• by Diane Mermigas , December 2, 2008

Yahoo's deepening problems could be expeditiously addressed by a multi-pronged value-creating deal involving Time Warner's AOL and Velocity Interactive--if the principals could just agree on the value of the newly combined entity.

Some sources say the concept of an AOL-Yahoo tie-up remains viable as Yahoo conducts a frenzied search for a new CEO by year's end. But Yahoo's needs, like AOL's, are complex. Yahoo needs new executive leadership, strategy and surefire execution. In the wake of founding CEO Jerry Yang's decision to step down, the company is hastily considering experienced Internet CEOs, for whom the Yahoo learning curve and period of adjustment would still be prolonged. Yahoo's stock continues to plummet to as low as $9 a share, or less than one-third the $32-a-share that Microsoft initially offered to acquire the company last spring.

Yahoo's continuing rejection of Microsoft's offers--and the software company's reiteration that it is now only interested in acquiring Yahoo's search business--have not kept the rumor mill from speculating on a MicroHoo tie-up. Indeed, Time Warner could also benefit more from an AOL-Yahoo alliance.

Although Time Warner CEO Jeff Bewkes is in the process of spinning off a majority stake in its cable systems subsidiary, he faces the predicament of his company's core content assets being unjustifiably undervalued in a recessionary market. A Bernstein Research report Monday underscored at least a 44% decline in the value of Time Warner's well-regarded, ad-supported content assets that include the Turner cable networks, Warner Bros. studio and publishing. The Time Warner content "stub" is trading at 5.9 times 2009 estimated earnings--the lowest P/E ratio in a group that includes CBS, Viacom, Disney and News Corp. Like other public players, Time Warner is being hurt by weak stock prices and uncertain values.

Even if Time Warner uses the $9.25 billion on proceeds from the cable spinoff to broaden its content holdings by acquiring NBC Universal or CBS in 2009 as has been speculated, Bewkes still must pursue the sale or a long-term growth plan for AOL, which some on Wall Street have assigned a zero equity value. On-again-off-again discussions about some kind of AOL-Yahoo alliance have been stymied over the valuation of the combined company, in which Time Warner would retain an 18% to 20% interest. (Alternatively, Time Warner could opt to sell AOL to Microsoft, or spin off its Platform A to Google, sources say.)

While none of the principals will comment, the one solution that could provide an effective shortcut would be to involve Velocity and its co-founding managing partners Jonathan Miller, formerly CEO of AOL, and Ross Levinsohn, former CEO of Fox Interactive Media. Velocity previously said it would take a 20% equity stake in a combined Yahoo-AOL, which Miller and Levinsohn would manage to create a new executive team and execute a new strategy before stepping away.

In order to execute this deal in the coming months, Time Warner would have to waive its non-compete provision over Miller through March 2009, which also prevents Yahoo from pursuing an independent arrangement with Velocity. Bewkes reiterated his intent to enforce Miller's non-compete provision when Time Warner abruptly halted its deal talks with Yahoo without explanation earlier this year. Yang and activist shareholder Carl Icahn expressed support for a Yahoo-AOL alliance that would involve Velocity, Miller and Levinsohn.

Since then, the stock market has deteriorated along with the values of both companies, and Yahoo's future is more unsettled than ever. Icahn, now a Yahoo boardmember, boosted his company stake to 5.5% last week sans good news. The consistent factor in Yahoo's continuing drift is that its destiny seems invariably intertwined with AOL and Microsoft. And there is another irony.

In the time it takes Yahoo to search for, select and acclimate a new CEO before revisiting any deals next year, Miller and Levinsohn could have Yahoo and potentially a combined AOL-Yahoo entity refocused and reenergized. Velocity has declined a report in the Sunday London Times that Microsoft will pay $20 billion for Yahoo's search business (all of Yahoo is valued at about $16 billion), and would provide a $5 billion infusion for Miller and Levinsohn to manage the business. Media fuss over the erroneous report deflects the real focus: Yahoo is failing to act on a viable solution that is right under its nose.

For instance, Yahoo should be growing its brand advertising and its online display operation, which would be more difficult if it sells its search business to Microsoft. Brand advertising is an area where AOL once competed and neither Google nor Microsoft now play. Miller and Levinsohn would be driven to improve the combined value and performance of Yahoo-AOL not only as equity investors, but as industry executives with deep Internet experience and contacts. This would free up Bewkes to grow Time Warner's content prospects by putting its $9 billion liquidity to work in an opportunistic acquisition of NBCU or CBS. A more robust Yahoo-AOL could consider a search deal with Microsoft or other alliances when its can negotiate from a position of strength in an improving economic market in 12 to 18 months.

So why doesn't some version of this particular scenario take place? None of the principals involved will say. However, it was telling that Bewkes answered analyst inquiries about an AOL deal during Time Warner's third-quarter earnings call saying: "... in the media business, there's been a lot of value destroyed through poor acquisitions and poor capital allocation...we'll look at anything that would improve our operating position and scale."