• by Diane Mermigas , March 14, 2008

Buying Bebo.com for $850 million boosts AOL's social-networking profile. But it will do little to improve its user engagement intelligence quotient unless it can master advertising without disenfranchising its fickle online communities.

AOL should study recent attempts by Facebook and News Corp.'s MySpace to discreetly integrate targeted ads into user-generated content. That tricky proposition is very different from AOL's traditional approach, as well as the ad-related applications rolled up into AOL's new Platform A. If social networking were easy to monetize, AOL would have been able to squeeze more value out of its instant messenger service, where each user has an average of 100 "buddies." Platform A's big brands will not necessarily transfer to Bebo, where users are accustomed to subtle engagement marketing, such as select ad placement in video dramas and a single targeted ad per page.

Still, AOL is betting there are ways to make it work.

eMarketer estimates that global ad spending on social networks should top $2 billion this year from $1.2 billion in 2007, and double to more than $4 billion by 2011. U.S. ad spending on social networks was about $1 billion last year, with $510 million going to MySpace and $145 million going to Facebook. Regular users of U.S. online social networks years will top 100 million by the decade's end, up from 86 million in 2008.

AOL's long-needed social-networking "beachhead," according to Bear Stearns analyst Spencer Wang, underscores the growing importance of online communities to advertising and commerce despite the fragile and complex ecosystem involved. Facebook angered its 67 million members with the short-lived Beacon initiative that tracked and shared their online purchases. It is now resorting to new tactics, including a new hyper-targeted ad system and a plan to pay users who assist merchants in selling their goods and services to their "friends."

The Market Lodge program will pay Facebook members a 10% sales commission on their successful recommendations. There is skepticism about Time Warner and AOL's planned ability to leverage established advertiser synergies. "Questions remain regarding the near-term appetite of advertisers to shift meaningful levels of their existing budgets to social-networking sites, particularly in the current weak ad environment," said Morgan Stanley analyst Benjamin Swinburne.

Market Lodge is one of the many new third-party developer applications aimed at generating new revenues for social networks. The rush of new applications, mostly in the form of widgets, are transforming social networks into springboards for advertising and commerce from places of confidential expression and chat. Widgets and advertising applications will more than double to $40 million this year, although they represent only 3% of domestic social networks' ad spending, according to eMarketer.

The real danger is that widgets will transform social networks into the kind of walled garden that AOL was a decade ago. Advertisers know they must follow along with the personalized applications that could make social networks the new one-stop ISPs. AOL faces the dual challenge of successfully adapting to the specialized ad environment of social networks and surviving its other ongoing internal turmoil.

AOL could realize immediate gains from Bebo's international and mobile reach and applications. Although the addition of Bebo makes AOL an even more attractive acquisition target, AOL has spent more than $1 billion in the past year buying advertising-related and other tuck-in Web sites and launching new features to energize its focus. Earlier this week, Time Warner CEO Jeff Bewkes said he was interested in combining AOL with another company to create more value, although it is not clear whether he had the Bebo transaction in mind or a complete AOL spinoff or sale.

The addition of London-based Bebo gives AOL much-needed international and mobile heft. Bebo is the second-largest social network in the United Kingdom behind Facebook, and the third-largest in the U.S. While it may make AOL look more appealing to Yahoo as a potential partner, analysts still expect Yahoo to succumb to Microsoft's $31 a share take-out offer.

AOL's willingness to pay an estimated $21 for each of Bebo's 40 million unique members looks cheap by comparison to the $300 for each of Facebook's 50 million members that Microsoft paid in October. Its overall $240 million investment in Facebook (less than 5%) suggests a $15 billion valuation for the privately held social network. MySpace, for which News Corp. paid $580 million two years ago, is now worth an estimated $10 billion. Bebo's 13-24-age audience, primarily outside the U.S., has been especially wowed by original Web content, such as LonleyGirl15 spin-off Kate Modern and The Gap Year.

Bebo, which is 3 years old, is expected to generate $10 million in earnings on $50 million in revenues in 2008, climbing to $92 million in earnings on more than $190 million in revenues by 2010.

Despite all the fuss over social networks, it is interesting to note that Google, News Corp., Yahoo and NBC Universal reportedly passed on Bebo, which was being pitched in recent months by Allen & Co. for about $1 billion. The hands-down winner in the deal is venture capital firm Balderton Capital, which will reap $140 million, or a nine-times return on its initial $15 million Bebo investment in 2006.