What would Ben do?

• Author: KABACK, HOFFER
• Position: Brief Article

Dot-com dealmaking presents directors with difficult valuation decisions.

WHEN IN 1984 Walt Disney Co. was put "in play," company executives wondering how to react asked themselves: "What would Walt do?"

In December 1999, a definitive agreement for the merger of TimeWarner and AOL was signed. New York magazine's Michael Wolff called it "a black-helicopter moment, a power move so large, so amazingly tectonic, that history would be written from here."

Assume the existence of Ben, a hypothetical TimeWarner director from whom approval of the deal was sought. Ben knows business and security valuation. He is aware that it's impossible to project the Internet content and distribution environments in even the near term. He also possesses the magical power to see into the journalistic future.

We are here privy to Ben's thoughts during a break in that "tectonic" board meeting:

"Well, Gerry Levin and the boys made a good presentation...But, let's face it, we're dealing with visionary stuff here, not something you can get your hands around. Manufacturing businesses -- those I understand....

"Even putting aside the deal as a whole, am I comfortable with the terms of exchange? Yeah, I saw the chart comparing the market valuations of the two companies. And that obviously favors AOL by an embarrassing margin. But we're bringing the lion's share of the cash flow to the table while, on these proposed terms, receiving a far smaller percentage of the combined enterprise....

"Gerry says that our very act of doing this deal 'validates' AOL's market valuation. Sounds good -- but it's pure bootstrap. So, any time a board accepts a deal for paper, that means that the value of the acquirer's paper has been 'validated'? No way. Perelman accepted Sunbeam stock trading in the $40s in 1998 in exchange for Coleman -- did that decision 'validate' the value of Sunbeam (now trading in the $3s)?...

"I'm troubled by the Fortune piece indicating that, on a Stern Stewart EVA analysis, AOL is grossly overvalued now. If that's so, then it follows that I'm being asked to approve contributing our hard assets, revenue, and cash flow in exchange for inflated paper that, we would then hope, will either continue to be inflated or will 'grow into' that inflated valuation down the line...Same basic analysis by Red Herring editor in chief Anthony Perkins in The Wall Street Journal ('AOL would have to grow its revenues at an average of close to 100% per year over the next five years in...