AOL is A-OK

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AOL is A-OK
By Paul R. La Monica
CNNMoney.com editor at large
http://money.cnn.com/2007/04/04/news/companies/tim ewarner_aol/index.htm? section=money_technology

NEW YORK (CNNMoney.com) -- It is the rumor that just won't die.

After a ballyhooed merger between AOL and Time Warner six years ago that has, to put it kindly, yielded mixed results at best, people on Wall Street love to keep speculating about AOL's future within the Time Warner organization.

In the past few weeks, analysts at both UBS and Bear Stearns have suggested that Time Warner could either spin off a portion of AOL, a similar strategy to what Time Warner (Charts) has done with its cable subsidiary Time Warner Cable (Charts), or merge it with another Internet giant. (Time Warner is also the parent company of CNNMoney.com)

Google (Charts), Yahoo! (Charts), Microsoft's (Charts) MSN or IAC (Charts), the Web conglomerate run by Barry Diller that owns Ask.com, have been mentioned most often as likely candidates in a merger scenario. Google, in fact, bought a 5 percent stake in AOL in late 2005 for $1 billion.

Shares of Time Warner have increased nearly 6 percent since UBS issued its report on March 16. The stock's rise probably is not due entirely to AOL speculation, however, since other big media stocks such as Walt Disney (Charts), News Corp. and CBS have also rallied, along with the broader market, in recent weeks. The Bear Stearns report came out on March 26.

Executives from Time Warner were not immediately available for comment. But president and COO Jeff Bewkes dismissed talk of an AOL spinoff or sale during a presentation at a Bear Stearns media conference last month.

"We are high on AOL's prospects now," Bewkes said at the conference. "We are optimistic about what they are going to do, which does not lead us to be thinking about taking AOL anywhere."

And some technology and Wall Street analysts also wonder if now is the right time for Time Warner to be considering such a drastic move for AOL.

"The world's biggest media company should have a big presence online and they should have it through a general purpose portal that serves a mass audience. That's the role that a media conglomerate should play," said David Card, a senior analyst with Jupiter Research. "AOL is still a natural for Time Warner. The execution has gone back and forth but they are running it well right now."

To that end, the Internet unit finally seems to be capitalizing on strong online advertising trends and also overhauled its senior management team in the past few months.

Last August, AOL announced that it would no longer charge broadband subscribers fees to have AOL e- mail accounts. The move came as AOL has steadily lost subscribers to both cheaper dial-up services as well as high-speed offerings from phone companies and cable outfits, including Time Warner Cable.

In November, AOL announced that it hired former NBC Universal executive Randy Falco to replace Jonathan Miller as AOL's chairman and CEO.

So far, the changes have led to some encouraging signs for AOL and Time Warner. AOL reported a 49 percent increase in online advertising revenue, as the division has focused more on driving traffic to AOL- owned properties such as the flagship AOL.com, celebrity news site TMZ.com and MapQuest.

"AOL is doing well now in terms of its ad revenue strategy. It made this painful transition from being a largely subscription-supported entity to an ad- supported entity, and there is a lot of momentum," said Greg Sterling, principal with Sterling Market Intelligence, a consulting and research firm focusing on online advertising.

But online advertising is still a small part of AOL's revenue stream. As such, overall sales and adjusted operating income before depreciation and amortization (OIBDA), a key measure of profitability, at AOL slid in the fourth quarter of 2006 due to lower subscriber fees.

Thomas Eagan, an analyst at Oppenheimer & Co. who follows Time Warner, said that with this in mind, it's too soon to talk about whether or not AOL might be spun out or merged with another Internet or media firm.

Eagan said it makes more sense for Time Warner to see whether or not AOL's new strategy can eventually lead to sustainable gains in profits before deciding to make any major changes regarding AOL's ownership.

"It's premature to spin off AOL, since Time Warner has been indicating that early results from the shift to advertising are positive," Eagan said. "It makes sense for Time Warner to give AOL some time for the new strategy to take hold."

That said, Eagan does not rule out Time Warner doing something with AOL in 2008 or 2009. That's because he expects Bewkes to be calling all the shots by then. Bewkes is widely considered the successor to current Time Warner chairman and CEO Dick Parsons when Parsons' contract with Time Warner expires in 2008.

And Bewkes, despite his support of AOL, did not rule out a possible spinoff down the road. At last month's Bear Stearns conference, he said that if AOL's turnaround continues and the market is willing to pay a higher price for the company, it "could be reasonable to create separate currency" for AOL in order to pursue more acquisitions.

According to a report by Bear Stearns analyst Spencer Wang, AOL could be worth more than $20 billion, or about a quarter of Time Warner's total market value.

But Greg Gorbatenko, an analyst with Jackson Securities in Chicago, said he did not think that a spinoff of AOL is necessary.

He argues that a separate stock for the cable unit made sense because Time Warner can use that to make major cable acquisitions. By contrast, AOL has made several smaller acquisitions, most notably in the online video market, during the past few years without having an AOL stock to use to finance deals.

"I wouldn't say they need to spin off AOL," Gorbatenko said.

Sterling said that he thought it would not be a good idea for Time Warner to give up any control of AOL now that it finally is benefiting from strong demand for online advertising.

"The promise of the original AOL merger is finally coming clearly into view so the timing of a spinoff or sale doesn't make sense," he said. "Now there is an opportunity for Time Warner to do something interesting with AOL. It's a valuable asset you probably would want to retain."

As for a merger, Sterling said he would not be surprised if Microsoft's MSN or Yahoo! would be interested in AOL since a combination could help boost their efforts to take market share from Google in search.

"Does AOL need to merge with another entity? Microsoft or Yahoo might be hungry for that type of thing," he said.

But Card thinks that a deal with either of those two would make little sense since AOL already has a relationship with, and an investment from, Google. So why abandon a deal with the established industry leader?

"Merging AOL with MSN or Yahoo might be good for jumpstarting their search businesses but it would not do much for AOL," he said.


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