How $100bn went up in a puff of smoke

How can you lose $100bn (£61bn)? It seems an impossible feat, but one American media company has managed it. Last week AOL Time Warner, a colossal empire whose products vary from Harry Potter films to Now magazine, reported it had made a loss of $99bn in 2002.

It seems an extraordinary vanishing trick, given the $41bn revenues in 2002. It was nothing to do with the sales figures, for although AOL Time Warner is enduring an advertising recession, total sales were up 8 per cent compared to the year before.

The cause is almost entirely the extraordinary merger that created the company in 2000. The fashionable America Online, a subscription internet company founded by the Hawaiian Steve Case, was valued so highly that it could take over the more traditional media company Time Warner. The combined value of the two was more than $300bn.

AOL's market valuation was so large, it could use its own shares to do the deal, although Time Warner's sales and profits dwarfed the efforts of the upstart internet firm. The deal was praised and Mr Case installed as chair- man. It was seen as the "new economy" of html and digital transmission triumphing over the boring but profitable sectors of film and magazines.

However, the stock market has had a brutal reality check. The combined company is now worth a little over $50bn. Last year's $100bn loss was mainly due to a writedown of the "goodwill" created by the merger.

"The market is now valuing the company's shares much lower than they were previously," explains Neil Blackley, media analyst at blue-chip investment bank Merrill Lynch. "The goodwill came in during 2000, and was fixed in the balance sheet, when the share prices were considerably higher." Companies were less willing to advertise in AOL's diverse media outlets last year, and the performance of its music division is suffering from piracy around the world.

The reason for Mr Case's departure earlier this month is now abundantly clear. But the departure last week of cable veteran Ted Turner, who had previously sold CNN to Time Warner, was more of a surprise. Mr Turner didn't mince his words when the merger was announced, saying he was as enthused by it as when he lost his virginity. But the former husband of Jane Fonda grew to resent Mr Case and was one of many investors who wanted to boot him out.

Now AOL is taking drastic action to reduce its $27bn debt, first spinning off the cable division. There is speculation the book publishing and music divisions might be sold off to raise money, and even Time magazine could be on the block. The new chairman, Dick Parsons, must be fuming about the potential loss of these media gems, sacrificed to solve a problem aggravated by internet silliness.

The former White House aide and banker started at AOL in 1995, but moved up as less favoured executives moved out. He must restore trust in AOL and strengthen the balance sheet. He is not as much of a celebrity as the departing executives Ted Turner and Steve Case – but shareholders need a little less pizzazz and a little more sobriety.