AOL (NYSE: AOL) shares traded as much as 6% higher on Friday, fueled by a Forbes report that Microsoft (Nasdaq: MSFT) was negotiating a deal to buy the fading dot-com legend.
It's easy to see why AOL's porch may be filling with gentleman callers. Its revenue-sharing search deal with Google (Nasdaq: GOOG) expires in six months, and it's in AOL's best interest to field search arrangements or outright marriage proposals. Or, if we can flip around the old saw: Why pay to milk the cow when you can have the cow for nearly free?
Yes, AOL is pretty cheap these days. Google paid $1 billion for a 5% stake five years ago, and that kind of change would be good to buy nearly half of AOL at today's enterprise value of just over $2 billion. Even if we bake in a healthy buyout premium, a buyout can be had for less than $3 billion. It's a far cry from the 12-figure market cap that AOL commanded at the peak of the dot-com bubble.
You get what you pay for
The rub with AOL as an acquisition target is that it's been backpedaling through most of the past decade. Its latest quarter was another disaster, with revenue, net income, and free cash flow all taking double-digit percentage hits.
AOL may seem cheap at 11 times trailing earnings, but it's actually fetching 15 times the $1.41 a share that analysts are expecting for all of 2010. It seems to be a perpetually sinking target, since those same pros were looking for a profit of $2.66 a share just two months ago.
There's no bottom in sight. Wall Street sees revenue falling 24% this year, and another 10% come 2011.
Why would someone snap up a retreating company when it should very well get cheaper in the future? Well, the bidding nature of any reverse auction is to come in at a low price, without risking another buyer. If a potential buyer waits for a bottom, it would also be less likely for AOL to consider cashing out. Besides, buyers are arrogant. If and when someone does snap up AOL it will be with the foolhardy arrogance that they're the one to stop the bleeding.
So who's on the porch? Let's take a look at some of the potential suitors.
Microsoft
Mr. Softy continues to lose money in its online division, despite Bing's success. Snapping up a profitable AOL would more than double Microsoft's online revenue. AOL and Microsoft also run in the same circles as competing platforms for free email, search queries, and content-backed page views.
It's a deal that would make perfect sense, especially if it means keeping AOL out of Google's chubby clutches.
Google
As successful as the world's leading search engine has been, it's often betting on the wrong horse. It has shelled out good money for primo advertising space on AOL and MySpace, just as the properties were peaking.
It may have little choice but to get involved here, even if it knows the value -- or diminishing lack thereof -- in serving up ads to AOL's visitors. It already let Microsoft strike a search deal with Yahoo! (Nasdaq: YHOO) last year, and it would send the wrong message to sponsors if it let Microsoft continue to fortify its empire.
Yahoo!
There's $3.2 billion in cash and short-term investments burning a hole in Yahoo!'s pockets, at a time when investors seem to be writing the company off after last year's deal with Microsoft.
AOL and Yahoo! have been joined at the hip as the saddest Siamese twins on the dot-com circuit in recent years, but Yahoo!'s latest quarterly report was everything that AOL's wasn't. Display advertising is roaring back. Earnings are growing. There is enough overlap in the two companies to create some serious margin improvement, too.
United Online (Nasdaq: UNTD)
One of the biggest mysteries at AOL has been its decision to all but abandon its once lucrative online access business. AOL had as many as 26.7 million access accounts when it peaked eight years ago. It's down to a mere 4.7 million users today.
If it didn't see value in keeping paying subscribers on its welcome screen, it should have sold its access business to United Online or Earthlink (Nasdaq: ELNK) ages ago -- when it was worth more than it would fetch today. The sad reality is that it will probably be worth even less if it doesn't cash out now.
United Online can't afford AOL on its own. And, to be fair, United Online also has seen the writing on the wall with its Juno and NetZero access roots. It has spent the past few years diversifying into Classmates.com, MyPoints, and floral delivery network FTD. If it can pull a deal off, it can fortify its access and content businesses. If not, United Online or Earthlink may be key players in snapping up AOL's remaining access customers from the portal that does ultimately buy AOL.
IAC (Nasdaq: IACI)
Ask.com's parent is blessed with a cash-rich balance sheet, but not enough to land AOL outright. However, the country's fourth largest search engine would aid its chances for medal contention by unhinging its jaws wide enough to swallow down No. 5.
If AOL is truly available -- and it should be given its dreary near-term prospects -- things should get interesting quickly at this point.
