German giant in a pickle over AOL deal

The AOL/Time Warner deal presents Bertelsmann with a dilemma – to give up a massive investment or work with its fiercest rival.

Are Bertelsmann chief executive Thomas Middelhoff and AOL boss Steve Case still close friends? When Middelhoff was head of the German giant’s multimedia operations in 1995, he persuaded his seniors to invest £31m in Case’s fledgling America Online Internet service.

But, almost five years after that deal, which launched Case’s assault on the Net access sector and led to the AOL Europe joint venture, the German giant faces a crucial decision as to whether it can remain close to AOL.

AOL’s £210bn merger with Time Warner, Bertelsmann’s fiercest global competitor, has thrown everything – especially the joint venture – up in the air.

Michael Schatzschneider, analyst with BHF Bank in Germany, says: “Bertelsmann is highly committed to its Net strategy, which is to put as much of its content as possible on the Web. This step might make it move faster… it must speed up.”

Problems arise because Bertelsmann, the world’s third-largest media/content provider after Time Warner and Disney, owns 50 per cent of AOL Europe, a stake worth about £1bn.

But the Time Warner deal has turned partner into competitor. Bertelsmann’s biggest rival has stolen a march in the battle to develop interactive media services, both on the Web and in digital TV.

One analyst comments: “Web consumers are notoriously disloyal and will flit from site to site until they see exactly what they need. With so much choice, filling their precise content needs is vital.”

A source within one of the leading Internet service providers (ISPs) says: “The proliferation of free ISPs on both sides of the Atlantic means access is no longer a competitive differentiator – content is king.”

But Bertelsmann needs access to a successful ISP to shift its content to the new medium and to take advantage of developments in digital TV, where many expect the Internet to achieve its next growth.

Schatzschneider adds: “Bertelsmann has two alternatives: it can either search for a new Internet platform, or stick with AOL and co-ordinate its Web content and services with Time Warner’s.”

While Middelhoff has resigned his seat on the executive AOL board as a result of the deal, most observers – including Bertelsmann itself – are expecting Middelhoff to stick to the AOL strategy.

Schatzschneider says: “I expect Bertelsmann to get closer to AOL. They are the dominant companies in their relevant markets in Europe and the US. Time Warner is new in Europe and Bertelsmann is market leader there, while the opposite is the case in the US. If they can co-ordinate their content across all markets, everyone will benefit.”

Bertelsmann spokesman Marcus Payer says: “What does competition mean any more where convergence is the biggest issue we have seen?”

He adds: “At the moment, we praise Steve Case for securing a fantastic deal and think that the combination of our resources and those of the new concern would reap huge dividends. Still, it is early days… we cannot say what the long-term plan will be.”

Whatever eventual path it takes, few deny the German media giant is at a crossroads.

Alki Manias, of Internet analysts NetValue, says: “The deal will definitely stir Bertelsmann. All the major players will consolidate – but it will have to be fast. As soon as the sites get market valuations, the sky-high share prices make their purchase prohibitive.”

A privately-owned company, Bertelsmann has been described as the most Net-savvy of all the old media players – in no small part thanks to Middelhoff, whose own belief in the new medium has permeated the company.

Bertelsmann owns shares in Fireball, a leading German search engine, and runs the books-to-music e-commerce site. It has also set up BV, a separate financing arm for Internet start-ups based on the US West Coast. Last week, it made the first of what are expected to be many investments in the Chinese-language Internet market, with the acquisition of Taiwanese portal operator Yam Digital Technology.

However, of all these investments, AOL is its most crucial venture. Last year, AOL Europe contributed 10 million of AOL’s 20 million subscriber base, and the company secures more than a third of its £7.5bn a year revenues from the US market. To lose Internet access there would be a crippling blow.

One analyst comments: “The Internet is Bertelsmann’s future and it knows it, while the US is just as crucial. The Time Warner deal could be the kick it needs to seal its success – or it could scupper it entirely.”

Bertelsmann, however, has its finger in many pies. Its music publishing business provides about a third of its annual revenue and rumours of a bid for Sony or EMI confirm it will not pursue the Internet at the cost of all else. Yet even the music business will rely on the Web as technologies evolve.

Bertelsmann may have to swallow its competitive pride and jump into bed with its main rival. The alternative – missing out on AOL’s new pulling power – could prove to be too harsh a blow.


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