Will the AOL Circle be Unbroken?

This morning Time Warner (TWX) announced it would spinoff AOL. So ends a drawing-room farce that began during our last boom-bust. Those who remember the tech bubble probably also remember that ownership runs the other way – AOL is supposed to own Time Warner, right?

To get our hands around the story lets journey back to 1992 when a small company called America Online, Inc. made a public offering on Nasdaq (424B, 3/20/92). AOL sold 2 million shares at $11.50 a pop, raising $23 million. By 1995, AOL was trading on the New York Stock Exchange at $58/share (S-3, October 1995). Although the price increase wasn’t gigantic, AOL had been issuing a tremendous volume of shares.

Because market capitalization was the name of the game – that’s what made it possible for a company with 12,100 employees and $4.8 billion in revenue (AOL 1999 10-K, 6/30/99) to buy a company with 67,500 employees and $14.6 billion in revenue (TWX 1998 10-K, 12/31/98). By 1999, AOL had 2.3 billion shares out. At $53/share that gave AOL a market capitalization of $121.5 billion (1999 10-K) – 2500 times larger than 1992’s market cap of $47.7 million (1992 AOL 10-K).

In early 2000, AOL decided to use its new paper wealth to buy a feeble, old-economy company called Time Warner Inc. AOL believed it was in a position to acquire TWX because the market had decided that AOL was the more valuable company. For purposes of the merger, AOL’s shares were valued at a very modest $53/share (in the second quarter of 1999, they went as high as $175/share). Although TWX’s shares traded higher at $83/share, TWX had fewer shares outstanding. So, TWX’s market capitalization, per the merger proxy (S-4, 2/11/00, 333-30184), was $99 billion to AOL’s $132 billion.

The merger was accomplished by organizing a new company called AOL Time Warner (ATW). Shareholders of AOL got one share of ATW for each AOL share they held. TWX shareholders got 1.5 shares. Because there were so many more AOL shareholders, they ended up with 56% of the ATW shares. In 2001, the new holding company, controlled by the former shareholders of AOL, started trading on the NYSE under the ticker AOL.

The trouble started almost immediately. In mid-2002, the Washington Post published a story about AOL’s accounting practices. Soon thereafter, the SEC began an investigation and by 2005 the Department of Justice was involved. During this period, the “AOL” started disappearing from AOL Time Warner. ATW dropped the AOL from its name and became, once again, Time Warner. It also retired the AOL ticker symbol and went back to trading under TWX.

So, AOL wanted to buy Time Warner, but by 2003 the acquisition vehicle had morphed into Time Warner and AOL was reduced to being a division of it. In the coming spinoff, AOL shares are going to be distributed to Time Warner shareholders (many of whom, presumably, were once holders of AOL shares?) for free and will reenter the secondary market – possibly on Nasdaq? We’ll have to wait to see what the opening price will be, but I’m betting on $11.50.