In March 1989, Time, Inc. entered into a merger agreement with Warner Communications, Inc. The deal was a planned stock-for-stock exchange that would be put before the shareholders of both companies for their approval. Paramount Communications, Inc. then entered the fray with a hostile tender offer for Time. This offer was structured by Paramount to be higher than the valuation that was inherent to the original Time-Warner agreement. Time then responded with a tender offer for Warner that featured a cash offer for 51% of Warner followed by a second-step transaction using securities as consideration. Paramount sued and contended that the original merger agreement between Time and Warner meant that there was an impending change in control, thereby bringing the Revlon duties of the directors into play. In Paramount Communications, Inc. v. Time, Inc., the court rejected Paramounts argument that there would be a change in control.a The court was impressed by the fact that both companies were public and their shares were widely held. Based on such reasoning, the court concluded that this was not an acquisition in which one company was acquiring another but rather a strategic merger. Therefore, Revlon duties were not triggered, and the normal business judgment rule standard applied. The significance of this decision is that the announcement of a strategic merger between two companies is not a signal that either of the companies is for sale. Therefore, the directors do not have to consider other offers as if there were an auction process. This implies that if there is an unwanted bid, the directors may consider the use of antitakeover measures to avoid the hostile bid while they go ahead with the strategic merger.In June 1989, Time, Inc. made a bid for Warner Communications, Inc., which was followed by a bid by Paramount Communications, Inc., for Time, Inc. Both combinationsTime-Warner and MARKETABILITY OF THE STOCK 559 Paramount-Timewould result in a highly leveraged company that would generate few earnings. Paramount took on $8 billion in debt to complete a $14 billion acquisition of Warner. This, however, did not make the company valueless in the eyes of its bidders. Paramount offered $12.2 billion, or $200 per share, for Time, Inc. The key to the targets value was the cash flowgenerating capacity of the media assets that these communications giants commanded. Whats significant is that Time, one of Americas leading companies, is putting a stamp of approval on cash flow valuations as opposed to earnings valuations, said Bernard Gallagher, vice president and treasurer of the Philadelphia-based Comcast Corporation, the nations third largest cable company. Paramount, Time and Warner, all traditional earnings oriented companies, are now saying that earnings arent nearly as important as combining and building assets that will generate cash in the future.a The cash flow method of analyzing companies gained in popularity in the fourth merger wave. Here companies with reliable cash flows discovered that they could do transactions using a lot of leverage and be able to find capital providers even though they tended to not have as many hard assets as traditional borrowers. Good examples were cable companies such as the then-Denver-based cable giant Tele-Communications, Inc. (TCI). The cash flows from their subscriber base provided these firms with reliable cash flows with which to service debt. Other cable companies learned from TCI, and the industry consolidated as cable companies built national networks.b The valuation of TCI and Media One, another cable company, became an important issue some years later when AT&T paid handsomely for these companies based upon a belief that synergies with AT&Ts telecom business would enhance the cash flows the combined companies generated. This analysis proved highly flawed. The presence of high cash flows is not enough to ensure profitability. The $8 billion Time borrowed to finance the merger with Warner left the combined firm, which became the worlds largest media company at that time, with $11 billion of debt. As with many of the leveraged transactions of the fourth merger wave, the pressure of interest payments on this debt took its toll on the firms profitability. Time-Warner posted a $432 million loss for 1989. It is ironic that Time turned down a substantial offer from Paramount, based on the belief of Times management that the price of Time-Warner stock would eventually rise to $200 per share. This decision was questioned when in early 1990 Time-Warners stock was trading as low as $96.125 per share, less than half managements projections.c This transaction, however, would prove to be one of many megaentertainment deals that would take place in the 1990s as this industry underwent significant restructuring. Time-Warner, a company that included many valuable assets, would rebound well from the initial falloff following the merger and would go on to grow in the fifth merger wave and become a valuable company for its investors. This value-creation process came to a crashing halt with its disastrous merger with AOL. AOL shareholders ended up owning the majority of the combined AOL-Time-Warner based on a speculative valuation of the companys stock. They gained at the expense of Time-Warner shareholders, who incurred major losses as a result of the poor dealmaking of their companys management.