AOL Hunts for Eyeballs With (Fool Plate Special) December 22, 1999

An Investment Opinion

AOL Hunts for Eyeballs With

By Brian Graney (TMF Panic)
December 22, 1999

Online services giant America Online (NYSE: AOL) has carved out a name by offering a popular way of navigating the vast expanses of the online medium. Now, the company is branching out to help users find their way around their own neighborhoods and the most direct route fromFlagstaff - Tallahassee.

This morning, AOL announced that it is acquiring online mapmaker (Nasdaq: MQST) in a stock swap valued at about $1.1 billion. Under the deal, each MapQuest share will be converted into 0.31558 of an AOL share, which works out to a value of $26.82 per share based on AOL's closing price yesterday. That's roughly the same price as the closing price of MapQuest's shares last Friday, prior to the stock's 21% run-up over the past two trading days ahead of the deal. Not surprisingly, MapQuest's shares quickly gave back most of this week's gain this morning as buy-on-the-rumor traders completed their time-worn Wall Street pas de deux by selling on the news.

As part of the required sales pitch to investors, AOL management stressed the important role it sees MapQuest playing on the local commerce level. "Eighty percent of purchases occur 20 minutes from home and MapQuest will give us additional strength in this critical local market, with maps and directions driving new increases in local commerce,'' said AOL executive Ted Leonsis. The idea is to add AOL advertisers on the local level, weaving AOL even further into the fabric of its users' everyday lives.

New-age PR firms and consultants may get weepy upon hearing such a strategy, but the prime rationale behind the purchase most certainly is Internet business at its cut-and-dried best. MapQuest has one thing that every Internet company -- even a 20 million-member powerhouse like AOL -- covets: eyeballs, and lots of them. According to Media Metrix, MapQuest is a top 50 website in terms of reach. It also delivers its mapping services to almost 1,000 websites and is linked to by almost 170,000 sites.

In this sense, AOL is not looking for MapQuest to provide incremental earnings to the bottom-line right away. Rather, it wants the incremental eyeballs, which may be used to generate more earnings at some point down the road. Shelling out a chunk of the company for potential earning power instead of kinetic earning power is nothing new in the merger and acquisition game, but the stock-for-eyeballs aspect of deals like today's AOL-MapQuest link-up adds a new twist.

Valuing Internet companies is still more art than science -- some would say an abstract art at that -- but there is little doubt that eyeballs are playing a big role in determining today's valuations. A recent Credit Suisse First Boston report found that the largest sites on the Web also attract the most traffic. In an index of 400 pure-play dot-com companies, the report's authors also found that 40% of the total market capitalization of the index was supplied by the four largest firms.

If this "biggest site wins" theory continues to hold in the years to come, then buying up eyeballs might be the most effective way for large Internet firms like AOL to influence their short-term market valuations. But unless all of the old valuation rules of yesteryear have been thoroughly wiped out by the Internet, at some point earnings from those eyeballs will need to support those valuations.

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