AOL: The Monkey On Time Warner's Back

Time Warner is struggling to command a respectable valuation for AOL in a troubled deal market--after running the once-premiere search engine into the ground. This may be the worst case ever of destroying shareholder value not once, but twice.

Plans by new CEO Time Warner Jeff Bewkes to sell off AOL's dwindling dial-up access business--and possibly the Web site and its advertising businesses as well--are the company's best solution for unlocking shareholder value, something TW has tried to do since the 2000 merger. Time Warner also plans to spin off its 84% stake in Time Warner Cable and sell some international publishing assets, creating a pure-play entertainment and U.S. publishing concern.

Any player hoping to better monetize and transform AOL's platform will be seeking bargain prices in a tumultuous market. Some analysts estimate that AOL in total could be valued as much as $20 billion. Morgan Stanley analyst Benjamin Swinburne estimates that AOL's 9 million subscriber dial-up access unit could fetch $4 billion, and its remaining advertising businesses $9 billion. InterActiveCorp Chairman Barry Diller, who previously expressed interest in AOL, said: "If AOL came down in price to something really ridiculous, we probably would look at it."



Cash-rich Google could seize AOL's Web and advertising operations to battle a proposed merger of Microsoft and Yahoo. A complete sale or deeper partnership would be hastened by Google's option to take its 5% stake in AOL public by July. There also are rumblings that eBay, an independent online retailer that increasingly relies on Google and Yahoo for traffic, could seek some security in buying AOL.

In the most simplistic terms, Time Warner has spent billions making a case for and utilizing AOL, only to potentially sell it off for much less than it was valued in 2000. In fact, analysts say Time Warner reducing itself to a pure-play film, cable and domestic publishing business would result in a price target of $20 a share--where it has been for most of this decade.

The AOL-Time Warner merger was fully valued at $190 billion when it was announced early in 2000, and deteriorated to $104 billion on volatile trading when it closed a year later, with AOL-Time Warner shareholders losing more than 60% of their value. (At that time, Google was a start-up going from 7 million to 100 million daily searches after becoming Yahoo's search default.)

A year later, AOL Time Warner shares dipped to $15 a share and founding CEO Steve Case resigned, leaving the hybrid in the hands of old-line TW executives. Two years later, AOL revenues declined more than 30%, and the combined company struggled to achieve 5% annual earnings growth--not the 25% originally promised.

Today, nearly all of AOL's business metrics are flat, at best. Only its ramping advertising revenues are growing double digits, bolstered by recent acquisitions. Swinburne projects that this year AOL earnings will decline 33% to $1.7 billion on a 15% decline in revenues to $4.4 billion. From now on, AOL will be a declining contributor to Time Warner fortunes, accounting for 11% of the company's revenues and 14% of its adjusted operating income. Separating AOL from Time Warner's content business is a must, because it will "allow for more focus on stronger businesses," said UBS analysts Michael Morris and Matthieu Coppet.

The sale or spinoff of all or part of AOL may render too little and prove too late. The two most logical buyer/partners--Microsoft and Yahoo--will likely merge with each other, creating a second insurmountable rival for AOL, after Google.

Bewkes was quick to say on his company's earnings call this week that Microsoft's unsolicited $45 billion offer for Yahoo underscores the value and potential of AOL--none of which Time Warner has been able to realize in seven years. However, the decision to finally spin off or sell AOL comes at a time when volatile markets, credit and fundamentals make it difficult to devise accurate valuations for any proposed acquisition. Technology and Internet stocks are getting clobbered on concerns they will be vulnerable in a weakening economy. The biggest Internet players are immersed in their own struggles and cautious forecasts.

Yahoo, which had a $107 billion market cap in 2000, is trying to fend off an unsolicited $45 billion takeover by Microsoft that is nearly double the market cap of its core Internet operations. (Another $20 billion in Yahoo value comes from its investments in Alibaba and Yahoo Japan). Microsoft's plodding MSN and other online units need Yahoo's domain online audience reach. IAC's struggling cornerstone brand Web sites also are being spun off in a controversial restructuring.

As some analysts have pointed out, stirring shareholder enthusiasm over break up or sale of an asset is not the same as fundamental strength. As investors grow restless, time is running out for AOL, and for Yahoo and Microsoft to get on with it. Time Warner would be better off focusing on development of its global video and film content and exploiting its key brands for the "sustainable long-term growth" it has long sought, rather than trying to beat it out of AOL and further asset divestitures. Enough merger remorse.

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