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For AOL, It's Decision Time

December 2005

By Steve Rosenbush  

For AOL, It's Decision Time  

The months of wooing and closed-door talks with rivals Microsoft and Google are almost over. Now, Time Warner is poised to announce which suitor takes the prize

December 7th 2005. The future of Time Warner's (TWX) America Online Internet division hung in the balance on Dec. 6, as the media giant held separate, ongoing negotiations with Google (GOOG) and Microsoft (MSFT). The discussions could lead to a joint venture with either. A Time Warner executive, who spoke on the condition of anonymity, told BusinessWeek Online that the media giant was likely to enter into exclusive talks with Microsoft or Google "within 48 hours." A deal could be reached by the end of the year.
The talks have been scaled back since earlier this year, when they included the prospect that Time Warner would sell a minority stake in AOL. But Time Warner has decided that the legal, regulatory, and managerial obstacles of a partial sale would be too complex, and it prefers to strike a commercial agreement instead, the executive said.

C-LEVEL CONVERSATIONS. There are two possible outcomes. Time Warner and Microsoft could create a joint venture combining their respective online networks, AOL and MSN. They would merge their online ad-sales operations, and MSN would replace Google as AOL's search engine. The outfits also are talking about making their instant-messaging platforms interoperable, BusinessWeek Online has learned. Both companies would retain 100% ownership of their own networks.

The Google talks could lead to a slightly different kind of deal. Google would remain as AOL's search engine, but it would give more revenue to AOL. The companies would combine online advertising operations, too. But Time Warner isn't contemplating making its America Online and AOL Instant Messenger systems, which have about 40 million users, interoperable with Google Talk, which has about 2 million users. MSN Messenger has about 20 million users, making it a more attractive IM partner for AOL.

The discussions have involved people at the highest levels of each company, said the executive. Time Warner execs at the table include Chief Executive Dick Parsons, Media Business Chairman Don Logan, Executive Vice-President Olaf Olafsson, AOL CEO Jon Miller, and AOL Chief Financial Officer Steve Swad.

The Microsoft contingent has been led by CEO Steve Ballmer. Google's team has been headed by CEO Eric Schmidt and founders Larry Page, president of products, and Sergey Brin, president of technology. Executives have crisscrossed the country and held near-constant talks on the phone in recent days.

DIFFERENT DEMOGRAPHICS. The outcome of the quickly developing situation could alter the competitive dynamic among big Internet players. The networks are similar in size. Yahoo! (YHOO) had 124 million unique visitors as of October, the latest month for which data are available, according to researcher comScore Networks. Time Warner, which includes AOL and other destinations, had 117 million visitors. MSN had 115 million visitors, and Google had 90 million.

But AOL's online advertising business isn't as profitable as that of Yahoo or Google. That's because advertisers believe that Yahoo and Google command a higher percentage of broadband users, as well as a higher percentage of daytime users who surf the Web at work. Rival AOL still is viewed as a medium for dial-up customers who log in at night.

By combining AOL with MSN, Time Warner could attract more daytime and broadband users, boosting its profitability. The deal also would improve profitability by allowing the new entity to sell ads to a larger base without significantly increasing fixed costs.

SEARCH FOR PAYOFF. Many outside observers believe that MSN has the edge. "I don't think that Google is going to win," says investment banker Ken Marlin, founder and manager of Marlin & Associates, a media- and technology-oriented investment bank in New York. (Marlin isn't part of the negotiations.) If nothing else, Microsoft appears to want it more.

The software giant believes its future is closely linked to the paid-search business, in which advertisers pay for good placement in search results related to their line of business. Microsoft, which is behind Google and Yahoo in this market, can't catch up on its own. If an MSN-AOL deal on instant messaging can be reached, the companies also would have dominance in a second area of importance.

Time Warner has been pilloried for merging with America Online at the height of the dot-com bubble. While the financial terms of the deal may never be vindicated, the strategy is looking sounder. AOL has long recognized the value of paid search, acquiring for $435 million in October, 2003 (see BW Online, 8/29/05, "Internet Mergers: Who's Next?"). The price seemed steep at the time, but online advertising is expected to rise 40% this year, to $13 billion, according to Marlin. Traditional advertising is growing at about one-fifth the pace.

MAINSTREAM MOVEMENT. Online advertising is closely related to search. As portals such as Google, Yahoo, MSN, and AOL develop local-search capabilities, they can sell ads for a broader array of searches. For example, a car dealer in Phoenix can pay to have good placement when someone searches for dealerships in that region. The market will grow as traditional advertisers shift to online spending, and as international markets come into their own.

Google also hopes to sell search as a tool for data-heavy industries such as health care. That's an area where Yahoo and AOL have less ambition, but Microsoft will be a player, Marlin says.

The AOL talks are just the latest sign of the Internet's move to the mainstream of media and entertainment. Google shares recently surpassed $400, a major milestone (see BW Online, 11/18/05, "Is Google Flying Too High?"). And traditional media companies like Knight Ridder (KRI) are on the defensive (see BW, 11/21/05, "Where Ridder Went Wrong"). Regardless of which company wins the AOL deal, the consolidation of big Web portals will only make the group more formidable as a whole.

Copyright © 2005 BusinessWeek. All rights reserved  

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