Time Inc’s Entry into Entertainment Industry

Irfan

Neha

Sandya

Vidya

Key Issue

Contents

Valuation

Conclusion

Detailed AnalysisManagements Decisions Paramount's offer

Possible Merger PartnersWarner Communications Paramount

Industry Analysis

Time Inc.

Time Inc

• Formed in 1924 by Henry Luce and Briton Hadden (New magazine)• Over 35 yrs, Time grew by introducing new magazines and acquiring

publications

Time Inc

Magazines42%

Books15%

Cable TV programming17%

Local Cable TV Fra

nchises25%

Time Inc.

• Magazines :– Time was the largest

publisher of general circulation magazines in the United States, with 15 titles, including Sports Illustrated, People, Fortune, and Money, as well as Time and Life.

– Time’s magazines accounted for more than 20% of advertising in U.S. consumer magazines each year.

– Foreign editions of Time and Fortune were published through joint ventures.

Time Inc

Magazines42%

Books15%

Cable TV programming17%

Lo-cal Ca-ble TV Franchises

25%

Time Inc.• Books: – Time distributed books through five

publishing organizations. – Time-Life Books was the largest

direct-mail publisher of general interest books in series, and Book-of-the-Month Club operated the largest general-circulation book club and several other book clubs.

– Little, Brown and Company published trade and professional books, and Oxmoor House published how-to and illustrated books on a variety of subjects.

– In 1986, Time acquired Scott, Foresman and Company, publisher and distributor of elementary, high school, and college textbooks.

Time Inc

Magazines42%

Books15%

Cable TV programming17%

Lo-cal Ca-ble TV Franchises

25%

Time Inc.• Cable TV Programming:

– Time invested in a cable television network in 1972.

– In 1989, Time operated both the Home Box Office (HBO) and Cinemax networks. Only consumers with hookups to local cable franchises were eligible to subscribe to these networks. Subscribers paid monthly fees for access to programming on HBO or Cinemax.

– HBO’s programming included feature-length films, sporting events, special entertainment

– events, and movies commissioned by HBO. – Cinemax offered a broad range of movies and

special– entertainment events. Experience had shown that

consumers did not often cancel their subscriptions– to cable-television networks. Most programming

on HBO and Cinemax consisted of recently released

– feature-length films.– HBO acquired programming through licensing

agreements with film producers and film distributors. HBO Video distributed films and other programming on home videocassettes in the United States and Canada. Time also had a 14% ownership interest in Turner Broadcasting System, Inc., a broadcast network.

Time Inc

Magazines42%

Books15%

Cable TV programming17%

Lo-cal Ca-ble TV Franchises

25%

Time Inc.• Local Cable TV franchises– American Television and

Communications Corporation (ATC), an 82%-owned subsidiary of Time, was the second-largest cable television franchise in the United States, with 3.9 million Subscribers.

– Local municipalities awarded franchises an exclusive license to distribute cable programming, such as HBO to subscribers television sets through a network of cables

Industry Analysis

Industry Analysis

Time’s Strategy for 1990

• 1983 and 1984 – Management reviewing Long term goals

• Magazine business though profitable did not assure enough growth(Almost Matured)

• Fastest growing - HBO and cable side of business(Half of Time’s earnings)

• Ended in decision to Expand its position in ownership and creation of video programming

• Vertical Integration

POSSIBLE MERGER PARTNERS

Warner

Paramount

Columbia

Disney

Twentieth Century-Fox

MCA

Less attractive

CLOSE PROBABILITY

Warner Communications

• Warner Brothers subsidiary• Warner produced ,financed and

distributed to theaters feature motion pictures distributed feature films to television stations, networks, and pay television systems and distributed prerecorded videocassettes and videodiscs.

• Warner Brothers operated a worldwide theatrical distribution organization through which it distributed its own films, as well as films produced by others.

• sixty percent of its sales were international.

Filmed enter-tainement

40%Music recording and publishing

45%

Cable and broadcasting

11%

Publishing and related distribution

4%

Warner

Warner Communications

• Another Warner subsidiary, Warner Cable, operated its cable television business, which comprised primarily the distribution of broadcast television signals and satellite programming to television subscribers.

• Warner Publishing published comic books (e.g., “Superman,” “Batman”) and hardcover books and distributed magazines and books through wholesalers in the United States and Canada.

• With 1.4 million subscribers, Warner was the sixth-largest cable operator

• The investment bankers’ presentation to the board emphasized Warner’s outstanding expertise in operating management

Paramount

• Formerly Gulf and Western• The entertainment operations

produced, financed, and distributed motion pictures, television programming, and

• prerecorded videocassettes and operated movie theaters in the United States and Canada.

• Paramount and MCA jointly owned USA Network, a national advertiser-supported basic cable television network, one of the largest of its kind in the United States

Entertainment39%

Publishing/Information23%

Consumer/Commercial finance

38%

Paramount

Paramount

• Paramount also produced and distributed series and made-for-television movies for network television, pay and basic cable, and videocassettes.

• In addition to distributing its own product, Paramount distributed to the foreign market television products acquired from independent producers.

• published hardcover and paperback books for the general published textbooks for elementary schools, high schools, and colleges.

• Paramount’s subsidiary, Associates Corporation of North America, provided consumer finance, specialized commercial finance and related insurance services in US, Canada , U K and Japan.

• Associates Corp. was the 3rd largest independent finance company in the United States

• Shearson and Wasserstein noted that Paramount would noted provide major cable assets, and the finance subsidiary, which represented 41% of total operating profit, did not fit with Time’s entertainment strategy.

The need for TIME Inc. To Merge

• Time Inc. was faced with the following problems

No major copyright in

video

Time was neither too diversified

nor global

Time`s stock not valued correctly

• Too expensive in the open market

• Only owned entertainment distribution channels

• Lacked a separate class of non voting stock

• Lacked vertical integration

• Traded at a fraction of its theoretical breakup value

Management’s viewpoint

• Address all three problems via a merger or acquisition– creating value through diversification– creating values through economies of scale

• Eliminate operational redundancies• Eliminate a competitor

– creating values through economies of scope

• Vertical integration• Motto: “To eat and avoid being eaten”• Diversification of business with international avenues for profits• Paramount and Warner Bros represented the best options in

terms of:– Size– Strategic fit– Management

Vertical Integration

• Time’s decision to enter the entertainment industry is driven by deregulation enabling vertical integration in media

• Vertical Integration is being motivated by– Increasing risk of holdup if acquiring

programming and outlets for Time’s HBO and Cinemax

– Reduced risk of losses from growing film production costs due to guaranteed returns in self owned outlets

– Multipoint competition

Warner vs. Time vs. Paramount

Overseas Revenues- 40%

Ownership of Distribution Channel- 100%

Corporate CultureMore of a partnership styleAutonomy to division heads. High creative independence

Overseas Revenues- 10%

Ownership of Distribution Channel>100%

Corporate CultureChurch-State separation

concept. High creative independence

Overseas Revenues- 16%

Ownership of Distribution Channel>100%

Corporate Culture

The Merger Deal

• Time wanted to go for a cash buyout of Warner’s shares• However Steve Ross of Warner wanted simply to merge

the hard assets of both companies through a stock deal• Deciding on the ratio of stock exchange was in Warner’s

favour as– Warner had higher earnings after taxes in 1988 of $423 million

as opposed to $289 million albeit Time had higher sales – Warner’s lower tax rate due to higher accumulated tax credits– Wall street favoured Warner’s business mix– Time had supported its own stock price – 10% buyback– Warner was deserving of a premium – its stock was about

35% of Time’s in 1988. – Time wanted to negotiate about 43%-45%, while Warner was

negotiating for 50%.

Time’s Offer for Warner

• Time’s shareholders offered a 59% stake in the merged firm to acquire Warner through a stock swap

• MV (Time: 109.125*57m shares=$6220.125 m

• MV (Warner): 45.875*178.5 m shares=$8188.6875m

• Completion of the acquisition requires shareholder approval; combined T-W value = 14.48Billion

Evaluating the Warner OfferIs Warner worth giving up 59% of Time Warner?

• Market value of T-W is $14.4B• Time pays 0.59 x 14.4B = $8.496B for Warner

• For Time shareholders to be indifferent between holding Time and holding 41% of T-W must have a value of $15.17B.

• $6.22B x 100% = Value T-W x 41%; Value T-W = $15.17B

• Time-Warner must create an additional $771M in synergies beyond their cumulative market values.

• This requires about $75M in additional annual cash flows.• Assuming a perpetuity with a 10% discount rate.

Paramount’s Offer

• Launched a cash bid for Time for $175 a share

• Time’s stock price rose from $44 to $170 per share, Paramount’s rose from $0.75 to $54.75

• Conditioned its tender offer on the termination of Time Warner merger and share exchange agreement

Reasons for Paramount Offer

• Preserve their empire – they were clubbing with other competitors to stop the Time Warner merger deal

• To not allow Time to gain merger cheaply without any debt or tax liability – wanted to saddle the company with debt to make it less competitive and make its prices go down so the high bid by Paramount would prove more attractive and acceptable

Paramount's Offer

• With Paramount’s offer, Times value increases to $9.975B

• $175 x 57M shares = $9.98B

• For Time shareholders to be indifferent between holding Time (cash from Paramount) and 41% of Time Warner, T-W must have a value of $24.3 B.

• $9.98B x 100% = VALUE (T-W) x 41%; VALUE (T-W) = $24.3B

• Time-Warner must create an additional $9.929B in synergies for shareholders to justify spurning Paramount’s offer.

• This requires almost $1B in additional annual cash flows.

• Assuming a perpetuity with a 10% discount rate.

Reaction of Time to Paramount’s Offer

• Time looked at Paramount’s bid as short term gain – since diversified fields in the industry wasn’t a match

• But to discount Paramount’s deal and to justify to its shareholders Time required to earn a rate of greater than 12%

• Paramount’s hike in offer to $200, would easily take Time Warner more than 7years of combined synergy to reach that level

• But to go ahead with Warner deal they acquired it for cash swap so as to avoid including shareholders point

Analytical Issues

• stakeholder interests should be served?

• Which interests are being served? (agency problems)

• How do we value the options?

• Where do we find the potential synergies?

Time’s Decision

• Time dropped its stock offer for Warner and paid a higher price ($13.1B; $72/share) for Warner with cash.

• This avoided the need for shareholder approval of the merger that surely would have failed given the Paramount offer.

• Paramount boosted its offer to $200 per share and indicated a willingness to go higher.

• Paramount sued based on the business judgment rule and lost.

ConclusionIs bigger the better?

• Time’s decision to eventually go ahead with Warner was viewed as the most viable long term solution

• Evan though Paramount had quoted a figure of $200 per share, Time had never wanted to be acquired.

• Warner represented the best strategic fit for Time• Although initial decision was a stock swap,

Paramount’s Davis made sure that the tax benefits that Time would have benefitted from, would be lost through their intervention, eventually making Time go against their shareholder’s interests

Conclusion

• At a discount rate of 12%, Time Warner would have been able to reach a share price of $200 only after 7 and a half years.

• However the synergies realized over a long term proved to be much higher.

• Time Warner had become the largest media empire on earth

• Also, Time’s shares in 5 years was anticipated to be $352 and $621 in 10 years.

• Thus their decision in the long term was a success in spite of the leveraged acquisition

Thank You

References

• http://hbr.org/product/time-inc-s-entry-into-the-entertainment-industry-b/an/293133-PDF-ENG

• http://money.cnn.com/magazines/fortune/fortune_archive/1989/11/20/72769/

• http://law.wustl.edu/courses/lehrer/spring2006/CourseMat/2006/ParamountvTime571_A_2d_1140.pdf