Time Warner, Inc., Is Playing Games with Stockholders Time Warner, Inc., the worlds largest media and entertainment company, is best known as the publisher of magazines such as Fortune, Time, People, and Sports Illustrated. The Company is a media powerhouse comprised of Internet technologies and electronic commerce (America Online), cable television systems, filmed entertainment and television production, cable and broadcast television, recorded music and music publishing, magazine publishing, book publishing and direct marketing. Time Warner has the potential to profit whether people go to theaters, buy or rent videos, watch cable or broadcast TV, or listen to records. Just as impressive as Time Warners commanding presence in the entertainment field is its potential for capitalizing on its recognized strengths during coming years. Time Warner is a leader in terms of embracing new entertainment-field technology. The companys state-of-the-art cable systems allow subscribers to rent movies, purchase a wide array of goods and services, and participate in game shows and consumer surveys--all within the privacy of their own homes. Wide channel flexibility also gives the company the opportunity to expand pay-per-view TV offerings to meet demand from specialized market niches. In areas where cable systems have sufficient capacity, HBO subscribers are now offered a choice of programming on different channels. Time Warner also has specialized networks, like TVKO, to offer special events on a regular pay-per-view basis. Time Warner is also famous for introducing common stockholders to the practical use of game theory concepts. In 1991, the company introduced a controversial plan to raise new equity capital through use of a complex contingent rights offering. After months of assuring Wall Street that it was close to raising new equity from other firms through strategic alliances, Time Warner instead asked its shareholders to ante up more cash. Under the plan, the company granted holders of its 57.8 million shares of common stock the rights to 34.5 million shares of new common, or 0.6 rights per share. Each right enabled a shareholder to pay Time Warner $105 for an unspecified number of new common shares. Because the number of new shares that might be purchased for $105 was unspecified, so too was the price per share. Time Warners Wall Street advisers structured the offer so that the new stock would be offered at cheaper prices if fewer shareholders chose to exercise their rights. In an unusual arrangement, the rights from all participating shareholders were to be placed in a pool to determine their pro rata share of the 34.45 million shares to be distributed. If 100% of Time Warner shareholders chose to exercise their rights, the price per share would be $105, the number of shares owned by each shareholder would increase by 60%, and each shareholder would retain his or her same proportionate ownership in the company. In the event that less than 100% of the shareholders chose to participate, participating shareholders would receive a discount price and increase their proportionate interest in the company. If only 80% of Time Warner shareholders chose to exercise their rights, the price per share would be $84; if 60% chose to exercise their rights, the price per share would be $63. These lower prices reflect the fact that if only 80% of Time Warner shareholders chose to exercise their rights, each $105 right would purchase 1.25 shares; if 60% chose to exercise their rights, each $105 right would purchase roughly 1.667 shares. Finally, to avoid the possibility of issuing equity at fire-sale prices, Time Warner reserved the privilege to cancel the equity offering entirely if fewer than 60% of holders chose to exercise their rights.

450 Chapter 14 The terms of the offer were designed to make Time Warner shareholders feel compelled to exercise their rights in hopes of getting cheap stock and avoiding seeing their holdings diluted. Although such contingent rights offerings are a common capital-raising technique in Britain, prior to the Time Warner offering they had never been proposed on such a large scale in the United States. Wall Street traders and investment bankers lauded the Time Warner offer as a brilliant coercive device--a view that might have been colored by the huge fees they stood to make on the offering. Advisory fees for Merrill Lynch and Time Warners seven other key advisers were projected at $41.5 million to $145 million, depending on the number of participating shareholders. An additional $20.7 million to $34.5 million was set aside to pay other investment bankers for soliciting shareholders to exercise their rights. Time Warners advisers argued that their huge fees totaling 5.22% of the proceeds to the company were justified because the offering entered uncharted ground in terms of Wall Street experience. Disgruntled shareholders noted that a similar contingent rights offering by Bass PLC of Britain involved a fee of only 2.125% of the proceeds to the company, despite the fact that the lead underwriter Schroders PLC agreed to buy and resell any new stock that wasnt claimed by rights holders. This led to charges that Time Warners advisers were charging underwriters fees without risking any of their own capital. Proceeds from the offering were earmarked to help pay down the $11.3 billion debt Time Inc. took on to buy Warner Communications Inc. Time Warner maintained that it was in intensive talks with potential strategic partners and that the rights offering would strengthen its hand in those negotiations by improving the companys balance sheet. Time Warner said that the rights offering would enhance its ability to enter into strategic alliances or joint ventures with partners overseas. Such alliances would help the company penetrate markets in Japan, Europe, and elsewhere. Critics of the plan argued that the benefits from strategic alliances come in small increments and that Time Warner had failed to strike any such deals previously because it wants both management control and a premium price from potential partners. These critics also maintained that meaningful revenue from any such projects is probably years away. Stockholder reaction to the Time Warner offering was immediate and overwhelmingly negative. On the day the offering was announced, Time Warner shares closed at $99.50, down $11.25, in New York Stock Exchange composite trading. This is in addition to a decline of $6 suffered the previous day on the basis of a report in The Wall Street Journal that some form of equity offering was being considered. After trading above $120 per share in the days prior to the first reports of a pending offer, Time Warner shares plummeted by more than 25% to $88 per share within a matter of days. This is yet one more disappointment for the companys long-suffering common stockholders. During the summer of 1989, Time cited a wide range of synergistic benefits to be gained from a merger with Warner Communications and spurned a $200 per share buyout offer from Paramount Communications, Inc. This is despite the fact that the Paramount offer represented a fat 60% premium to the then prevailing market price of $125 for Time stock. During the succeeding two-year period, Time Warner stock failed to rise above this $125 level and traded as low as $66 per share during the fall of 1990. Meanwhile, the hoped-for Time Warner synergy has yet to emerge.

Game Theory and Competitive Strategy 451 A. Was Paramounts above-market offer for Time, Inc. consistent with the notion that the prevailing market price for common stock is an accurate reflection of the discounted net present value of future cash flows? Was managements rejection of Paramounts above- market offer for Time, Inc. consistent with the value-maximization concept? B. Assume that a Time Warner shareholder could buy additional shares at a market price of $90 or participate in the companys rights offering. Construct the payoff matrix that correspond to a $90 per share purchase decision versus a decision to participate in the rights offering with subsequent 100%, 80%, and 60% participation by all Time Warner shareholders. C. Describe the secure game theory strategy for Time Warner shareholders. Was there a dominant strategy? D. Explain why the price of Time Warner common stock fell following the announcement of the companys controversial rights offering. Is such an offering in the best interests of shareholders?