Clash of The Titans

By John Greenwald

The phone on the desk of Richard Munro, chairman of Time Inc., rang at 6 p.m. last Tuesday. On the line was Martin Davis, chairman of Paramount Communications, a onetime industrial conglomerate that had changed its name from Gulf & Western just the day before. Davis had a stunning message for his fellow chief executive. Although Munro had assurances from Davis that he would not mount a takeover bid for Time, Davis was reneging: he declared that Paramount was launching an offer to acquire Time for $175 a share, or $10.7 billion. Time stock had closed at 126 that day.

Paramount's tender set the stage for a clash of media titans that could lead to months of multibillion-dollar broadsides, legal pyrotechnics and dangerously unpredictable consequences. The Paramount bid came just 2 1/2 weeks before shareholders of Time and Warner Communications were to vote on merging their firms into the world's largest media company, with total revenues of $10 billion. But the sudden strike by Paramount, whose operations include one of Hollywood's top movie-and-TV studios and the giant publishing house Simon & Schuster, disrupted those plans and threatened to provoke a free-for-all in which the ownership of all three communications giants could be up for grabs.

Rarely had three firms of comparable size and stature been locked in such a bizarre triangle. "You can't help worrying now about what kind of company this will produce. No one knows where this sort of runaway sled ends up," said Richard Christian, associate dean at Northwestern University's Kellogg Graduate School of Management. Declared a Los Angeles-based securities analyst: "This is going to be the greatest battle that Hollywood has ever seen."

The offer touched off a frenzy among Wall Street arbitragers, who snapped up Time stock in the belief that Paramount would prevail or attract other bidders into the fray. Time shares skyrocketed from 126 to 170 on Wednesday and finished the week at 170 1/4. Since Wall Street investors considered all three companies now to be in play, Warner stock jumped to 56 1/8, up 4 points for the week, and Paramount rose to 59 1/8, up 5 5/8.

The bid, which was 35% more than Time's stock price before the offer, exploited the dissatisfactions of many on Wall Street who had long cherished the notion that Time was worth more in pieces than whole. Since the merger agreement was reached on March 3, some investors had complained that the terms provided Time shareholders with no immediate financial reward. Reason: the agreement called for a debt-free swap of 0.465 shares of Time stock for each Warner share.

The arrangement would give Warner stockholders a premium, reflecting the fact that in effect Time was acquiring a slightly larger company with many more outstanding shares, but would leave Time's stockholders with only the prospect that their stock would appreciate over the long run. Moreover, the process of getting Government approval and working out legal details required a 3 1/2-month gap between the announcement and the stockholders' vote on the deal, which left enough time for a hostile bidder to marshal his forces.

Yet to those who admired the Time-Warner deal, an old-fashioned debt-free and tax-free stock swap between friendly companies, the Paramount bid raised disturbing doubts about whether corporate America can free itself from the frenzied deal making, staggering debt loads and ultimate dismemberment that have plagued U.S. industry in the 1980s. Among other considerations, the absence of heavy leverage in the Time-Warner arrangement was aimed at helping the merged company compete globally against such foreign media giants as West Germany's Bertelsmann and France's Hachette.

But Paramount would have to borrow some $10 billion to acquire Time at the offering price, which Davis admitted at an analysts' meeting would mean no earnings for at least two years and would be a long-term drain on operations. At the very least, the debt would impose the kind of cost cutting that has characterized Laurence Tisch's management of CBS. At worst, it could force the sale of certain assets to meet the bankers' bills. Indeed, almost any of Time's defensive strategies would require heavy borrowing that would sap profits from whatever entity results when the dust settles.

While Time said it would give the Paramount bid a fair hearing, as the law requires, there was every indication that Time's top executives would fight to repel the intruder. In a three-page "Dear Mr. Davis" letter, Munro chastised the Paramount chairman for breaking his spoken agreement to leave Time alone: "On a personal level, I'm disappointed that I can't rely on you as a man of your word. Live and learn." Munro said the Paramount offer consisted of "smoke and mirrors," since it was subject to several conditions that included Paramount's ability to obtain financing and regulatory approval, a process almost certain to take longer than the Time-Warner proposition had. Such conditions, Munro argued, could not be met by the July 5 deadline that Paramount set on its bid for Time shares. The letter added, "Hostile takeovers are a little like wars: once they start, it's impossible to tell where they may end. The full effect of what you've set in motion remains to be seen."

In response, Davis says he discussed a friendly merger with Munro and Time president N.J. Nicholas several times from 1986 through 1988, but was rebuffed on each occasion. As a result, Davis told TIME senior correspondent Frederick Ungeheuer, "I said we would not do anything hostile and would respect Time's decision to remain independent." But Time then "put itself up for sale," Davis argued, by agreeing to merge with Warner. He said the deal would end Time's independence because the merger would give Warner shareholders 60% of the stock of the combined company.

While that distribution reflects the premium that Warner stockholders will get for their shares, Time officers argued that it does not translate into corporate control because Time and Warner stockholders would not form separate voting blocs after the merger, and for that matter much of the stock of both companies is held by large institutional investors, creating overlapping ownership. Moreover, Time was, in fact, acquiring Warner, and Munro, 58, and Warner Chairman Steven Ross, 61, had agreed to share power as co-chief executives of the new company until Munro's retirement, planned for next year. - Time's Nicholas, 49, would then replace Munro in the power-sharing arrangement and become sole chief executive when Ross was contractually required to step down five years after the merger. The Paramount bid, by contrast, would leave Davis as chief of the combined company.

The Paramount proposal sent the combatants rushing into court. In New York City, Warner brought a $1 billion suit against Citibank, which had provided $1 billion in initial funding for Paramount's bid and was planning to raise an additional $13 billion through a loan syndicate. Warner accused Citibank of violating a promise not to back efforts to break up the Time-Warner deal. Citibank replied that it was "surprised" by the suit and denied violating any such agreement.

For its part, Paramount asked a Delaware chancery court to overturn a takeover defense in the Time-Warner agreement. Under terms of the deal, Time and Warner could immediately swap around 10% of their shares to make both companies more costly to take over for a hostile bidder. At week's end the court denied Paramount's motion for a temporary restraining order to bar such a swap. In another provision, called a poison pill, Time has arranged to sell its stockholders new shares for half their market value, which could make it prohibitively expensive for Paramount to acquire the expanded number of shares.

Time may well take the offense and come out swinging. The company's war chest includes a $5 billion line of credit arranged months ago that could be used, for example, to help finance a bid for Warner and thus preserve the acquisition. But such a buyout could saddle Warner shareholders with heavy capital-gains taxes and hobble Time with debt. Another potential strategy would be the so-called Pac-man maneuver, in which Time would turn around and make a bid for its attacker.

One of Time's defensive moves could be to boost the value of the combined Time and Warner stock. Analysts estimated that each new Time Warner share would initially trade for somewhere between $110 and $115. That would be well below the $200-plus break-up value that some Wall Street analysts say Time stock would be worth if the company were dismantled and sold off in pieces. While the long-term value of the merged Time Warner stock could grow substantially if the deal created a strengthened company, many investors, particularly arbitragers and institutional fund managers, have more interest in short-term gains. Thus the company could conceivably offer a special, one- time dividend that would reward stockholders for going along with the Time- Warner plan.

If all else failed, Time could seek a so-called white knight to save it from Paramount's grasp. But almost any bidder with enough financial backing could jump into the fray without being invited. Moreover, Wall Street analysts believe that all three companies are now up for sale, since their stock is falling into the hands of speculators who will gladly sell to the highest bidder. "I bet none of the three companies will exist a year from now," says Ellen Greenspan, a leading Wall Street arbitrager.

As the combatants plotted, some major Time shareholders sat comfortably on the sidelines watching their profits add up. They included billionaire Donald Trump, who confirmed that he owns 2.8 million shares of Time, or 4.9% of the outstanding stock of the company. At Time's current price, Trump has paper profits of more than $200 million on his holdings, which could go a long way toward the $365 million cost of the former Eastern Air Lines shuttle he acquired last week.

In some respects, a Time-Paramount combination would create a company similar, in structure if not in control, to the one envisioned in the Time- Warner deal. Time's magazine and book publishing operations, which include TIME, PEOPLE, SPORTS ILLUSTRATED and TIME-LIFE Books, might dovetail effectively with Paramount's book division. Time's cable television programming units, including Home Box Office and Cinemax, could mesh with Paramount's film-studio and television ventures. Time's cable-television systems would provide distribution vehicles for that product. Warner, meanwhile, has film, cable-TV and publishing units and differs from Paramount in owning the largest domestic record company. "Time would make a good fit with either Warner or Paramount," says Peter Appert, a media analyst for the investment firm of C.J. Lawrence, Morgan Grenfell.

In some important ways, however, the matchups look quite different. For one thing, the debt-free nature of the Time-Warner deal would have given the merged company far more flexibility than a Time-Paramount consolidation might have. "The Time-Warner combination left everybody's powder dry to be able to go out and make acquisitions," says Larry Gerbrandt, a vice president of Paul Kagan Associates, a California-based communications-industry analyst. "But in a tender offer like Paramount's, you have to load up with a tremendous amount of debt that limits your options. The strategy can work, but it's much riskier."

In his interview with TIME last week, Davis sought to downplay the debt issue. "We have the ability and the credibility to manage this debt," he said. "Also, it will not last forever. We will bring it down in time." An avowed cost cutter, Davis strongly denied rumors that he would dismantle Time by selling off its magazine operations to reduce the debt. "We are not going to sell anything," Davis said. "We are not bust-up artists." He also said he would maintain the editorial independence and integrity of Time's books and magazines. "Not only will we maintain editorial independence," Davis insisted, "we will demand it." Journalists at Time Inc. were concerned because, reassuring as such statements made in the heat of battle may be, they fall well short of the written, legal guarantees that had been cemented into the Warner merger.

While rumors had circulated for months that Davis was preparing a bid, Time executives counted on his promise of noninterference. "He's on the telephone to us almost every day," a senior Time officer said several weeks before Davis made his move. "He's just unhappy that he's been left out. He can't stop kibitzing." All the while, however, Davis was preparing his attack under the code name Kronos, for a Greek god associated with time. Davis was advised by Robert Greenhill, vice chairman of the Morgan Stanley investment banking firm, which is now Paramount's chief adviser in the bid. Paramount said last week that Donald Rumsfeld, a former Defense Secretary, has agreed to serve as trustee for tendered Time stock until Paramount clears all legal barriers to its takeover.

Investment bankers, who stand to make hundreds of millions of dollars in advisory and underwriting fees no matter who comes out on top, had been hunting for months for a firm to derail the Time-Warner deal. Morgan Stanley gave its search for a spoiler the code name Project Clock. Merrill Lynch, another Davis adviser, assigned the name Space to its project. Citibank, for its part, stands to make $350 million in fees for putting together Paramount's war chest. At the same time, the bank manages 1.5 million shares of Time stock for its clients, on which they stand to make a huge profit if the deal goes through.

In Washington, where Congress and regulatory agencies had already given their blessings to the Time-Warner transaction, legislators adopted a wait- and-see attitude toward the Paramount bid. Ironically, approval of the Time-Warner merger could make it easier for a Time-Paramount deal to win acceptance, since the two combinations are similar. But a senior congressional aide called such speculation premature. Said he: "The Paramount bid is just the opening move in a game of chess."

It is a game, however, with extraordinary stakes. The Time-Warner deal had gathered support among many U.S. business leaders because it suggested a healthy way for companies to grow and expand without incurring a backbreaking load of debt. But the frenzy that surrounded the Paramount proposal last week seemed more closely linked to the merger mania of the roaring '80s than to hopes of restoring U.S. competitiveness in the 1990s. At the very least, the managers and employees of Time, Warner and Paramount stand to be distracted for months by the takeover struggle. And while a clash of the titans may be an exciting spectacle, it can waste huge amounts of time and money that might better be used to improve products at home and compete with firms abroad.

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Joe Lertola

CAPTION: CUTTING INTO THE DEAL

With reporting by Thomas McCarroll and Frederick Ungeheuer/New York, with other bureaus