• by Wendy Davis  @wendyndavis, December 19, 2005

Reports surfaced late last week that Google would buy a 5 percent stake in AOL for $1 billion--a move that solidifies the relationship between the two companies while dashing Microsoft's hopes of bolstering its fledgling search engine with AOL's traffic.

The deal, if approved when the Time Warner board meets this week, means that Google will continue to power AOL's search engine for at least five more years; the pay-per-click revenue from those searches alone currently accounts for an estimated 11 percent of gross Google revenue. The deal also reportedly involves AOL selling ads to be displayed on publisher sites within Google's AdSense network.

The combination of Google and AOL potentially creates an online advertising juggernaut. Last month, Google drew 85.5 million unique users and AOL drew 74.3 million uniques; combined, they far overshadow the previous leader, Yahoo!, which garnered 103.8 million uniques.

The deal also thwarts Microsoft's hope that it could promote its search service by replacing Google at AOL. Currently, MSN Search lags far behind both Google and Yahoo! in market share. In October, Google accounted for 48 percent of all searches, followed by Yahoo! at 21.8 percent, and MSN a distant third, at 11.3 percent.

Microsoft had been courting AOL since January, but news of the talks was kept secret until September, when the New York Post revealed the negotiations. After the account was published, Google reportedly also started courting the company.

One source told OnlineMediaDaily that AOL insiders favored Google over Microsoft, because Google's culture appeared more similar to AOL's than did Microsoft's.

The deal values AOL at $20 billion, which is on the high end of analysts' estimates. Time Warner's most recent stock filing showed $959 million in AOL ad revenues for the first nine months of the year--a 39 percent increase from 2004. AOL also collects revenues from its subscribers, currently numbering around 20 million, but the subscriber ranks are quickly diminishing as users migrate to broadband.

The deal also requires Google to direct traffic to AOL and, in some fashion, to give prominence to AOL properties within the search results. But the exact shape that portion of the deal will take is unclear. The New York Times reported that Google agreed "to give AOL ads special placement on its site," but noted that such a move is inconsistent with Google's prior business plan. "Until now," wrote the Times, "Google prided itself on its auction system for ads, which treated small businesses on an equal footing with its largest customers."

The Washington Post described that component of the deal in a more limited fashion, reporting that AOL will be able to "buy graphic ads that appear alongside the text-based ads Google traditionally has displayed to the right of its free search results."

AOL's video service will also be promoted in Google's video search, according to both The Washington Post and The Wall Street Journal.