Shares of the Pair Slip as Euphoria Fades

The breathless talk a day earlier of America Online and Time Warner becoming the world’s premier media company faded quickly Tuesday as shares of both companies slid hard.

In late trading Tuesday, AOL was off $8.63 to $64 and Time Warner was down $6.25 to $86. On Monday, AOL had eased $1.13 while Time Warner soared $27.50.

As institutional investors mulled the deal Tuesday, there was widespread agreement that the proposed alliance makes sense long-term. But many were dismayed that the merger plan was short on specifics as to how fast-growing AOL would wring out better sales gains from Time Warner.

“You have some element of the shareholder base saying: ‘We like the strategic combination. We think it’s going to be a real dynamic company someday--underscore “someday�--but right now it’s a very complex company to get ahold of,’ � said John Faig, Internet analyst at the American Express mutual fund group.

Predictably, AOL shareholders were most concerned that AOL is no longer a “pure play� bet on the Internet. And many worry that AOL’s growth--revenue surged 55% last year--would be throttled significantly by the addition of an old-line media company growing less than a third that pace.

“You have some traditional AOL Internet-type shareholders who look down and say: ‘Geez, I’m trading 50% growth [in cash flow] for 30% growth. I’d rather own something pure in the Internet,’ � said Bill Feiler, co-founder of Century City-based Bel Air Investment Advisors, which holds a large position in Time Warner and a smaller stake in AOL.

Merrill Lynch’s Internet analyst, Henry Blodget, may have contributed to the selling Tuesday by predicting that AOL could trade as low at $55 in the near term.

“The big question for shareholders is whether the market will accord the new entity a traditional valuation or an ‘Internet valuation,’ � Blodget wrote to clients Tuesday morning. “Our answer to this is not surprising: probably somewhere in between.�

But the “right� valuation is far from clear to many AOL holders--which makes the stock vulnerable to more selling in the near term, analysts said.

“It’s very difficult when you take two companies with such disparate valuations [and try to figure] what the new valuation should or would be,� said Alan Dworsky, an AOL shareholder and head of Mt. Auburn Management in Boston. “You can come up with theoretical answers, but you’ll have to wait and see.�

One concern is whether AOL, during the nine to 12 months it may take to finalize the deal, will be distracted from its main business, Faig said. Given that changes sweep the Internet sector with lightning speed, AOL can’t afford to be flat-footed, he said.

In addition, it’s unclear how AOL would tackle the huge task of integrating Time Warner, Faig said. For example, how would AOL Time Warner make the transition to distributing music online instead of by CD? Ditto for Time Warner’s publishing segment, which takes in the vast majority of its revenue from its traditional paper products.

“We don’t know if those tough decisions will be made, when they’ll be made, who’ll make them and if they’ll be made in the best interests of shareholders,� Faig said. “If Time Warner was growing 15% or so, AOL is not going to get [it] to 20% magically.�

Nevertheless, some investors gave AOL the benefit of the doubt.

“You’re going to have a group of investors that says, ‘This is the dominant media company in the world now and I want to own it,’ � Feiler said. “And there is value that they will be able to create between the two companies that is not being measured right now.�