What's to Be Done with AOL?

Sure, it gets no love from Wall Street, but potential buyers and dance partners abound

by Jon Fine

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Time Warner CEO Bewkes is likely to prefer a deal for AOL that nets the most cash Noah Berger/Bloomberg news

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Istvan Banyai

For Time Warner, AOL is the gift that keeps on giving, assuming "gift" means "that which kicks you in the shins, over and over again." As I write, Time Warner's (TWX) share price has drooped below $15. Wall Street wiseguys say this is at least partly because the market essentially values AOL at zero.

It's always been easy to hate on AOL (TWX). It's a New Media property with Old Media problems, dependent on outmoded businesses—hello, dial-up subscribers!—and in need of reinvention. (Even though AOL has had so many strategic reboots I've honestly lost count.) It's a technology company based on lousy technology. But in an ongoing mystery of modern media, it persists. It has a constellation of enormously trafficked sites ranging from AOL Sports to tmz.com. Last year AOL took in $5.2 billion in revenue and threw off $1.8 billion of cash flow. Its traffic may be stagnant, but around 110 million people still visit each month, and it remains an unquestioned giant of the Web.

What would happen to those big numbers if AOL were to sell its dial-up business (which it's mulling) is a bit unclear. A recent public filing stated: "AOL's advertising revenues associated with the AOL network [of owned and co-branded sites and applications], in large part, are generated from the activity of current and former AOL subscribers." Also, while last year's revenue was $5.2 billion, in 2006 it was $7.8 billion. Almost half of AOL's first-quarter revenues still came from the subscriber business, and ad revenue rose a measly 1%, while overall Web spending was up by double digits. In 2007, AOL's ad growth was 18%—better, but still behind overall online gains of 26%.

Still, AOL's cash flow and traffic (and its revamped ad capabilities) are worth well north of zero to similar players. The dissonance between market value and potential-buyer value gives Time Warner some flexibility in figuring out how to scrape this scab off its portfolio. Bet on something happening in the not-too-distant future. As for with whom, a quick rundown:

Microsoft

At the time of the Google deal, Microsoft (MSFT) came thisclose to creating a joint venture between AOL and its own Web assets. Two executives say a Microsoft deal almost happened at least once before then as well. Microsoft is AOL's current buyer of choice, especially since Microsoft's botched bid for Yahoo! (YHOO) drove that portal into Google's smothering embrace. Also, the pricetag for AOL is all but guaranteed to be less than one-fourth the fortysomething billion Microsoft offered for Yahoo, and as of Mar. 31, Microsoft had more than $26 billion in the bank. Wild card: Microsoft's apparent ambivalence about spending palpitation-inducing sums for media businesses.

Google

Bought 5% of AOL in December 2005 and is its longtime search partner. At the end of June, Google (GOOG) can exercise an option to sell its stake or require AOL to buy it back, but look for no change in the status quo.

Still, the search deal terminates if AOL changes hands—which might make Google play hard for AOL should other buyers swoop in. Google couldn't buy it outright, of course—if antitrust types are howling about Google's recent nonexclusive partnership with Yahoo, they'd have heart failure if Google bought AOL. So imagine a joint venture that combines AOL with some stray Google assets, with Google anteing up enough for a 49% stake—including the subscription business. How about some Google-branded, ad-supported Web access—for free?