CH-ZWA645-005jsmGB

Horizontal Scope

James OldroydKellogg Graduate School of ManagementNorthwestern University

j-oldroyd@northwestern.edu801-422-7888650 TNRB

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Cross Media Rivalry MatrixCompany News-

paperTV Cable Pub Live Out-

doorRadio Online Video

and Ent.

Music

Tribune X X X X X X

New York Times

X X X

Dow Jones X X

Gannett X X X

Knight-Ridder

X X

ClearChannel

X X X X

Viacom X X X X X X X X

AOL/Time-Warner

X X X X X X

Disney X X X X X X X

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One of The Problems

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

1 Average day readership2 Average half hour3 Average quarter hour4 Average half hour

58.8% 58.7%58.6%

57.9% 56.9%56.2%

45.3%

42.4%40.8%

39.6%38.5% 37.8%

25.5% 25.4% 25.7% 25.5%24.5%

23.4%

11.0% 10.4% 10.3% 10.5% 11.3%12.0%

Daily Newspaper1

Prime Time TV2

Morning Drive Radio3

Prime Time Cable4

19961996 19971997 19981998 Spring 1999Spring 1999 Fall 1999Fall 1999 Spring 2000Spring 20000%0%

10%10%

20%20%

30%30%

40%40%

50%50%

60%60%

70%70%

Exhibit 1

Percent of Adults Reached

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MOTIVATIONS FOR A MERGER AT TIME INC.

Slow growth in magazine divisionGrowth in cable networksTime 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 Time’s HBO and Cinemax• Reduced risk of losses from growing film production costs

due to guaranteed runs in self owned outlets• Multipoint competition

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TIME’S 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

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EVALUATING THE WARNER OFFERIs Warner worth giving up 59% of Time Warner?

Market value of T-W is $14.4BTime 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.

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EVALUATING THE PARAMOUNT OFFERIs Warner worth giving up the Paramount 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 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 Paramount’s offer.

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

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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?

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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.

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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 IntegrationDiversification

1. Choose business areas to participate in2. Choose strategies to enter/exit business areas

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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 commonalitiesUnrelated diversification – totally new business activities

Similar Value Chain

Hardlines Softlines Food

TravelInsurance

Different Value Chains

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EVALUATING DIVERSIFICATION

How can diversification create value?Acquiring and restructuringTransferring competenciesEconomies of scale Economies of scope

How can diversification dissipate value?Bureaucratic Costs• Information overload• Coordination limitations

Pooling RiskManagerial 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