the business of selling connect time; it was in the business of selling advertising.

The leap to an advertising business model in early 1997 was audacious, blithely ignoring even the most obvious obstacles:

  • AOL's audience consisted mostly of people in chat rooms, mostly talking dirty -- not an obvious environment for America's consumer products.

  • AOL's audience for anything but the most heavily promoted areas on the service was minuscule (its prime-time audience -- now up to a still relatively modest 625,000 -- was then less than 100,000).

  • Nobody really had any idea how users respond to advertising in an interactive medium -- the fact that users had even greater power to ignore advertising online than off- was almost never discussed.

But Pittman, with David Colburn, AOL's Geffenesque deal-maker, and Myer Berlow, AOL's Milo Minderbinder-style salesman, began making a series of killer deals. Tel-Save, a long-distance reseller in New Hope, Pennsylvania, was the first to come in. For $100 million (that's right, one hundred million dollars), AOL would be Tel-Save's marketing partner, selling the heck out of Tel-Save online and in telephone solicitations to its members. CUC (which would shortly merge with HFS to form Cendant, and cause an immense accounting scandal) committed to a $50 million promotional deal; Barnes & Noble agreed to pay AOL $40 million; 1-800-flowers came in at $25 million.

Now, the AOL team could make these kind of deals because while there was no proof that they would work, there was also no proof that they wouldn't. Indeed, in almost every instance, when a company committed to one of these mega-million-dollar deals (called "slotting" deals or "carriage" deals or "portal" deals), it got a big stock boost -- i.e., the deal paid for itself, or, more accurately, investors paid for the deal.

Meanwhile, AOL piled on more and more users. Sex chat existed side-by-side with teen talk. My daughter, with a 70-person buddy list, chats with eight friends who, in turn, chat with eight friends each, and on and on until the whole teen universe is connected.

The problem, however, was that this new environment, this new kind of audience, this new form of user-created content, this new medium, wasn't -- and isn't -- really selling product. Indeed, Tel-Save, after huge losses, is reportedly attempting to renegotiate its AOL deal.

To understand the real dynamic of the Internet business, you have to appreciate that as much as it is business, it is business theory. The need to eventually sell products (or a lot more products than are being sold now) co-exists side-by-side with the ever-evolving theories about how this will come about. The fact that new theories are manufactured for every new billion of valuation seems to cause the investment community little concern. Indeed, the Internet has turned investors into futurists and sociologists and philosophers. Accordingly, AOL charges past the issue of Tel-Save et al. and buys Netscape. On the theory side (the waterfront-property theory), it couldn't seem more brilliant. AOL now owns Netscape's 45 percent of the browser market, and in addition, it owns the 40 percent of the Microsoft browser market that comes through AOL (which provides its users the Microsoft browser). In other words, it's a wrap. AOL does own the Internet -- for what that's worth.

But if I know anything, it's that before it becomes clear that owning the Internet is more like owning the air we breathe than the shore we covet, AOL will have traded up.

"It's all about convergence," brokers will tell their clients.

The great American audience, analysts will say, is no longer reachable through even a Super Bowl ad. This audience grows more and more disparate, fractured, elusive. To reach this audience -- to approximate the golden age of network television -- you have to be able to communicate through a finely layered web of highly targeted media. Only then will your message be heard by the American consumer. This is called a package. It is, no doubt, as right as any advertising pitch, and as full of baloney. But it will provide the rationale for AOL to take its $46 billion worth of value and -- breathing one hell of a sigh of relief -- buy itself a real, profit-producing media company.

The odd thing is that somewhere in this process, I bet, AOL will become a more or less normal place, its management team will become just your ordinary difficult media executives, and the Internet will turn out to be just a way to get into the television business.

E-mail: michael@burnrate.com


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