Wall Street was abuzz last week with a startling rumour -- that America Online, perhaps the most dominant company in the Internet economy, was planning to buy CBS. Imagine -- AOL, once the laughingstock of cyberspace, buying the Tiffany Network, the broadcasting pioneer that gave the world Edward Murrow, Walter Cronkite and Captain Kangaroo.
While strange to contemplate, in some ways a combination of this size and scope seems inevitable. And Netheads remain obsessed with the notion of convergence, in which the Internet and television blend into one.
It's easy to see the logic of AOL buying CBS. The TV network needs a Net strategy robust enough to keep it up to speed with ABC and NBC. ABC, of course, is part of the Disney empire, with its expanding collection of Web and cable properties. NBC, a subsidiary of General Electric, has MSNBC and a deal with Snap. CBS boasts links to SportsLine and MarketWatch.com -- but not much else.
There's a big problem with this fantasy, however -- one which will trip up any deal that contemplates the teaming of an Internet company with one from the offline world. Remember what happened when USA Networks announced its bid for Lycos? Lycos shares plummeted. If AOL and CBS try to tie the knot, expect the Street to react badly.
The numbers tell the story. AOL has a market cap of almost $US150 billion, about five times the valuation of CBS. But by any other measure, CBS is the bigger company: at the end of last year it had more than 46,000 employees, while AOL had fewer than 9000. CBS also has considerably higher revenues. AOL, on the other hand, is far more profitable, and growing much faster. AOL-CBS would be a company losing market share in its core TV business, operating with a unionised labour force and relying on a delicate relationship with the FCC. Would investors value that company at 700 times earnings?
A few years back, a Wall Street biotech analyst tried to explain to me the disappointing reaction of investors to the FDA's approval of a drug long in development. With a real source of revenue, he said, the company no longer merited "a biotech multiple".
The Net is now haunted by the same paradox. While the huge valuations of Net stocks have enabled the biggest players to spend freely for other Net pure plays, the same valuations cripple the industry's ability to make acquisitions outside the Net. We're in Bizarro World, where the worst thing a Net company can do is to buy a company with real-world assets and a big workforce.
But make no mistake: as the Internet absorbs more and more of the economy, the logic of combining Net companies with offline rivals will be hard to resist. One of these days, AOL really will buy CBS -- or Charles Schwab will take over Merrill Lynch, or eBay will snap up Sotheby's. And investors won't like it. How ironic it would be if the end of Net-stock mania were triggered by the relentless drive of the Internet economy itself, as it swallows everything in its path.