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What's really wrong with the Google-AOL deal
By Kevin Kelleher 12/23/2005
Carl Icahn is mad. Oh, he's hopping mad.
He doesn't like Google buying a 5% piece of the AOL pie from Time Warner. And he's sent out an open letter to say so.
Of course, investing with Icahn frequently means a bumpy and downhill ride. His signature deal -- the hostile, junk-bond fueled takeover of TWA in 1985 -- presaged not one but three bankruptcies for the airline in the following 16 years. As a director of Blockbuster (BBI, news, msgs), he's helped steward its transition into an antiquated business model. And as chairman of XO Communications (XOCM, news, msgs), a once-relevant telecom company, he's managed to steer the stock near a record low.
So, if Icahn is barking about Google's (GOOG, news, msgs) investment in AOL, your inner contrarian might believe this is actually one of the better deals of the year. Icahn's beef is that by shooing away potential suitors like eBay (EBAY, news, msgs), Yahoo! (YHOO, news, msgs) and IAC/InterActiveCorp (IACI, news, msgs), the Google stake in AOL is interfering with the core function of the global economy -- making Carl Icahn more money.
On the other hand, as Time Warner's (TWX, news, msgs) board is expected to quickly approve Google's investment in AOL, the members might want to consider that Icahn has a point. This isn't a terribly good deal for anyone involved, only not for the reasons Icahn states. His specific complaint -- that the investment kills the chance for an outright takeover -- doesn't ring true. If anyone were interested in buying all of AOL, they had a golden chance this month.
Related news and commentary on MSN Money
Best option: an IPO
What everyone wanted, it seems clear now, is the attention of AOL's 20 million subscribers and the help of its sales staff -- only without the downside of actually owning Internet operations still lodged in the 1990s. The Internet has evolved. AOL hasn't. What the past few weeks make clear is that Time Warner's best option is to spin off AOL into an IPO and hope for the best.
And that's why the deal is the wrong one for AOL. Would the public market put a value on AOL of $20 billion, the valuation implied by the Google investment? It easily could. A value of $20 billion is less than one-fifth of the price tag that Time Warner paid for AOL five years ago. It's only twice as much as AOL itself paid to acquire Netscape a year before that.
Even by today's more modest valuations, $20 billion is only 2.3 times AOL's revenue last year. (By contrast, Yahoo! is trading at 12 times its 2004 revenue.) It's only 11 times AOL's operating income before depreciation and amortization -- well below similar valuations of many Internet highfliers. And AOL is getting leaner. Its revenue may have grown only 1% last year, but its operating income grew 41%.
From a strategic standpoint, Google is the best partner AOL could ask for, especially in an era in which search technology rules the Internet. But was it necessary to sell off 5% of itself for that alliance when the marketing partnership AOL has had with Google was ready for renewal? Couldn't AOL have strengthened its existing partnership without selling 5% of itself at a discount -- and leaving on the table the additional money it could have raised in a public offering?
Google's gain, Microsoft's loss
So, the Google purchase isn't ideal for AOL. And, as many others have already noted, it's a raw deal for Microsoft (MSFT, news, msgs). (Microsoft owns MSN Money.)
"Strategically, it keeps MSN from getting the only large Internet asset that could have made it a real contender in both (the) search and display ad business," Youssef Squali, an analyst at Jeffries & Co. (which has no underwriting relationship with Google, Time Warner or Microsoft), wrote in a research note. "AOL would have materially increased MSN's share of search (and lowered Google's) and put it in the leadership position for display ad revenues," he wrote.
Understandably, the blow to MSN has unleashed a lot of pent-up schadenfreude among those used to seeing Microsoft elbow its rivals out of partnerships that would have helped them.
A loss for the Internet
But hold on there. Is this blow to Microsoft really such a great thing? A page from Microsoft's playbook is bad for innovation, whether it's being played by Microsoft or against Microsoft. Why? Because right now, Google and Yahoo! are the only search companies with deep-enough pockets to invest heavily in the development of the Internet. Adding a third big player would only strengthen the competitive race.
Microsoft, which has $40 billion in cash and short-term investments, would be willing to invest more of that in new search technologies if it had a bigger foothold in search. That's why seeing Google resorting to this kind of bullying -- even against Microsoft -- is especially depressing. Google used to pride itself on investments in smarter technology, not in shoving competitors out of the market.
And playing the bully isn't going to help improve Google's increasingly negative image among users. Neither will stories that Google will give AOL preferred placement in its rankings, including plunking the AOL logo into its search results. The New York Times says Time Warner asked Microsoft for a similar concession, but "Microsoft refused, calling the request unethical."
So the overhyped Google-AOL deal probably will deprive AOL of badly needed capital it could have raised in an IPO, kick a potential and cash-rich innovator out of the running for search and further tarnish a rapidly deteriorating public image for Google. Carl Icahn is right, if for the wrong reasons: This deal stinks.
The only long-term winners may be the search companies that don't adopt Google's worrisome tactics, companies that will draw new users who are hewing to the ethical guidelines Google originally set down. Companies like Yahoo!, which has made some of the smarter deals this year but backed away from AOL early on.
The only other winners? The attorneys for Icahn and Time Warner, if the corporate raider decides to sue to prevent this deal.
By Kevin Kelleher, TheStreet.com
At the time of publication, Kevin Kelleher did not own or control shares of companies mentioned in this column.
© 2006 TheStreet.com, All Rights Reserved.
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