While the pending merger of America Online Inc. and Time Warner Inc. has roiled both stocks, many money managers give the deal a thumbs-up.
"We don't know why it's taken people on Wall Street so long to understand the company. We're taking advantage of the confusion to buy more stock," said John Schneider, an assistant portfolio manager with Janus Capital Corp.'s Janus Fund, Denver.
Janus is one of the biggest shareholders of both AOL and Time Warner, owning 1.7% of AOL and 7.75% of Time Warner stock. It has been adding to its positions in both stocks as prices have plunged.
Time Warner initially soared from $64.75 on Jan. 7 to a high of $102 on Jan. 10, the day the deal was announced.
It has since fallen back, closing on Jan. 20 at $87.79.
AOL shares have been harder hit, dropping 25% to $64.06 since the Jan. 10 high of $80.
The problem for investors has been figuring out how to value the combined company.
"You have two different kinds of metrics to value the two companies by," said Robert Finch, a portfolio manager with Aeltus Investment Management Inc., Hartford, Conn., which owns 1.3 million shares of AOL and 855,000 shares of Time Warner.
While Time Warner is valued on a cash flow basis, AOL is valued by methods used for Internet companies that include counts of page views, new subscribers and commerce revenues, Mr. Finch said.
The different valuation methodologies cause the market "to get schizophrenic," Mr. Finch said.
Managers, however, believed the combined companies' stock will be viewed as a growth stock, though perhaps not as turbocharged as AOL on its own.
"It's going to be a slower growing stock than AOL alone, but still a growth stock," said Alan Lowenstein, portfolio co-manager of John Hancock Advisors Global Technology Fund, Boston, which owns about 700,000 shares of AOL.
"Shareholders of both companies will benefit equally from this deal," he added.
"The AOL stock going down is only a short-term problem. It had doubled before that, so for it to give back 20% to 30% is not so unusual."
AOL Time Warner's stock "will have many characteristics of a growth stock but may not get the big multiple (of a growth stock)," said David Brady, portfolio manager of the Stein Roe Young Investor Fund, which has a 2.4% stake in AOL.
Brian Arena, an analyst with the $60 billion New Jersey Division of Investment, Trenton, said, "Time Warner by itself is a growth stock. AOL is a growth stock. So when you combine the two companies you still have a growth stock. It should be able to grow strongly after the merger."
New Jersey owns 5.7 million shares of Time Warner and slightly less than 9 million shares of AOL.
His only apprehension is a concern about whether there will be a problem integrating the two companies.
While Stein Roe's Mr. Brady is basically positive about the deal, he also pointed out the ramifications if the deal doesn't work.
"AOL is the Internet's blue chip company. If the deal doesn't work -- and it's entirely possible there won't be the synergies expected -- it will be bad for all the technology companies" that are looking for content partners, he said.
A good fit
However, Karen Southard, an analyst with INVESCO Inc., New York, said, "there are few people who would say the merger isn't a good fit." She expects the new company's stock to be a strong growth stock.
The group of investment firms under the INVESCO umbrella owns 2.3 million shares of AOL and 1.5 million shares of Time Warner.
Ms. Southard said the most important determinant of the stock's the success will be how fast the merged company can increase its free cash flow. The stock market should value the new company "at a 50% to 100% premium of its free cash flow," she said. So if AOL is trading at between $75 and $85 a share, she explained, and AOL is giving 1.5 of its shares for every Time Warner share, that would give AOL a value of $112 to $127 for each Time Warner share.
Janus' Mr. Schneider predicted the combined company "will grow its free cash flow at a 40% rate going forward," a very strong growth rate.
"In the first week Time Warner shareholders made out better, but as one of the largest institutional holders of both AOL and Time Warner, we think (shareholders) of both will make out well," he said.
James Russo, a portfolio manager with J.P. Morgan Investment Management Inc., New York, which owns 2.6 million shares of Time Warner and 7.2 million shares of AOL, said: "We're looking at the deal strictly on a cash flow basis. We expect the deal to be valued at about 25 times EBITDA (earnings before interest, taxes, depreciation and amortization)."
When Time Warner stock was at $80 a share the deal was valued at about 25 times EBITDA. With Time Warner stock jumping to $91 a share in intraday trading on Jan. 21, the deal is valued at about 30 times EBITDA, Mr. Russo explained. With AOL stock trading at $65 a share currently, and AOL offering 1.5 shares for each Time Warner share, this values the Time Warner stock at $97.50 a share.
However, Mr. Russo said that J.P. Morgan is bullish on AOL stock and said it could rise in the future, which would put a higher price on the deal.
The big question for the future, according to Mr. Russo, is how fast the cash flow of the merged company will grow. Time Warner and AOL executives have said cash flow will grow at a rate of 30% or better, but some analysts think that figure is too high.
In general, J.P. Morgan officials are bullish about the deal, he added. "We think it's the best of both worlds. It brings together the best content company, Time Warner, and AOL, with its digital connection to 20 million subscribers."
Some managers, however, are taking a wait-and-see attitude toward the deal.
"I don't think anyone knows if it's a good deal or a bad deal yet," said Ethan Silverman, general partner of Silver Tree Capital, a Greenwich, Conn.-based hedge fund that owned 40,000 shares of Time Warner stock when the deal was announced. "I don't think anyone can fathom it until we see more announcements of more synergies."
He sold 20,000 shares of his Time Warner stock after it had fallen back from its meteoric price rise when the deal was announced.