BW Online | January 30, 2003 | AOL-Microsoft? Not Likely, Just Logical

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JANUARY 30, 2003

STREET WISE
By David Shook

AOL-Microsoft? Not Likely, Just Logical
[Page 2 of 2]

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TWO-WAY CHANNEL. Scan the landscape of potential buyers, and you'll find none more able or motivated to swing the deal than cash-rich Microsoft, with its grand strategy to be the largest purveyor of consumer software and interactive games on the Internet. The reason Gates created MSN was to give his company a two-way channel to millions of consumers. By acquiring America Online, the Redmond (Wash.) software king could ensure itself of regular contact with 40-odd million people. Such a huge customer list might be just what Microsoft needs to finish executing its Net strategy. "AOL is still the largest consumer hub on the Internet. That's not changing anytime soon," says Adam Sarner, a software analyst for Gartner Group.

Thanks to the prowess of Gates's army of programmers, a Microsoft-powered AOL service might also deliver improvements and upgrades to customers faster. For example, e-mail on AOL, while reliable, is slower and less user-friendly than competing products from Microsoft and Yahoo! (YHOO ). And Microsoft's technical expertise in other areas, such as Web browsing, far surpasses AOL's.

More important from Microsoft's viewpoint might be its neck-and-neck battle with Nintendo (NDTDOY ) for the No. 2 spot in the lucrative video-gaming market. Sales of Microsoft's Xbox console, while still small in relative terms, represent the company's fastest growing segment. Xbox still has only 11% of the $10.3 billion gaming market, vs. Sony Playstation's 56%, according to gaming-industry researcher NPDFunworld, but Microsoft is clearly gunning for Sony (SNE ).

"EXTREMELY POWERFUL." Online gaming -- where players compete against one other live on the Net -- represents some of Microsoft's best ammo. And, Microsoft could gain faster on Sony if it could market its new Xbox Live service to millions of America Online customers. "With AOL's customer list, Microsoft would be able to expand its reach in several software markets," says Eric Paulak, a vice-president and research director for Gartner Group and an ISP expert.

Another incentive for Microsoft is that America Online, despite its problems, is still a profitable company, with more than $8 billion in annual revenues. Notes Yankee Group analyst Rob Lancaster: "I think Microsoft buying America Online is a stretch, but keep in mind that a lot about AOL remains quite valuable. It has all those relationships with partners, the huge online traffic, millions of customer relationships, and the ability to reach out daily to 30 million people for an average of 1 hour a day. That's an extremely powerful medium."

Of course, a number of obstacles make a Microsoft-AOL deal improbable. It would certainly attract the attention of antitrust watchdogs at the Justice Dept. And it would be hard to settle on a price. Most likely, AOL Time Warner would want at least the $8 billion to $9 billion or so in debt that it assigns to the online service. At some $250 to $300 per customer, that would be a lot to swallow, even for Microsoft.

INTERNET DREAM. Still, "it would make sense to buy AOL if it could be integrated into Microsoft in a way that would make MSN more profitable than it might be otherwise," says Peter Cohan, founder of investment management firm Peter Cohan & Associates in Marlborough, Mass. Microsoft guards MSN's financials so closely that it's impossible to guess how such a deal might affect the service's profitability.

AOL CEO Richard Parsons has often said he intends to keep the online business. Yet given its other troubles and America Online's dimmed prospects, AOL Time Warner might have an incentive to sell America Online before its value falls further. And Microsoft might have an opportunity to achieve its Internet dream with one transaction. It's possible that no one inside either company has had such thoughts. But who knows -- maybe they have.

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Shook writes about the markets for BusinessWeek Online in New York

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