CH-ZWA645-005jsmGB

Horizontal Scope
James Oldroyd Kellogg Graduate School of Management Northwestern University j-oldroyd@northwestern.edu 801-422-7888 650 TNRB

Cross Media Rivalry Matrix

Company Newspaper X TV Cable Pub Live Outdoor Radio Online Video and Ent. X Music

Tribune

New York Times

Dow Jones Gannett KnightRidder Clear Channel Viacom

X
X X X

X
X

X X X X X X X X X X

AOL/TimeWarner
Disney

X
X X

X
X

X
X

X
X

X
X

X
X
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One of The Problems

Exhibit 1

Percent of Adults Reached

70%
58.8% 58.7% 58.6% 57.9% 56.9% 56.2%

Daily Newspaper1

60% 50%
45.3%

Prime Time TV2

42.4% 40.8% 39.6% 38.5% 37.8%

40% 30%
25.5% 20%

Morning Drive Radio3

25.4% 25.7% 25.5% 24.5% 23.4%

10%
11.0% 0%

Prime Time Cable4

10.4% 10.3% 10.5% 11.3% 12.0%

1996
1 Average 2 Average 3 Average 4 Average day readership half hour quarter hour half hour

1997

1998

Spring 1999

Fall 1999

Spring 2000

Sources: Scarborough Research 1999 Release 2, Top 50 Market Report Prepared by NAA Research Department Note: Radio drive times reflect Mondy-Friday average quarter hour

MOTIVATIONS FOR A MERGER AT TIME INC.

Slow growth in magazine division Growth in cable networks Time Inc.s decision to enter the entertainment industry is being driven primarily by deregulation enabling vertical integration in media. Vertical integration in being motivated by Increasing risk of holdup in acquiring programming and outlets for Times HBO and Cinemax Reduced risk of losses from growing film production costs due to guaranteed runs in self owned outlets Multipoint competition

TIMES OFFER FOR WARNER

Time shareholders offer a 59% stake in the merged firm to acquire Warner (through a stock swap)

MVT = $109.125 * 57M shares = $6,220,125 M MVW = $45.875 * 178.5M shares = $8,188.6875 M Assumes share prices at the data of the announcement

Completion of the acquisition requires shareholder approval; combined T-W value = $14.4B

EVALUATING THE WARNER OFFER

Is 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.

EVALUATING THE PARAMOUNT OFFER

Is Warner worth giving up the Paramount Offer?

With Paramounts 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 TimeWarner, 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 Paramounts offer. This requires almost $1B in additional annual cash flows.
Assuming a perpetuity with a 10% discount rate.

ANALYTICAL ISSUES

Which 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?

TIMES 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.

CORPORATE-LEVEL STRATEGY- How big is the sandbox?

The Scope of the Firm

Corporate-Level Strategy is action taken to gain a competitive advantage through the selection and management of a mix of businesses competing in several industries or product markets. Vertical Integration Diversification 1. Choose business areas to participate in 2. Choose strategies to enter/exit business areas

CREATING VALUE THROUGH DIVERSIFICATION

Diversification is a strategy attempting to improve long-run

profitability by acquiring and managing new business lines.
Related diversification value chain commonalities Unrelated diversification totally new business activities

Different Value Chains

Similar Value Chain Hardlines Softlines

Food

Travel Insurance

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EVALUATING DIVERSIFICATION

How can diversification create value? Acquiring and restructuring Transferring competencies Economies of scale Economies of scope How can diversification dissipate value? Bureaucratic Costs

Information overload Coordination limitations

Pooling Risk Managerial Opportunism (Agency Problems)

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CREATING VALUES THROUGH ECONOMIES OF SCALE

Eliminate operational redundancies Reduce costs in common activities

Eliminate a competitor Reduce competition and rivalry; increase prices through increased market power

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CREATING VALUE THROUGH ECONOMIES OF SCOPE

Operational Economies of Scope Shared activities Core competencies Financial Economies of Scope Internal capital allocation Risk reduction Tax advantages Anticompetitive Economies of Scope Multipoint competition Exploiting market power

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