A giant's demise: How the AOL and Time Warner marriage turned sour

Most of us are afraid of genetic engineering. We get nervous when we hear about animal cloning or the rejigging of the chemistry of our tomatoes. But there is something else we all consume that should similarly make us pause. It is AOL Time Warner, home to Madonna, Harry Potter, CNN and Loaded magazine.

When AOL, the online service provider, stepped forward in January 2000 and said that it was using its wildly inflated stock to purchase Time Warner, it offered a compelling sales pitch. The deal would infuse an overweight and fusty media company with the DNA of the Internet Age.

At any other time in history, the deal would have seemed preposterous. Only a few years earlier, AOL, based in Virginia, had been just one of a group of companies offering portals to the new-fangled internet, along with the likes of Prodigy and Netscape. This was a David with the chutzpah actually to take Goliath by the ankle and propose becoming his master.

Even Stephen Case, the godfather of AOL, was uncertain if he would be laughed at. When he first approached Gerald Levin, the then CEO of Time Warner, in the autumn of 1999, he privately told friends he doubted his proposal would fly. But Mr Levin was actually excited. Time Warner, he thought – like a dull tomato – was about ready for some nifty DNA engineering.

The experiment, we should say first, is not over yet. Yesterday the company appointed Jon Miller as the new chairman and chief executive of its AOL division. Mr Miller comes from USA Interactive – in an earlier life, he nimbly introduced Nickelodeon to British cable audiences – and everyone seems to like him. AOL Time Warner shares even pepped up a bit.

But consider what Mr Miller, 45, is walking into. Eighteen months after the $164bn (?107bn) merger was completed, AOL Time Warner is a mess. Far from shiny, it is bruised and, aside from a few buyers yesterday, no investors have been willing to pick it from the shelf, however low its share price has gone. The shares have sagged 70 per cent since the merger, recently hitting four-year lows. Many are left with very sour faces, including Ted Turner, the founder of CNN, who took Time Warner shares when he sold his television network to the media giant, and then ended up with Aol Time Warner paper after the mega-merger.

That things were not going to plan first became inescapable in September last year, when the company confessed to analysts on Wall Street that it was not going to make its projected earnings for the year. The slide in its stock price began to accelerate as it became clear that the promises of hi-tech Nirvana made back in January 2000 had been pie in the sky.

Those pledges, made most memorably by Robert Pittman, the third in command of the merged company who was abruptly forced out last month, had indeed been grandiose. Behind the DNA metaphor, was a scenario of magical synergy. It was the marriage of old-fashioned content – Time Warner encompasses everything from magazines, to film studios, recording artists, TV channels, including CNN, and books – and the biggest internet highway there was.

But many things started to go wrong all at once. The almost manic efforts of Mr Pittman, who came from AOL to be chief operating officer of the new giant, to cross-fertilise advertising between the two sides of the marriage simply did not work. Meanwhile, AOL, that had promised to be such an engine of revenue growth, suddenly started to sputter.

Whether he knew it or not, Mr Case made his move on Time Warner when his company was at the peak of the mountain. (If he saw over the edge, presumably Mr Levin did not.) Such had been its saturation of the market, that AOL soon after began to struggle to find new subscribers. Half the internet users in the US, already access the net via the company's welcome page. And advertising numbers have been fizzling fast – a phenomenon suffered by many other media companies. AOL recently revealed that its advertising revenue for the second quarter was down 40 per cent. The marriage to Time Warner was meant to deepen the advertising pool. But it hasn't.

Some wondered about a possible culture clash between the companies. Well, indeed. The Time folk quickly grew resentful of the flashy Mr Pittman and his cohorts from Virginia. "The Time Warner guys hate the AOL guys," one former AOL executive recently noted. "And all the Time Warner guys hate each other. Everybody hates everybody over there". Morale across the company has collapsed as fast as the value of everyone's shares. "People had these stock options, and they were planning their futures based on them, and they blame the AOL people," commented David Geffen, the Hollywood mogul and a Pittman pal.

Cap all that with the announcement last month of two federal investigations into possible accounting problems by AOL in the period it was trying to complete its acquisition of Time Warner and you see how miserable the picture has become. We will know shortly whether the Department of Justice sees reason to turn the inquiry into a criminal one.

What to do? Richard Parsons, the soothing African American who succeeded Mr Levin this spring, is taking a series of steps, including the removal of Mr Pittman and the hiring of Mr Miller, who is thought to have his own ideas for burnishing AOL. First, he may clean house at the top. Wall Street will be watching for him to find ways to focus more on AOL's customer and less feverishly on the bottom line. And while advertising will remain key, he is likely to seek ways to prise more money out of existing customers with exclusive content.

Mr Parsons is also busy de-emphasising the rush to synergy and returning power and accountability to the different entities within the conglomerate. And, tellingly, he has elevated some old Time Warner hands to positions of greater power, making HBO's Jeff Bewkes and Time's Don Logan his two most senior deputies.

The healing of Time Warner will take many months and much else may have to happen. Some on Wall Street are even speculating about the eventual demise of Mr Case, who as non-executive chairman, has been surprisingly low profile. One thing is becoming clear. The DNA of AOL Time Warner is starting to re-arrange itself once more, with Time Warner emerging back on top. Wags like to speak of a new name for the company – Time Warner aol. (Note the non-capital letters.) Occasionally, you hear talk of Time Warner jettisoning its internet spouse altogether. That would make for delicious news. But it is not going to happen soon.