This story is from the November 20, 1989 issue of Fortune. It is the full text of an article excerpted in Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012, a Fortune Magazine book, collected and expanded by Carol Loomis.
FORTUNE — Around six o’clock on the evening of June 6, Time Inc. CEO J. Richard Munro walked into the office of President N. J. ”Nick” Nicholas Jr. holding a fax message in his hand and a blank stare of disbelief on his face. Munro is normally outgoing, excitable, and expressive, but his stunned look told Nicholas all he needed to know. ”He did it,” Munro said to his friend Nicholas. ”Martin Davis did it.”
Davis is the CEO of Paramount Communications. And what he did was waltz by Time’s dream house with a pail of gasoline and a flame thrower, torching the company’s long-planned merger with Warner Communications and touching off one of the most ferocious corporate clashes in a decade chock-full of them. The battle provoked tremendous controversy and touched every bare-wire business issue of the age: long-term vs. short-term value, shareholder rights, the significance of corporate culture, executive compensation, business ethics, management practice, and merger and acquisition tactics. The full story of it, revealed through interviews with most of the drama’s major actors and in 12,000 pages of sworn depositions, many not made public before, shows the extraordinary way in which one mammoth deal was conceived and carried through. It may prove a fitting sign-off to a decade in which both the Dow Jones average and corporate hostility reached new heights — for while it typified the Eighties takeover by being huge and vicious, it also suggested a new battle plan for the Nineties by refuting the accepted wisdom that a cash offer is curtains for a target company.
Paramount’s offer to buy Time for $175 a share in cash hit barely two weeks before Time stockholders were set to vote on the planned merger with Warner, the diversified entertainment and media company run by Steven J. Ross. To hold off Davis and hold on to its independence, Time instead acquired Warner for $13.1 billion in cash and securities.
Time’s decision to change the transaction from merger to acquisition without a shareholder vote — one the management almost certainly would have lost — added a new page to corporate law that may affect some future mergers and acquisitions. When Paramount sued Time in Delaware’s Court of Chancery to undo the deal, the outcome held the potential to kill stock-for-stock mergers, the kind Time and Warner originally attempted. The M&A business froze in its tracks until the courts decided that in this case Time directors, not the shareholders, retained responsibility for determining the firm’s direction. That ruling looks to some like a short circuit in shareholders’ ability to have the ultimate voice in the corporations they own.
No one disputes that Time and Warner are an excellent fit. The combined company is an American giant in an age when global behemoths rule the media planet. Time Warner (TWX) makes movies, television programs, records, tapes, books, and magazines, including this one, and can sell virtually all of these things around the world. It sells pay TV through Home Box Office and Cinemax to 23 million subscribers, and owns cable TV systems serving six million households across the U.S. ”It is awesome how impressive this company will become,” says Munro, now co-CEO of Time Warner with Ross. Sales in 1989 will approach $11 billion, and the underlying assets are worth some $25 billion. All that and Bugs Bunny, too. Awesome indeed.
But agreement about the combination ends there. Davis too wanted to walk in the land of the giants and saw a combination with Time as a perfect way to get there. In launching his bid Davis acknowledged Munro’s logic but chose as a weapon a rather basic fact of arithmetic: $175 is more than $120. The first figure was Paramount’s initial offer for each share of Time; the second was the maximum value Paramount and its investment adviser, Morgan Stanley, figured Time Warner’s stock would reach if the original merger went through. Davis assumed that given the choice, shareholders would take the cash. He was probably right. They generally do. He was definitely wrong in assuming that they would get the choice.
Time and Warner managers view the acquisition as a perfect combination that would have sailed through in its original form had it not been for that spoilsport Davis. But he couldn’t let it sail through, they say, arguing that the debt-free, tax-free merger would have left Paramount too small to compete with a media and entertainment powerhouse such as Time Warner. In this view Davis looked at a no-lose situation and jumped in: He might succeed in buying Time cheaply, or he might break up the deal, or he would at least saddle the new company with debt, making it less competitive. Davis says that notion is ridiculous.
Davis declined to be interviewed for this article. But Paramount’s lawsuit to prevent Time from buying Warner alleges that Munro and Nicholas sold the shareholders out to preserve their own empire. He said they did this on the pretense that Time’s editorial independence and culture demanded it. Munro and Nicholas insist that notion is ridiculous. Says Munro, 58, who will retire as co-CEO next year after ten years of running Time: ”This is my legacy. I did not work here 33 years to bust the company up.” He and Nicholas, 50, own loads of company stock, he points out. If they had just wanted to get rich, they would have sold the company to Davis or the highest bidder — and cleared many millions of dollars each.
Steve Ross, 62, Warner’s affable, high-profile chairman and CEO, demonstrated once again that in the music of deals he has perfect pitch. Ross orchestrated a great short- and long-term bargain for his shareholders and flattened a persistent boardroom antagonist. He now will share the CEO’s job for five years at a company twice the size of Warner. He also retains a compensation package so abundant in dollars that, should the oilman fail to show this winter, Ross can shovel money into his furnace and have plenty left over in the spring.
The strategy emerges
Publishing is a wonderfully profitable business. Basically it comprises a bunch of people and a bunch of trees that eventually run into each other at a printing press. The product of this union is sold to readers and to advertisers who wish to communicate with them. Publishing can offer a high return on assets and terrific margins. Time’s magazines, which include Time, Fortune, Life, Sports Illustrated, Money, and People, plus a score more wholly or partly owned, are doing just swell, thank you.
But over the past decade Munro, Nicholas, and Time vice chairman Gerald M. Levin came to believe that the magazine division was not growing fast enough. Revenue gains in the division have averaged about 5.7% a year since 1985, and when the Warner deal was announced in March Time’s investment bankers could not project anything beyond 6% for the future. Time already has about 22% of the U.S. magazine advertising business, more than twice the share of its nearest competitors, and 33% of magazine profits. Says Munro: ”We have two huge engines that drive that division, People and Sports Illustrated. So I would say that the growth there is a little bit limited.”
While Time’s soul is in publishing, the company tried for decades to find another leg to hold up the financial body. Magazine publishing is a cyclical business hitched to the U.S. economy, and Time Inc. has suffered through several profit swings. The corporation has bought and sometimes sold newspapers, television stations, and forest-products companies in several unavailing efforts to diversify profitably.
Successful diversification did not come until the company happened on cable television and pay channels early in the game, and lo and behold, they took off. Time had picked up a few cable systems in the Sixties, and in the early Seventies a free-spirited entrepreneur named Charles Dolan had briefly joined the company and started something called the Green Channel, soon renamed Home Box Office. By 1974, after years of losses and frustration, these ventures were about to start spouting money, and the executives in charge happened to be three young men named Munro, Nicholas, and Levin. With less than ten years’ TV experience among them, they faced the best problem a manager can have: struggling to handle all the growth. Time’s future was getting tuned in to a new channel. Today the video side and the magazine side are approximately the same size, $2.1 billion and $1.9 billion, respectively, in sales.
That was terrific, but as of the mid-Eighties Time’s top executives still saw three large problems with the corporate structure.
Problem No. 1: Time didn’t own any significant copyrights in the fastest-growing sector of the media business, video. Copyrights are a central concept in media. When a film, book, or magazine is produced, distributed, and sold, the copyright owner makes a big chunk of the money. With its cable and pay TV operations Time owned entertainment distribution channels, but it didn’t own any entertainment. That stuff had to be bought on the open market, and prices were getting steep.
Problem No. 2: The media industry is increasingly diversified and global, and as Munro and Nicholas saw it, Time was sufficiently neither. While foreign companies such as Bertelsmann, Hachette, and Rupert Murdoch’s News Corp. (NWSA) inhaled properties through the mid-Eighties, Time’s management thought of these companies as collectors paying crazy prices. Gradually, as prices continued to spiral and Time watched from the sidelines, another thought took hold.
Nicholas understood that not only would the prices continue to increase, but the very mass of these new empires also offered security from business risks. In addition, mass offered more protection from the appetites of the acquisitive. In a rapidly consolidating media industry, it was eat or be eaten — and Time sincerely, intensely wished to avoid being eaten.
In pursuing this wish Time lacked a powerful weapon available to most of America’s other great publishing enterprises: a separate class of nonvoting stock, which a company’s founding family would sell to outside investors while retaining control of the voting stock. New York Times Co. (NYT), Dow Jones, Washington Post Co. (WPO), Times Mirror, all had created these two classes of stock, and all had remained independent. Failing to create such stock was, Nicholas says, one of founder Henry R. Luce’s few big mistakes.
Besides being tough to take over, the newly forming media empires had another advantage, a capacity for laying off risk. Says Nicholas: ”The idea is a very simple one. You get some businesses where you can spread your overhead. You’ve got to be able to control or have relationships with enough distribution channels to know you’ve got a great shot at amortizing the fixed costs.” In other words, the $35 million price tag of a movie like Batman looks less chancy when a company knows it can get its money back by showing the movie in the U.S., then showing it abroad, selling the videocassette, selling the soundtrack on records, compact discs, and tapes, showing it on pay TV, and perhaps selling related books or producing related TV programs, all using the company’s own resources. This year Warner’s Batman opened the way for sales of videos, record albums, books, and even comic books (where the character originated) — all owned by Warner.
Problem No. 3: Wall Street was not in love with Time Inc. and traded the stock at a fraction of its theoretical breakup value. Investors didn’t like the variability of Time’s earnings. With increasing frequency the stock would rise on rumors that Time was about to be taken over, but this was not Munro’s idea of good news.
In the mid-Eighties Munro saw a way to attack all three problems: Hook up through merger or acquisition with another media giant. Allen Neuharth, chief of Gannett Co. (GCI) and self-described S.O.B., came calling in 1985. Gannett’s newspapers and broadcast division might have fit well with Time, but its management wouldn’t. Munro had a cast-iron condition for any potential combination: Time Inc. would run the show or would share top-level authority equally. Neuharth scoffed at the idea.
CBS chief Tom Wyman also chatted with Munro about a merger in 1985, when Ted Turner was quixotically attacking CBS (CBS), but the talks led nowhere. In the fall of 1988, Warren Buffett came by with his friends from Capital Cities/ABC, in which he was a major investor. Munro and Nicholas met with Buffett and Cap Cities CEO Thomas Murphy and President Daniel Burke. The meetings continued into December, until, according to Nicholas, Murphy mentioned that in any deal there should be one or two more Cap Cities directors than Time directors. Munro says he told Murphy, a good friend, thank you very much but Time Inc. is not for sale. A Cap Cities source says the two men couldn’t agree on who would be boss.
Time had rebuffed Buffett before. In 1984 he had asked Munro informally about acquiring up to 10% of Time Inc.’s stock, enough to frighten a raider. Buffett’s practice with other large stockholdings is to hang on to them for years or decades and become a trusted board member and adviser. But when Munro took Buffett’s feeler to the board, the directors — to Munro’s regret — discouraged him from pursuing it.
Munro and Nicholas in 1987 began speculating about combining with a film and video producer. Disney (DIS) had an excellent studio, but 60% of its revenues are from theme parks, a business in which Time had no expertise. Columbia Pictures, MCA, Fox — each had charms but lacked size, strategic fit, or management. Only two companies looked right: Paramount (then called Gulf & Western) and Warner.
Warner was more profitable and a better strategic match than Paramount. Importantly, at a time when foreign markets offer the brightest growth opportunities, 40% of Warner’s revenues come from overseas, vs. less than 10% of Time’s (and only 16% of Paramount’s). In movies and television both Warner and Paramount produced outstanding returns, but only Warner owned 100% of its movie distribution business. Additionally, Warner had 1.6 million cable subscribers who could combine nicely with the 4.3 million of Time’s American Television & Communications, already America’s No. 2 cable company (after Tele-Communications Inc.). Paramount’s publishing division, Simon & Schuster, would also have fit well at Time, but the company wasn’t looking to expand in book publishing. Instead Time got big eyes for Warner’s wildly profitable record business, which accounts for about half the company’s operating income.
Nick drops a dime
One day in May 1987, Nick Nicholas found himself with an unexpected free afternoon. Citizen Nick had planned to spend the day on jury duty in state supreme court in Manhattan but was dismissed early. From the courthouse lobby he punched the digits for Warner Communications and asked for Steve Ross. Did Ross have some time that afternoon to discuss a couple of things? If Ross didn’t have time, he soon made some available.
Nicholas knew Warner’s cable operation well — he had once negotiated, unsuccessfully, to sell Time’s Manhattan Cable to it — and he was interested in a joint cable venture. Ross was also interested because Warner was at a crossroads in cable — “too big to be small and too small to be big,” says Ross. In 1986 Warner had bought its partner American Express (AXP) out of joint ownership in a cable television company that held systems Time coveted. A joint venture offered a way for Time to get co-ownership of those systems.
Ross took the idea one step further. During several subsequent meetings that summer he developed the notion that Time should throw in its HBO unit, while Warner would contribute its Warner Brothers studio. Such a combination would create a vertically integrated entertainment venture.
The egos in the media corporations that cluster around Manhattan’s Sixth Avenue are as big as the buildings, and that was the problem the two sides grappled with in a sit-down at the Helmsley Palace Hotel on November 4, 1987. From Time came Munro, Nicholas, Levin, and HBO Chairman Michael Fuchs. The Warner group included Ross, Deane F. Johnson from Warner’s office of the president, and Warner Brothers studio bosses Robert A. Daly and Terry S. Semel. There were no Indians among these chiefs, making the subject of just who would report to whom a touchy one. Ross wanted Warner Brothers left alone; Time felt the same way about HBO. Both sides agreed the cable systems could be jointly run.
Even before they reached those matters, the two groups had to figure out if they could stand each other. And Ross left the meeting apparently smitten. The Time side left the meeting impressed by the Warner people but not willing to rush into anything. Levin wrote to Munro: ”The key here is to keep our options open with Warner, cool Steve’s ardor somewhat, but maintain a deepening relationship.” The joint venture idea intrigued Time’s team, but Levin wanted a month or so to think about it.
As the talks progressed a number of hurdles sprang up. There were questions of how much money each partner could take out of the venture, serious tax problems within the new company, and a need to develop a divorce agreement should the two parties, like those in so many other joint ventures, decide they didn’t like each other after all. Against that formidable stack of problems a simple solution occurred to several of the people involved: Just merge the companies.
Nicholas, with Munro’s agreement, popped that merger question in early June 1988, after a year of trying to work out a joint venture. Ross thought about it for a week and agreed to begin negotiating. In the original joint venture proposal, Munro and Ross would have been co-CEOs of the enterprise, with HBO reporting to Munro, Warner Brothers reporting to Ross, and the cable companies reporting jointly. This structure carried over into the merger talks. The two sides spent the better part of the summer divvying up the reporting relationships and hammering out the roles of the chief executives.
The concept of a co-CEO is not foreign to Ross. He shared the title at Warner with William Frankel from 1967 until Frankel’s death in 1972. At one meeting he brought along a Fortune article that discussed Unilever, invariably described as the ”Anglo-Dutch consumer products company.” Unilever is essentially two companies and has two CEOs, one in the Netherlands (UN) and one in Britain (UL), who run what Ross called a staple corporation. The two are joined at the bottom line.
Without much debate, Ross and Munro agreed to make Nicholas their successor. Ross had no logical No. 2 to compete for the spot, and over the months of negotiations he had become increasingly impressed with Nicholas. Ross says, ”If he weren’t with Time I would have made overtures to have him with us. I think he is extremely capable and very knowledgeable. So we never had a problem.” A culture clash, however, has the makings of a problem.
Above all other considerations in any merger, Munro felt compelled to defend the Time culture. He sincerely believes, as do many employees, that working for Time isn’t like working for, say, Amalgamated Spark Plugs. The executives and employees consider Time Inc. a kind of public institution and believe working for it confers special status.
The most famous feature of Time’s culture is the separation, both psychic and structural, of church and state. Time founder Luce decreed that the editorial side of the business (church) would report directly to the editor-in-chief rather than to the publishing side (state), as it does in nearly every other journalistic enterprise in the world. The arrangement gives editors freedom to report and analyze the news without influence or interference from the business side and its advertisers.
The benefits of separating church and state are obvious: It attracts top journalists, it increases a magazine’s value to readers, and it makes a magazine more valuable to advertisers, even though they may occasionally take their licks in the editorial pages. But the idea of dual hierarchies reaching all the way to the board is unknown at most companies, including Warner. Jason McManus, 55, Time Inc.’s editor-in-chief and church’s high priest, took a philosophic view toward Warner. He was part of the tradition — he had worked for Luce — but believed that if Time didn’t merge it would be taken over, with who-knows-what effect on the magazines’ independence. ”There was a nostalgia for Time Inc. as it was imagined to be,” he says, ”but the people who felt ‘Gee, if we hadn’t done anything we’d have been fine’ were living in a dream world.”
In style, Time was long a classic Ivy League preserve, particularly on the business side of publishing. The management approach was restrained, the process collegial, the meetings frequent and primly structured. An investment banker for Time calls it ”the preppiest company I have ever seen in my life.” The Warner style, by contrast, is streetwise New York and entrepreneurially driven. Problems are solved family-style — in frequent scream fests.
Warner behaves more like a partnership than a corporation. Under Ross, division managers have total autonomy in operations. This policy proved expensive in 1983 and 1984, when the Atari videogames division pulled the entire company into the red after managers failed to anticipate the cooling of the videogames fever. In general, however, Ross picked extremely able division heads, including Daly at Warner Brothers and Morris ”Mo” Ostin of Warner Brothers Records.
The two companies’ cultures do not clash in respect for creative independence. Just as Time’s publishing managers leave the editorial types alone, so Warner’s film, record, and book producers create free of the company’s corporate overseers. Time executives say Warner’s attitude was an important reason they preferred to join with it instead of with Paramount.
To preserve the church-state structure, Warner acknowledged — not that Time considered the matter negotiable — the corporate hands-off policy regarding Time’s magazines. Editorial operations would report only to editor-in-chief McManus, who is one of Time’s four inside directors (the others: Munro, Nicholas, Levin). McManus reports only to the board. It exercises its responsibility for editorial operations through a committee of six outside directors, with four seats going to people who were on Time’s board before the merger. Warner demanded the same protection for its creative output. Time agreed to an entertainment committee, controlled by directors who had been on Warner’s board, to oversee Warner’s movie and record businesses.
The Time directors came up with another method to ensure cultural survival: They authorized Levin, 50, to negotiate long-term contracts for Munro, Nicholas, and himself. Says Munro: ”We told the board that we didn’t want contracts, but they insisted.”
Munro had long said that by age 60 he would step aside both as CEO and as a director. Working out the merger terms, he changed his mind in order to smooth the transition and be available should Ross be incapacitated. Munro’s contract makes him co-CEO with Ross until he steps down next year. After that he will be chairman of the board’s executive committee until 1994 and an adviser for five years more. He will be paid at least $1.5 million annually in salary and bonus as co-CEO. From 1990 until 1999 he will be paid at least $750,000 a year. He will later get another $4,275,000 in deferred compensation. Nicholas also signed a roughly comparable ten-year contract, making him co-CEO with Ross as soon as Munro resigns, and sole CEO in five years.
In theory the board could undo these arrangements, subject to restrictions in the contracts. But to the extent it was possible, Time had ensured that its cherished culture would have advocates at the top of Time Warner for a decade. The contracts put Munro in the position of explaining to employees, including hundreds of journalists, that he and Nicholas accepted the extraordinarily handsome agreements to protect them.
As for the differences in corporate style, Ross advised his guys not to worry. ”They were upset, but I told them once this deal was concluded the company would be Time Warner,” he says. ”We would be unable to distinguish between Time executives and Warner executives. The question is then: Who are the people who are going to lead us into the next century?” He assured his executives that he would be around to take care of them, and that Time Warner would grant the same kind of autonomy he had given them.
The task of negotiating the merger’s financial terms fell to Levin from Time and to Oded Aboodi for Warner. Aboodi, 48, is neither a Warner officer nor a director, nor an investment banker in the usual sense, though he is sometimes called one. But Ross wouldn’t make a move without him. A Jerusalem-born accountant, Aboodi handled some Warner transactions while a partner at Arthur Young & Co. Technically astute, he loves the creative aspects of dealmaking, and in Steve Ross he found a soul mate. Says Levin: ”He reads the psychological set of the people he deals with.”
Levin, an attorney by training and Time’s chief strategist and planner, insisted from the beginning of negotiations in early 1988 that Time had to be the acquiring entity. Says he: ”There was never a discussion of the acquisition of Time by Warner. We were interested in an acquisition — where the Time culture, the Time institution, the Time tradition prevails.”
That was fine with Aboodi. He had an imperative of his own: Ross’s demand that the deal be erected not as a cash buyout but as a merger in which only stock changed hands. Ross wanted Time to issue millions of new shares with which to buy Warner from its stockholders. Time executives had hoped to borrow billions in good old cash and buy Warner that way, preserving greater assets and earning power for each Time share. On this issue Time gave in early. Says Ross: ”They threw in the sponge because they knew finally that I wasn’t going to do anything but a stock deal.”
One reason Ross insisted on this form of merger was that it would let the merged company treat the deal as a pooling of interests, a now rarely used accounting method that combines the assets of the merging enterprises as if they were never apart. Most mergers use purchase-price accounting, a technique with an insidious cost. Acquired companies are generally worth far more than the value of the hard assets shown on their balance sheets. The difference between the price paid and an acquired company’s updated asset value is called goodwill. Under purchase-price accounting this amount is amortized over a long period, with the amount amortized each year deducted from reported profits, even though no cash loss is involved. In the Warner deal goodwill amounts to $10 billion to $12 billion, or something like $300 million to $400 million a year for 30 years. Ross did not want such a hit to earnings.
So the deal would be an exchange of stock — but at what ratio? By the end of June 1988, the talks focused on that question. Aboodi was in the driver’s seat because Warner had a better bottom line and a higher market value than Time. In 1988 Warner earned $423 million after taxes on sales of $4.2 billion. Although Time had sales of $4.5 billion, its net profit was $289 million. Main reason: Warner enjoys a lower tax rate resulting from accumulated tax credits.
Warner’s sales and earnings growth were outpacing Time’s. Had the two companies remained independent, Warner’s sales would have overtaken Time’s this year. Aboodi argued further that Warner’s stock price would rise faster and carry a higher earnings multiple because Wall Street liked its business mix better. He also noted that Time was supporting its own stock price, having bought back 10% of the shares, while Warner was not. Finally, and most important, Warner had to be accorded a takeover premium.
Time indicated it was willing to pay a premium for the right to take Warner out. The price of Warner’s stock had been about 35% of Time’s over the previous 12 months. Adding to that a premium of around 10 percentage points, Levin figured to get a deal at a ratio of 43% to 45% — or, as the negotiators say, .43 to .45. He started at .40; Aboodi talked .50. They would not get any closer that year.
The $193 million man
A far more delicate challenge also awaited Levin, Munro, and Nicholas: how to sell Steve Ross to the Time board. Money and controversy have followed Steven J. Ross like stray cats in search of a meal. Ross’s contract was as lush as that of any CEO in America. In 1987, following a wild board meeting ending in a 9-to-6 vote, Ross took home a ten-year employment contract that guaranteed him base pay of $1.2 million a year. That’s not unheard of, but the contract included a bonus that would pay an average $14 million a year for ten years if Warner stock appreciated 10% a year. It has.
Under his amended ten-year contract with Time Warner, Ross is due $193 million at the close of the deal for stock-based compensation he had coming at Warner: $70 million in cash and $123 million in deferred payments. He also gets the same $1.2 million annual salary and deferred compensation he did at Warner plus a minimum bonus of 0.4% of Time Warner’s earnings before taxes and some amortization and depreciation. And he receives options on 1.8 million shares of stock at a minimum price of $150 a share. After 1999 he will collect $750,000 a year for five years as an adviser.
Time’s management convinced the board that Ross’s contract was his reward for founding the company in the 1960s and successfully nurturing it. Curiously, Ross owned only about 1% of his baby’s stock, which is where most founders get their reward. Very few Time directors liked Ross’s contract, but they viewed it as part of Warner’s price. Says director Donald S. Perkins, a former CEO of Jewel Cos., a supermarket chain: ”It just comes down to a cost of doing business. It was part of the price of the deal.” Says another, who prefers to remain nameless: ”I’ve made a lot of guys rich who didn’t deserve it. The deal is what’s important.”
Ross patched Warner together initially by grafting a rental car business onto his father-in-law’s funeral parlor business. He added parking lots and took the company public as Kinney National Service in 1962. In 1969, Kinney bought Warner Brothers-Seven Arts, then a broken-down relic of a Hollywood studio, for a reported $400 million in stock. But Warner also had real estate, a film library, a great record company, and good executives, such as Ahmet Ertegun of Atlantic Records. Warner is the ultimate people business, and it fit Ross’s schmoozing style. A big guy’s big guy, Ross lives the high life and makes no excuses for it. His longstanding friendships with Hollywood glitterati — Clint Eastwood, Barbra Streisand, Steven Spielberg — are counted as corporate assets.
Ross combined an uncanny sense of the future, a genial manner, and shrewd dealmaking skills to lift Warner onto the Fortune 500 in 1971. He put someone he could trust in charge of each business, left him alone, and paid handsomely if the division performed. The pay included stock appreciation rights. The deal with Time will enable about 700 Warner employees to cash in options totaling more than $600 million.
Retired Time president James Shepley, who died in November 1988, made no attempt to hide his belief that Ross and Warner were unsavory partners. In the early Eighties, Time lost three cable television franchise battles to Ross in Pittsburgh, Cincinnati, and the New York City borough of Queens, and Shepley was sure Warner had played dirty. Dick Munro had led the battle in Pittsburgh. He remembers: ”We had the champagne all ready to pour. And then the word came that Warner had been picked. We couldn’t believe we’d lost. They must have paid somebody off.” Time sued Warner and the city of Pittsburgh, charging improper bidding procedures. The two sides eventually settled out of court.
Prosecutors had won several indictments and one conviction involving Warner. In 1973 Warner invested $250,000 in a new stock issue floated by Westchester Premier Theatre Inc., a performing arts center in Tarrytown, New York. The amount was a piddling part of Warner’s $200 million investment portfolio, but it came out later that Premier Theatre was controlled by the mob, according to federal authorities.
When Premier Theatre went bust five years after Warner made its investment, a subsequent federal investigation led to Jay Emmett, a member of Warner’s three-person office of the president. Emmett was indicted and pleaded guilty to defrauding Warner by approving invoices for nonexistent services not rendered by one Leonard Horwitz, a broker enlisted by Premier to sell the new stock issue. Horwitz later worked for Warner as a consultant. The feds ”flipped” Horwitz and Emmett, getting them to rat on Warner’s then assistant treasurer, Solomon Weiss, in exchange for leniency. Weiss was convicted of mail fraud and racketeering in connection with Warner’s purchase of the stock. Emmett and Horwitz got suspended sentences. Weiss appealed, lost, and got five years of probation tied to performing community service.
During the trial, Assistant U.S. Attorney Nathaniel H. Akerman told the jury Ross was the mastermind, alleging that he put Weiss in charge of a secret cash fund to use at his discretion. Ross was never charged with any offense and was not called to testify at the trial. By agreement between his lawyer and the federal attorney, Ross, under oath, denied all allegations to the prosecutor.
Ross knew the issue would come up again when the Time merger was announced. He says, ”I just don’t let it bother me. I’ve made the right decisions.”
Time executives were also well aware of the issue. Levin raised it in a memo to Munro, and Time sources began to ask around. Says Munro: ”We must have talked to 100 people about Steve Ross, and not only did we not find anything [bad], we found just the opposite.” Another Time executive says: ”We do have some pretty good investigative resources around here. And we came up empty.”
Time’s board hops on
Munro told Time’s board in June 1988 that his team was talking to Warner about a merger, but he gave no details. The directors also received copies of a new report by a group of fast-track Time executives charged with recommending a corporate strategy. One of their conclusions: Focus investment on video programming, ”an area where we are underdeveloped and underleveraged.” During the next few weeks Munro, sometimes accompanied by Nicholas, spoke with each director privately to explain his vision of Time Inc.’s future and ask for approval.
Events of the Eighties had affected several of Time’s 12 outside directors in various ways that would directly influence their view of any deal. After he retired, Donald Perkins watched American Stores take over his Jewel Cos. and unhinge the organization he helped create. Edward S. Finkelstein, chairman of R.H. Macy & Co., had taken the retail merchandiser private when it became raider bait. James F. Beré, chairman of Borg-Warner, took his company private in a leveraged buyout to fend off raids by Irwin Jacobs and GAF.
A key player was director Michael D. Dingman, who is chairman of Henley Group, at least this year. An astute shuffler of corporate assets, Dingman had done more deals in a few years than most executives do in a career. He knew leverage, he knew shareholder value, he sure as hell knew mergers and acquisitions — and he knew as of late July 1988 that among Time directors Munro’s merger plan with Warner was dead. Says he: ”It was damned controversial. If you ran a board vote on it, it would have failed.”
Levin was also keeping score, and it wasn’t looking good. His handwritten notes revealed the tally: Beré was unenthusiastic, Perkins lukewarm, ditto Clifford J. Grum, CEO of Temple-Inland. Another director, Henry C. Goodrich, former chairman of Sonat, an Alabama energy company, was down as a flat no. John Opel, chairman of IBM’s (IBM) executive committee, was skeptical but open- minded. David T. Kearns, chairman and CEO of Xerox (XRD), was signed on, as was Finkelstein. Levin had no read on the board’s two academics: Matina S. Horner, president of Radcliffe College, and Clifton R. Wharton Jr., former chancellor of the State University of New York and now chairman of Teachers Insurance & Annuity Association/College Retirement Equity Fund.
Director Arthur Temple’s name did not appear on the list. Nor did that of director Henry Luce III, son of Time founder Henry R. Luce. There was no need.
Arthur Temple would no sooner get in bed with Hollywood than he would climb a loblolly pine naked. Temple joined the board in 1973 after his family’s pulp and paper company, Temple Industries, was acquired by Time in an ill-considered diversification foray. (”By whom are you currently employed?” a lawyer asked him in a deposition for Paramount’s lawsuit. Replied Temple: ”I’m not employed by anyone. I’m chairman.”) Time later bought Inland Container, a containerboard maker, and merged the two subs. Temple-Inland was a voracious consumer of capital, as was cable TV, and the two branches competed for the company’s cash. But Temple-Inland was a commodity business, quite unrelated to Time’s basic enterprises. Money spent on it could have been much more profitably invested in Time’s media and entertainment properties.
At the urging of Nicholas, Time spun Temple-Inland off to shareholders in 1983. But the effects of opportunities missed lingered on. Nicholas believed that had Time never acquired Temple and Inland, Time last year would have earned not $5.01 a share but $10.
Temple-Inland is headquartered in Diboll, Texas, miles from nowhere, but close to Jesus, in Bible belt country. Temple holds the Hollywood crowd responsible for the moral breakdown of America, and he regularly encouraged Munro to sell HBO and the cable companies while the market was hot. Buy more magazines, he said.
Temple isn’t trying to be a moral grandstander. He believes that in the next decade the phone companies will use fiber optics to usurp cable television. Temple was close to James Shepley, the former Time president, and Shepley was filling his ear with nasty tales about Ross and Warner.
Director Henry Luce III wasn’t wild about Hollywood either, but more fundamentally he did not yet buy the strategy. He had worked at Time for 30 years, including tours as publisher of Fortune and Time, then retired in 1981 to run the Henry Luce Foundation, which controls about 3.5% of Time’s stock. For years he had approved company expansion into other media with mixed emotions. He accepted that Munro’s strategy might be valid but felt it was not necessarily the only effective one. Says he: ”I expressed disagreement to Dick and his colleagues. They made all their points that it was an important strategic move, but they left me unpersuaded.” And like Temple, Luce was appalled by the rich employment contracts for Munro, Nicholas, and Ross.
Luce also believed that his father, Harry, would not have approved the Warner deal. In late July 1988, he sent Munro a note that quoted his father’s will: ” ‘Time Inc. is now, and is expected to continue to be, principally a journalistic enterprise, and, as such, an enterprise operated in the public interest.’ ” Luce III continued: ”In the spirit of the above, and in view of many other specific factors, I don’t believe I could vote for the proposition … ” Luce instead urged Munro to go after McGraw-Hill (MHP), the undermanaged publishing house two doors down Sixth Avenue from Time.
Out of courtesy Munro told retired Time executives about the deal and sought their approval. Andrew Heiskell, who as CEO had more or less wandered into the cable business, recognized the logic in the Warner merger. But he was unenthusiastic. Retired director Hedley Donovan, Luce’s personally chosen successor as editor-in-chief, did not hide his disappointment when Jason McManus informed him: ”I disapproved unless I was convinced that all other reasonable alternatives had been explored, and I hadn’t been. I told Jason, if Time had to get bigger to avoid takeovers, then to do so by buying other print.”
Nicholas and Munro spent the summer on the stump, presenting their strategy to the directors in a series of one-on-one meetings. They developed strong allies. Donald Perkins became intrigued by Warner’s international business. He had on several occasions warned management that Time’s lack of significant global business was a major problem.
Dingman had come to believe that Time was right to be expanding in TV. Says he: ”I had been skeptical from day one of cable, HBO, and the broad entertainment business. It has a propensity to vaporize. If left to our own devices, we [the board] would have sold those assets. But Dick and Nick convinced us that cable was tied to the future. It was real vision, and they never wavered.” The Warner deal, Munro persuaded him, was the capstone to this strategic vision.
Dingman served as an antidote to Temple. The two had been friends for 20 years, and Temple served on the Henley Group board. Munro and Nicholas presented their merger case to them together at Dingman’s headquarters in Hampton, New Hampshire. Dingman and Temple spoke often on the subject, sometimes heatedly, but Temple would not be swayed. In one talk Dingman discovered that Shepley had been denigrating Ross to Temple. Dingman passed the information to Munro.
Although Temple remained unconvinced, he acknowledged that the deal would work out financially. He did not make a commitment then, but eventually voted for the deal. Temple quit the board last April and since January has been liquidating the Temple Foundation’s holdings of Time stock.
There was no antidote to Luce, and none was needed. Luce may have been the walking legacy of Time’s creator, and also an intelligent, thoughtful man who did not hesitate to offer his opinion. But as neither a Time executive nor a heavy-hitting CEO or former CEO on a board that was full of them, his views carried relatively little weight.
In the summer of 1988 Munro probably could have campaigned for the merger and mustered the votes to win approval. But giant mergers almost always upset someone and attract lawsuits. Because of the probable legal challenges, Munro believed obtaining a unanimous vote was essential.
Ross takes a hike
If anyone held fears of a boardroom showdown, they were dispelled on August 11, 1988, when Ross pulled out of the talks after an emotional meeting at his Park Avenue apartment with Munro, Levin, Nicholas, Aboodi, and attorneys. (No meetings were held in the Time & Life Building. As Ross noted, ”They were a magazine company, filled with reporters.”)
Some Time directors felt relieved. Although many of the so-called governance issues had been worked out, the Time board had insisted that Ross accept a finite term as co-CEO and the assured succession of Nick Nicholas as sole chief. ”We didn’t want another Armand Hammer,” explains one director. Lawyers for Time kept referring to Ross’s tenure as transitional. The language grated on Ross. He felt unwanted and unloved by the Time board, and worse yet feared being locked into a lame duck status, which would undermine his authority.
The last thing Ross wanted was another contentious board. At Warner he was living with an archenemy in Herbert J. Siegel, the Chris-Craft Industries chief who as a director controlled 17% of Warner stock and who often clashed with Ross over strategy. But Ross usually got his way. Says he: ”The way Warner survived and achieved its goals was that the board and I understood each other. The disagreements we had stayed in the boardroom, and we all came out of the boardroom with one goal in mind — to use the best ideas.”
Once again Dingman stepped into the deal, this time to explain to Ross how things work in the Time & Life Building. Toward the end of 1988 the two met for dinner at Ross’s apartment, and Dingman told Ross that he had put Munro and Nicholas in a bad position with the Time board over the governance issue. The Time executives had talked up Ross, but if the merger was ever to get back on track the Time directors needed to know that Ross had no designs on a power grab, and they needed it in writing.
Ross relented. He says, ”I realized that I’ve got to decide what I want to do — take off those deal blinders and say, Okay, Steve, you’ve been guiding the company, enjoying working with your people. You enjoy long range planning, you enjoy dreaming of tomorrow and seeing what you can do. But there’s one thing you don’t enjoy doing, and that’s running a business on a day to day basis … So I said to myself, Maybe this is an opportunity.” He told Dingman he would agree to retire as co-CEO in 1994 and retain the chairmanship another five years, through 1999, to give Nicholas whatever strategic help was necessary.
Dingman reported back to Munro that Ross was ready to deal again. Time’s directors had viewed his reluctance to set a date for his retirement as the last roadblock to an agreement in principle. Levin and Aboodi resumed negotiations in January 1989, and over the next month closed the gap. On March 2 Ross was summoned from a Warner board meeting to a session with Aboodi, Levin, and Nicholas. They had a ratio: .465 shares of Time to be exchanged for each Warner share.
Felix and Herb
Felix Rohatyn, the renowned investment banker with Lazard Frères (LAZ), was a longtime friend and adviser to Ross, and he sold the merger hard to the Warner board. The thought of combining Time and Warner would not have crossed his mind ten years earlier, and deals cross Rohatyn’s mind the way cars cross the George Washington Bridge. To Rohatyn the cultures were vastly different. So were the businesses. But with Time’s growth in television, that situation had changed. Says he: ”In its original form I think this was the best merger I had seen in decades — a combination of dominant businesses in fields that lent themselves to global expansion in a financial structure that was a powerhouse.”
Lazard partner Jonathan O’Herron told the Warner board that any exchange ratio higher than .40 was a fair price, and anything over .45 was a ”hell of a deal.” Rohatyn assured the directors that even though Time would be the surviving corporation, ”in no way could it be considered” that Time was buying Warner. That was because at the agreed exchange ratio, Warner shareholders would own the majority of the stock. In the Paramount suit to stop the deal, Paramount’s attorney would use Rohatyn’s statement to bolster its claim that Time was being sold.
When Rohatyn extolled the deal to the Warner directors, he was perhaps trying especially to convince Herb Siegel. Ross and Siegel hooked up in 1984 when Ross was trying to shake the takeover grip of Rupert Murdoch. Warner issued new shares to Chris-Craft in exchange for 42.5% of Chris-Craft’s broadcasting subsidiary, BHC Inc. The move shut out the Australian (Murdoch had not yet become a U.S. citizen) because U.S. law forbids foreign ownership of American broadcast properties.
The relationship between the two men soon disintegrated. Siegel believed Ross was greedy and ran an expensive operation. Siegel manages Chris-Craft with a corporate staff that would have a hard time fielding a softball team. He travels by limo but pays his own way. Siegel also believed Ross was structuring deals to dilute Chris-Craft’s stock and thus Siegel’s power on the board.
In board meetings Siegel said very little about the Time deal, but he had his own view of shareholder value. He’s the buy and hold type, while Ross doesn’t like to sit still. Says Ross: ”Herb’s a very astute, very smart investor. We [at Warner] are operators. Those are two very different and distinct worlds, and that’s something I should have realized up front.”
Warner’s strategy for dealing with Siegel, as one high Time executive explained it, is to figure out a reasonable position and then be totally unreasonable about it. The company’s theory is that in any event Siegel will just ask for more. Siegel owned Series B and C Warner preferred stock, securities that could be converted to common shares and that carried rights to an independent appraisal in the event of a merger or buyout. Through a legal complexity, Siegel’s requesting an appraisal would disallow the pooling of interest accounting that Ross so coveted in the merger.
No one knew if Siegel intended to seek the rights. But Time and Warner hated knowing that Siegel could in effect push a button and blow up the merger. Martin Payson, Warner’s general counsel, fired a warning shot across Siegel’s bow. In a board meeting Payson said that if Siegel should seek appraisal rights, Time and Warner were ready to restructure the deal as an acquisition of Time by Warner, thus denying him a payoff for his stock. This was untrue. Whatever Warner’s desire, Time had no such intention. More important, under accounting rules Siegel could have scotched the pooling of interest anyway by selling Warner stock.
Eventually the parties settled the extraordinarily complex problem. Warner distributed its BHC shares to its own stockholders as part of the merger deal. Siegel took some new nonvoting Time Warner stock in exchange for his Warner preferred. Chris-Craft’s profit on its five-year investment in Warner: at least $2.1 billion.
Warner’s board approved the merger on March 3. Siegel abstained. Across Sixth Avenue, Time’s board gave its unanimous approval.
A sensitive issue remained: how to announce the deal. Warner insisted that the word ”acquisition” not be used by itself. Ross didn’t like the connotation, preferring to call the combination a hybrid, a merger/acquisition. ”He didn’t want people to think Warner would be operated like some subsidiary,” says Aboodi. To Time, using the word acquisition shouted the news that Time was the successor company. Ultimately, the six-page press release announced that the companies would ”combine” and noted only once that Time would ”acquire” Warner.
Time for a counterattack
Dick Munro felt certain that Martin Davis would not move against Time. He believed he had secured a firm promise that Davis would respect Time’s independence. A few days before Davis announced his bid, Munro found out that Davis was to lunch with Joseph Flom, the famous M&A lawyer from Skadden Arps Slate Meagher & Flom who is a Time attorney. Munro, not exactly thrilled to learn that one of his attorneys was breaking bread with a potential enemy, sent word to Flom to feel Davis out one more time. According to depositions, Flom asked Davis if he knew anything about a raid on Time. Davis said something on the order of ”Time? It’s 12:30. I’ll have the soup.” Munro understood that the road to the deal wasn’t mined.
Neither of Time’s investment advisers, Bruce Wasserstein of Wasserstein Perella and J. Tomilson Hill of Shearson Lehman, was all that surprised by the Paramount raid. From the beginning they considered the all-stock merger a risky piece of dealmaking because it could be easily upset by a higher cash bid like Davis’s. Neither Wasserstein nor Shearson was willing to recommend the deal without a commitment that Time would complete it for cash if the merger fell through.
Despite their concerns, Time’s investment bankers had believed it was an auspicious time to try the merger. With the market set to digest the huge amounts of junk bonds being floated in early May in the RJR Nabisco takeover, buyers for newer issues might be scarcer, and the political environment was growing increasingly anti-buyout. These factors could discourage potential raiders, who might try to finance their attacks by issuing junk. Says one ”Wasserella” staffer: ”We thought the usual crazies would lie low. We went down the roster. We all knew these people and their predilections.”
Still, Time’s stock had begun to climb, from $110 in early March to about $135 by May 30, in anticipation of a raider’s play. The investment bankers picked up Paramount’s trail in late March, and it led to Morgan Stanley, the investment banking house. Morgan Stanley had marked Time for two years before the Warner merger, occasionally sharing its information with Paramount. Soon after Time and Warner announced their merger, Morgan sent Paramount a business-by-business analysis of Time Inc. with an estimate of what a potential acquirer might expect to pay for the company. And incidentally, if Paramount was interested, Morgan was ready and able to assist said potential acquirer to make the purchase. Morgan wasn’t alone. Salomon Brothers smelled blood, too, and made a similar presentation to Paramount.
Charles Dolan, founder of HBO, was also nosing around in March with A. Jerrold Perenchio, a former boxing promoter, television producer, and theater owner. Jerry Levin phoned his friend Dolan — who had hired him at Time Inc. in 1972 — to catch up on old times, and uh, by the way, you wouldn’t be thinking about making a bid, would you? Dolan was noncommittal.
Time’s executives, their antennae up, tried to track down other rumors. Munro called General Electric (GE) chief Jack Welch to flesh out a story that GE Capital would fund Dolan’s effort. He also asked Welch about GE’s designs. Welch wasn’t talking. Munro next called Robert Bass, another rumored bidder, and asked his intentions. Bass said he wasn’t active in the Time situation.
That Paramount was talking to Morgan Stanley did not seem all that threatening. Time’s investment bankers assumed Davis was lining up a partner should someone else try to break the Time-Warner deal. He might then step in as a white knight, or buy one of the pieces. In fact, Paramount was getting calls from Bass and other interested parties about making a joint run at Time.
Davis, Munro, and Nicholas had circled one another for years. HBO signed a deal long ago to show Paramount movies and renewed the arrangement last year. The three men chatted occasionally, and several times they gathered for breakfast at the Ritz-Carlton Hotel on Central Park South, between Time’s and Paramount’s headquarters. Says Nicholas: ”The discussions about doing things together probably lasted no more than five minutes, and they were initiated by Martin Davis, and he made comments like, ‘You know, we’re a great fit.’ And then he would say, ‘Gee Dick, you’re retiring and then I can run it, and then Nick, you’re younger and you can eventually run it.’ That’s about as substantive as it got.” Davis also shared a lunch with Hollywood-hating Arthur Temple to get to know such an influential Time director a little better.
It is Munro’s distinct recollection that Davis told him several times that Paramount would never attack Time. ”I never asked Martin if he would make a hostile attempt to take over Time,” says Munro. ”He volunteered that on at least two or three occasions — that he would never do anything hostile, period.” In testimony for his lawsuit, Davis agrees with Munro on one point: They did meet. Memories diverge after that. Davis says Munro told him that Time Inc. was not interested in the motion picture business and wanted to remain just as it was.
By the end of May Paramount had hired Morgan Stanley to prepare for a raid on Time, with Paramount wheeling in the financial ammunition. Paramount paid Citibank to issue a ”highly confident” letter stating that Paramount could secure the credit needed to take Time over.
Davis decided on Friday, June 2, that he would pull the trigger, and he sent relevant information to his directors so they could consider the matter over the weekend. He sounded out a small group of lieutenants but spent hours thinking by himself. Paramount’s board met the following Tuesday, June 6, and Davis got the go-ahead then. The merger that had been all wrapped up and ready for delivery suddenly wasn’t.
The Time-Warner-Paramount battle brought together a monsoon’s worth of Wall Street rainmakers. The Time lineup included Cravath Swaine & Moore, one of the company’s law firms for more than 60 years, led by senior partner Samuel Butler and merger ace Allen Finkelson. Takeover titan Joe Flom was also on hand, as were Bruce Wasserstein, who has had a finger in nearly every big takeover pie, and Tom Hill, Shearson Lehman’s top merger mogul.
Some of the bills were shocking. Cravath and other law firms jacked up their normally stiff hourly rates because of the difficulty of the assignment. Time’s bill for Cravath and Skadden is $14 million and rising. Warner’s fees, to be paid by Time Warner, include well over $25 million due the firm of Wachtell Lipton Rosen & Katz.
As the tense days progressed, the Time executives began to meet in ever smaller groups, sometimes without outside help. Says Munro: ”We had some meetings that were just crazy, where one rainmaker says go to the mountains and another says go to the valley. We managed a lot of it ourselves.” That chafing cut both ways. ”Time doesn’t use its advisers too well,” notes one of the highly paid lawyers in the case.
Warner’s legal team included Arthur Liman of Paul Weiss Rifkind Wharton & Garrison. Liman, a legendary litigator, last made headlines as one of Ollie North’s interrogators in the Senate’s Iran-contra hearings. Warner also had Herbert Wachtell and Martin Lipton of Wachtell Lipton, the firm that virtually created all modern corporate defense strategies. As investment adviser, Ross had another old friend, Rohatyn of Lazard, assisted by three partners.
Paramount was outmanned but not outgunned. Davis’s team included his inside counsel, Donald Oresman, a former partner at Simpson Thacher & Bartlett, Paramount’s outside counsel and the law firm that represented Kohlberg Kravis Roberts (KKR) in the RJR fight. Paramount often worked with Lazard and Wasserstein, but their dance cards were obviously filled. So Davis went with Morgan Stanley. Stephen Waters, ex-Shearson merger specialist and no stranger to the takeover wars, led Morgan’s group. The M&A experts are like the Pharaohs: few, rich, powerful, and incestuous. They are also hired guns, and many of them had met a few months earlier at the battle for RJR, or in even more recent business. Rohatyn had worked for RJR’s special committee of the board, prominently including Martin Davis. Shearson had banked Ross Johnson’s losing hand in the RJR game. Wasserstein’s was one of four banking houses employed by KKR; Morgan Stanley was another. Paramount retained Wasserstein for a year, until February, 1989, to review acquisition strategies. Lazard had represented Paramount in the recent sale of its Associates subsidiary; a Lazard partner sits on Paramount’s board.
The sides chosen, the gang was ready to play again, and for big money: $16 million each for Shearson and Wasserella. Morgan signed on for pocket change, $2.5 million, but stood to gain more than $100 million in fees if Paramount’s bid succeeded.
The acquisition solution
”We will not make a decision this week.” Time’s board convened on Thursday, June 8, to those words from Munro. The decision not to choose a response to Davis’s hostile offer had several purposes, the first being to see if any other players were going to jump out of the wings. The second was to take some heat off the board and minimize the chance of committing a tactical error under pressure. The third and most important was to give the board time to carry out its strict legal duty of carefully deliberating over its next step.
Munro, livid and convinced that Davis had snookered him, sent the Paramount chief a so’s-your-old-man letter flooded with invective and hyperbole. ”You’ve changed the name of your corporation but not its character: it’s still ‘engulf and devour,’ ” he wrote. ”Hostile takeovers are a little like wars: it’s impossible to tell where they may end.”
If Munro wanted the head of Martin Davis, an in-your-face, Pac-Man counterattack could deliver it. Just buy Paramount. Director John Opel asked the advisers for a detailed analysis of the pros and cons of Time making a counterbid for Paramount, the so-called Pac-Man defense. The company was, after all, No. 2 on Time’s short list of merger-acquisition candidates, and it would be cheaper to buy than Warner.
The problem with Pac-Man attacks is that they seldom succeed, and the tactics are messy. There was, however, one intriguing potential outcome: Once Time turned the tables on Paramount, Davis might be amenable to a mutual disengagement. But then again he might not, and the strategy would be a step removed from the real goal of merging with Warner. So Time renounced Pac-Man.
Instead, Time attacked Paramount’s bid on two fronts, price and conditions. Mack Rossoff of Wasserstein Perella appraised Time’s value at $238 to $287 a share, a range some directors thought far too low. Later, however, Wasserstein lowered it a bit.
Even by that measure, Paramount’s $175-a-share offer didn’t get into the ballpark. The Time board cited the low bid as a reason for refusing to negotiate with Paramount. The advisers figured that if Paramount owned Time, Paramount’s stock price might double in a year. Wasserstein and Shearson’s analysis of Paramount indicated that it could afford at least $225 a share.
Paramount attached a large number of conditions to the deal. Time had the usual poison pill defenses that Paramount wanted rescinded. As part of the original merger deal with Warner, the two companies had also agreed to exchange a small amount of each other’s stock. Such a swap would increase the price Paramount would have to pay, and Davis wanted the obstacle removed.
Davis’s offer had a standard ”financing out” condition, a technical way of saying, ”If we can’t get the money, the deal’s off.” More important, the offer was contingent on Paramount’s obtaining approvals from cities and towns across the U.S. for the transfer of cable television licenses from Time to Paramount. ”If theirs was such a great offer,” asks Ross, ”why were there 27 conditions to it?”
Rossoff, Levin, and ATC Chairman Joseph J. Collins argued at one Time board meeting that Paramount’s bid had to be discounted because the company needed at least three months and more likely a year to get approvals for the cable franchise transfers. Cable franchises generally carry a right to renewal, but Collins explained that it goes out the window in any change of ownership that is not first approved by the governing municipality. Furthermore, he said, no hostile acquirer had ever asked for franchise transfers; maybe some wouldn’t be granted at all. Wasserstein noted that at a discount of 1% per month compounded — the rate of return Time shareholders expect on their investment — $175 four months down the road is worth $170 today. If the payoff is a year away, the present value is only $155.
In addition to the franchise transfers, Paramount also had to obtain license transfers from the Federal Communications Commission for such things as microwave relays and radio operating permits associated with cable transmission. That too would take a while. So Paramount asked the FCC to let it establish a voting trust, run by former Defense Secretary Donald Rumsfeld, that would hold Time shares while the company pursued the license transfers. Since Paramount’s offer prevented the company from buying shares until it got FCC license and cable transfers, the company planned to have the trust pay Time’s shareholders immediately. Collins told the Time board the trust was probably illegal.
In response, Time launched a guerrilla attack to delay the transfer approvals. Lawyers for Time and ATC told officials in many cities and towns that Paramount’s plan to set up a trust for the shares violated franchise agreements. Should city fathers be as horrified as Time Inc. at this state of affairs, Time would help them sue Paramount for illegally interfering with the franchise. Time sent to officials of about a dozen large cities all the legal papers necessary to file suit — just fill in the blanks — and told a couple of cities it would even pay the legal costs and indemnify the plaintiffs against countersuits by Paramount. The company also challenged Paramount’s application to the FCC to set up a voting trust. ATC sued Paramount in Connecticut for illegally interfering with its business.
Such civic-mindedness is hardly the type of behavior that usually characterized the preppies of Time Inc. This is big league, sharpen-your-spikes-and-slide-in-high type stuff. Asked by Paramount’s lawyers if the legal ambush was an ethical business practice, Munro was clearly uneasy: ”I would have a little trouble with that. I’m not sure it’s right or it’s wrong, but it’s marginal.” (Not to director Finkelstein. He says: ”One pursues the tactics that one thinks are in one’s own interest. Both sides do that.”)
During meetings on June 8, 11, 15, and 16, the Time board debated options. It could do nothing and risk the shareholder vote on the Warner merger. It could take on debt and pay out a big dividend to the shareholders, enough to induce them to reject Paramount’s bid. Or it could change the deal. Wasserstein told the board that by selling off 1.5 million cable subscribers (out of Time’s 4.3 million) plus Scott Foresman, a Time textbook publishing subsidiary, and borrowing against the remaining assets, management could in theory raise enough cash to pay the stockholders $185 to $200 a share in a restructuring or leveraged buyout.
Only remotely did Time’s board consider selling the company and delivering cash to the shareholders. The directors were convinced the Warner deal would pay off down the line. Only if the company lost Paramount’s suit would they consider a sale. The lawyers assured the board there would be plenty of time to do that.
Having eliminated a sale, buying Paramount, or an LBO, the board focused on Warner. Says Finkelstein: ”In looking at a variety of options that [the advisers] presented, including what shareholder value would be two, three, four years down the line on the merger, and various other approaches … I came to the conclusion Time’s a very valuable company, and it’s my own judgment that the acquisition of Warner will magnify that value.”
During the meeting on the 15th, advisers took the board through a variety of scenarios in which Time would buy Warner for $70 a share, either in cash or in combinations of cash and securities. The advisers favored a deal they had worked out with Warner: Time would tender for about 50% of Warner’s stock in cash, with payment for the rest — the so-called back end of the deal — to be considered later.
Warner’s stock was then selling for $55.63. Directors peppered the advisers with questions about why the back end was left so vague. The answer was straightforward: The back end was open because Warner negotiated it that way. Steve Ross was leaving himself some room to make a deal within a deal.
On the 16th the board voted unanimously to acquire about 50% of Warner for $70 a share in cash and to pick up the rest for cash or securities or some combination. The board then postponed the shareholders’ meeting scheduled months earlier for June 23 to vote on the original merger.
The directors debated little whether to ask Time shareholders to approve the new proposal. Time executives later explained that it would take too long to mount the educational campaign to persuade them of the deal’s long-term advantages. By that time Warner might have dropped out, and the overriding concern was getting the deal done. Even though most shareholders would have preferred to take Davis’s cash, Time’s board was persuaded that in the long run the Warner acquisition would be more valuable to them. Says Finkelstein: ”Once you believe you are acting in the best interests of the shareholders, you can continue on until you have a better argument, and I don’t think we were presented with a better argument.”
When Munro explained the new deal to sometimes skeptical employee groups over the next couple of days, a number of them asked about the shareholder vote. He told them bluntly: ”We are going by the law.” Shareholder approval was not needed. It would not be asked for.
Even as the Time board was moving forward with an acquisition, Ross tried desperately to save the merger. According to Arthur Liman, he was even willing to consider lowering the exchange ratio in light of the rise of Time’s stock. Although a creative dealmaker, Ross still carried the baggage of many Depression-raised executives — he didn’t like leverage one whit.
With Time stockholders almost sure to vote down the original all-stock merger in the face of Paramount’s offer, Ross focused on doing that deal without them. He had a problem: The New York Stock Exchange then required a vote when a company wants to increase its shares by 18.5% (now 20%) or more in an acquisition, as Time would have done under the original terms. Ross set out to persuade the stock exchange that the rules didn’t really mean what they said, that a shareholder vote wasn’t necessary. The idea was farfetched but worth a try.
Ross had no contacts on the NYSE. Munro did, and Ross asked him to try to arrange a meeting with NYSE Chairman and CEO John J. Phelan Jr. Alas, he was traveling. Warner lawyer Martin Lipton then drafted a letter to the Exchange — cosigned by Sam Butler of Cravath — that explained, through a variety of contortions, why a shareholder vote really wasn’t necessary.
Time viewed the letter with decidedly mixed feelings. The top executives preferred a cash or cash-and-debt acquisition and always had, because it would not dilute the stock. Time had agreed to the original merger only because Ross wouldn’t do the deal any other way. Butler may have signed the letter knowing the NYSE was nearly certain to reject the plea. Ross suspected as much: ”I had a feeling that if we did get approval there would have been one hell of an argument” between him and Munro over how the deal would be structured. As the Warner directors met on June 16 to consider Time’s $70-a-share offer, they got word that the NYSE had rejected any waiver of a shareholder vote on the merger. They voted for the acquisition.
After the meeting Ross told Time he was triggering the stock swap that the two companies negotiated as part of the original deal. The swap put 11% of Time’s shares in Warner’s hands and 9% of Warner’s shares in Time’s, an exchange that rendered a raid more costly and difficult to execute. Ross was playing defense: If Time did get taken over by Paramount, Warner would at least get a sweet going-away gift when Time’s price rose. On June 23 Davis turned up the pressure by increasing his bid to $200 a share, a maneuver the Time directors fully expected. They held firm.
Davis wows ’em
Martin Davis won the media battle with startling ease. As a former movie publicist he understands how the press works. And as CEO of a once wide-ranging conglomerate he knows many industries and the reporters who cover them. Davis also happens to be a terrific source: knowledgeable, articulate, and unafraid to tackle tough questions.
On this issue Davis delivered a simple message: Here’s the offer, it’s cash, we don’t plan to sell assets, and yes, we expect to have all the approvals we need just as quickly as we can get them. Clearly Paramount’s deal was not that simple, but why complicate the issue?
Davis defused Munro’s charge that Paramount would violate Time’s editorial integrity. Why would he want to interfere with such great magazines? He told Fortune he would put in writing a pledge not to meddle with the magazines’ editorial operations.
Munro told everyone who would listen that Paramount’s offer was illusory, inadequate, and highly conditional, and that Davis was a lying so-and-so who would have to sell huge pieces of Time to finance his debt. His protestations did not get him far.
Some Time executives and Wall Street bankers had naively assumed the press would rally around a brother media company to repel such a raid. Instead, much of the press slammed Time. Davis framed the issue in black and white and left Munro to struggle with a dozen shades of gray. The media do not write much about gray.
Directors were disappointed by the cynicism shown their efforts to make an American institution into an international one. The cancellation of the shareholder vote, the rejection of a $200-a-share cash offer without negotiating, the high-paying, long-term contracts for top executives — there were answers on all these issues, but explaining them took time and more willing ears, and Munro didn’t find enough of either. Time could not even begin talking about Davis’s bid until the board had fully considered all options — and that took days.
The Time Inc. magazines (including Fortune) drew fire for their coverage. McManus had to defend Time magazine’s failure to cover the initial merger announcement, a decision he made because he wasn’t sure Time could do a story sufficiently complete — the announcement came on the day the magazine goes to press — to avoid allegations of favoritism. And in a bizarre editorial the Wall Street Journal chastised Time for trampling shareholder rights — bizarre because common shares of Dow Jones, the Journal’s owner, have one vote, while the Class B shares, controlled mostly by insiders, have ten votes each.
The whole extravaganza headed for a rock’em sock’em showdown at Time’s annual meeting June 30 to elect four directors. The combatants would be management and the shareholders, by now perhaps one-third arbitragers, who were in to make some fast money and wanted the company to deliver. The showdown never occurred.
The dippy gadfly Evelyn Y. Davis (no relation to Martin S.), attired in a Batman hat and T-shirt, broke the tension. She nattered endlessly about her pet topics and offered words of advice to management. CEOs value Ms. Davis’s attendance about as much as they do an SEC investigation, but Munro and Nicholas couldn’t have asked for more. Dissenters, perhaps thrown off stride by the babbling batwoman, did not materialize. Quite the opposite: A few Time shareholders and employees swore their fealty to the cause. Munro was elated. It was one of the few pleasant moments he had had in the past month.
War in Delaware
The day was July 11, and members of the Delaware bar said it was the damnedest thing they had ever seen. The 1989 Super Bowl of corporate litigation, Paramount Communications v. Time, was under way. A mob of photographers and TV cameramen, reporters tethered to them by microphone cables, waited on the steps of the Court of Chancery in Wilmington. At 9 A.M. men and women began wheeling huge cartons of documents up the steps. The gang with the cameras followed en masse, a media mummers’ parade capturing for posterity what appeared to be an office move.
About 85 stultifying degrees of thermal energy and twice that many lawyers, arbitragers, and reporters crammed into the corridor when courtroom 301 opened. An ugly scramble for seats forced the bailiffs to call for order. This being Wilmington in July the heat would have shown up anyway, but the crowd might have been thinner had everyone known what Robert D. Joffe knew.
Cravath’s Joffe, lead counsel for Time, was going to argue before Chancellor William T. Allen. Joffe knew that Paramount’s lawyers had deposed 13 Time and Warner executives, directors, and advisers. He knew they had copies of the minutes of board meetings, handwritten notes of phone conversations, and presentations made by Time’s and Warner’s bankers. And he knew they didn’t have the case they went looking for.
Joffe knew even before Paramount deposed Munro on July 1. Paramount had chosen to depose Munro last, and by then Joffe figured there was no way it could make its case. He told Munro just to answer the questions and not screw up. Says Munro: ”Going into my deposition we were sure we had an 80% chance of winning the case. And we were certain that if we lost at the lower level we’d win on appeal.”
Delaware law has always given directors wide latitude in determining corporate conduct. Only in recent years have the courts tightened the reins on them, and only in a few narrow cases. In Revlon v. MacAndrews & Forbes Holdings, a 1986 case now known as Revlon, the Delaware Supreme Court ruled that if the directors decide to sell a company, they must sell it to the highest bidder. No favorites. In a 1985 case, Unocal Corp. v. Mesa Petroleum Co., called Unocal, the court ruled that directors defending their company from a raider may respond only in a reasonable way. ”Reasonable” did not necessarily mean ”fair” to the raider. To prevail, Paramount would have to demonstrate clearly that Time had broken the Revlon or Unocal mode rules.
Paramount built its case on two foundations, the first being that Time put itself up for sale when it agreed to merge with Warner on March 3. The argument was largely technical: When Time acceded to a swap at a .465 ratio, 60% of its shares — a majority — would have gone to Warner stockholders, and Paramount said that’s a sale. If it was, then Time was in the so-called Revlon mode and had to sell to the highest bidder. The second and more complex argument charged Time managers with entrenching themselves at shareholder expense and responding unreasonably to Paramount’s bid, violating the Unocal rule. Time’s plan to acquire Warner without shareholder approval was Exhibit A.
Paramount’s attorney, Melvyn L. Cantor of Simpson Thacher, tried to string together a cohesive tale of entrenchment. In a calm though faintly sardonic voice he led Allen through the negotiation of the merger ratio, the management contracts, the governance provisions, the refusal to negotiate with Paramount, the cancellation of the shareholder vote, and the new plan to acquire Warner. He also suggested that Time didn’t really believe that preserving the editorial culture is vital to the company. After all, he asked, ”Who is going to preserve this culture, your honor? Nick Nicholas, a man who has worked 20 years in cable television.”
The closest Paramount got to a smoking gun was a memo written by Time vice chairman Levin in August of 1987. Levin, Time’s Big Thinker, outlined the logic for combining with Warner and Ted Turner’s TBS. (Time then owned about 12% of TBS; Time Warner owns 18%.) He sketched what he believed would be the relative positions of Time’s other businesses in the future. Levin also noted, ”An overriding question would still be: Have we secured the company? Is sheer size sufficient protection, or will we still need a large block of stock in friendly hands?” To Paramount, the statement was direct evidence that Time’s executives desired the company for themselves. But Levin closed the memo by saying, in effect, he was just thinking out loud, a postscript that may have been vital to Time’s defense.
Cantor was terrific, but his argument didn’t have much law behind it, and Joffe attacked it head on. Time’s decision to merge with Warner was more than two years in the making, he pointed out. If that isn’t thoughtful corporate planning, what is? Warner attorney Herbert Wachtell asked the court: Had Paramount not appeared on the scene, would any court have prevented the original Time-Warner combination? The answer, as Wachtell knew, was no — the proposed merger was clearly legal. Just because Paramount decided to make a bid for Time a day late and 50 bucks short, he argued, that was no reason for the court to stop the Time-Warner deal. Besides, for all Time had done, it had in no way prevented any future bids for the company. If Davis wanted to buy the new Time Warner, Wachtell noted, nobody was stopping him.
Chancellor Allen agreed wholeheartedly. In a slam dunk opinion he gave full support to the Time board as the corporation’s caretakers in this matter. It didn’t matter that the shareholders might well have preferred to accept Paramount’s bid. ”The corporation law does not operate on the theory that directors … are obligated to follow the wishes of a majority of shares,” he wrote. ”In fact, directors, not shareholders, are charged with the duty to manage the firm.”
Allen said Time’s directors acted reasonably in rejecting Paramount’s bid because they were pursuing a major strategic plan in acquiring Warner. That suggested that a long-range strategy might join the poison pill in U.S. corporations’ defensive arsenal. (Who knows, it may even help the business.) Allen added another potential new factor to future takeover fights when he cited the board’s concern for preserving Time’s culture. ”I am not persuaded,” he wrote, ”that there may not be instances in which the law might recognize as valid [in a defense against takeover] a perceived threat to ‘corporate culture.’ ” Most of the Fortune 500 are already incorporated in Delaware, and Chancellor Allen’s granting of such broad authority to directors is a powerful reason to stay there.
On appeal the Delaware Supreme Court upheld the decision unanimously. Justice Randy Holland asked Cantor, ”Do you agree that Time and Warner is a good deal?” ”Yes,” Cantor agreed, but before he could add that Time Paramount was a better one, Holland shot back: ”Then don’t you lose?” You do.
The raid on Time cost Paramount more than $80 million pretax. But it resulted in Time’s having to borrow $12 billion, an enormous debt load. As a result Time Warner paid $451 million in interest and financing fees in this year’s third quarter and took a $40 million earnings hit for amortization of goodwill, contributing to a loss for the quarter of $176 million. The question is inevitable: Is this the reason Davis pulled the raid? ”Just look at the depositions,” says Davis. ”You’ll see that there isn’t a shred of truth” to the charge.
A better question might be: Assuming Paramount really wanted to own Time, did it choose the right tactics? A lawyer involved on the Time side says, ”Morgan Stanley had to know that Time was worth at least $225 a share. Why give the board a reason to reject you by coming in so low?” Court documents show Morgan Stanley valued Time at a minimum of $217 a share. Some investment bankers wonder why Davis didn’t play the last card: bid for the merged Time Warner after prearranging a deal with some third party to take Warner off his hands.
After losing in court Davis said he was not interested in further pursuit of Time Warner. He did not say he was not interested forever. But now Paramount has another set of variables to deal with. Sony’s (SNE) pending buyout of Columbia Pictures Entertainment for about $3.4 billion (plus the assumption of $1.4 billion of debt) has revalued the entertainment business once again. That sale makes Time’s deal a little better looking, and it puts the spotlight back on Paramount. Selling its Associates financial business has made the company even more attractive: a media play loaded with cash. Paramount’s stock, around $55 when it attacked Time, rose to about $65, apparently in anticipation of a buyout.
Is bigger better?
Dick Munro, Nick Nicholas, and Steve Ross have their dream come true: Time Warner is the largest media empire on earth. Now these three men have some substantial promises to keep in the face of considerable uncertainty. They must show that an important premise of the deal was valid — that the companies can enhance the value of print, video, and music and create new profit opportunities together. They must pay off at least some of Time Warner’s $12 billion debt without divesting the core businesses of magazines, pay TV, cable systems, and film and record production — though a rise in interest rates could poleax their repayment forecasts.
Munro must show that he was right to spend $13.1 billion for a company that depends enormously on one man. For now he acknowledges that ”If I’m wrong about Steve Ross, it will be the biggest mistake I’ve ever made.” Nicholas will eventually have to show that he was worth signing up as CEO five years in advance. All three executives will have to demonstrate that they merit their extraordinary long-term contracts.
Perhaps most important, Munro and Nicholas will have to show that their fundamental act of stewardship in this deal — repulsing a highly conditional offer for Time shares in favor of a highly leveraged acquisition — was sound. Remember that at one point they discounted the value of Paramount’s offer by assuming Time investors demanded a 12% annual return. They also argued that their deal might not look as good as Paramount’s in the short term but would be far more valuable in the long term. Fair enough. The $200 a share Time stockholders didn’t get, at 12% a year, will be worth $352 in five years, $621 in ten years. The stock was recently around $140. The managers of Time Warner must now demonstrate that bigger is better. And in a big way.