Yahoo (YHOO) and AOL (TWX) are talking more seriously about a merger as an alternative to the Microsoft (MSFT) bid, the WSJ says. Specifically, Time Warner is preparing a proposal that Yahoo can take to its board and shareholders. The proposal would involve Time Warner folding AOL into Yahoo for a sizable minority stake (we estimate 25%-35%–see spreadsheet). As with the Microsoft option, the companies are discussing the usual $1 billion in synergies.
In our opinion, Yahoo is unlikely to be able to persuade shareholders that an AOL merger would be a better option than taking Microsoft’s money (plenty of integration challenges there, too, and no quick payoff), but it’s worth a try. If nothing else, a real option here might extract a few more dollars out of Microsoft.
YAHOO-AOL WOULD BE A SMART COMBINATION
As we argued several months before the Microsoft bid, a Yahoo-AOL combination would make sense for all parties–Yahoo, AOL, and Time Warner:
The combination would bolster Yahoo’s domestic market position, especially in ad networks and display advertising. Yahoo and AOL have almost the same strategy with regard to owned-and-operated properties and third-party ad networks. By combining forces with AOL’s Advertising.com, Tacoda, et al, Yahoo would dominate the third-party network business. It would also have far stronger owned-and-operated properties than AOL ever will as a standalone. The combination would allow the company to more effectively become a “must-buy” for advertisers, as well as a desperately desired alternative to Google.
The combined company would have a stronger share of search queries. Yahoo’s search share has been declining, as has AOL’s. It’s true that tying two bricks together won’t make them float, but neither will keeping them separate. More share is good, especially with search algorithm efficiency heavily dependent on volume.
AOL’s stand-alone brands–TMZ, Mapquest, Truveo, etc.–would fit will within the Yahoo empire and could be further leveraged though Yahoo’s global distribution platform. .
AOL’s AIM, ICQ, and Yahoo Messenger could all be standardized and made interoperable. This combination would make Yahoo by far the most powerful online communications platform, an area where Google is still weak.
Yahoo could replace AOL’s ghastly email system with Yahoo Mail, bolstering Yahoo Mail’s competitive position. This would save money and customers.
Yahoo could cut a lot of redundant cost (technology, data centres, distribution), which would make the AOL business far more profitable than it is today. The WSJ speaks of $1 billion in synergy. This could make the deal less expensive.
Yahoo could cut long-term distribution agreements with other Time Warner content properties, which would benefit both sides.
We estimate that AOL is worth about $10-$12 billion. Yahoo currently has about a $40 billion market cap (thanks to the Microsoft bid). A stock deal would produce a combined company worth about $50-$55 billion, with Time Warner shareholders owning about 25%. Time Warner would likely argue that it should get at least a third of the combined entity, because Yahoo’s stock has been inflated by the Microsoft bid. Please see this online spreadsheet for details