An activist investor wants Yahoo! (NASDAQ:YHOO) and AOL (UNKNOWN:AOL.DL) to merge in order to save money through eliminating inefficiencies, while creating an opportunity to divest from non-core businesses with a lessened tax liability. Starboard Value announced Sept. 26 that it had acquired a "significant stake" in Yahoo!, and had delivered a letter to CEO Marissa Mayer as well as the company's board of directors.
In the letter, Starboard wrote that the combination could improve Yahoo!'s competitive position and deliver savings of up to $1 billion. The investor believes that would happen "by significantly reducing the cost overlaps in their Display advertising businesses, as well as synergies in corporate overhead," according to the letter. Starboard also believes that, simply by being larger, the company would be better suited to compete.
Importantly, we believe the combined entity would be able to more successfully navigate the ongoing industry changes, such as the growth of programmatic advertising and migration to mobile. In addition, we believe a combination could also lead to revenue growth opportunities given the broader user base, higher quality content, better technology assets, and enhanced relationships with advertising agencies.
This potential deal has been talked about before, but it may make more sense now than it has in the past because Yahoo! and AOL have morphed into companies that offer a very similar portfolio of products competing for the same customers and ad dollars. If you're going to battle Google (NASDAQ:GOOG) (NASDAQ:GOOGL), which dominates the ad space with more than $50 billion in sales in a market valued at $117 billion in 2013, size matters.
As of Tuesday afternoon, AOL had not posted a press release or statement to its media relations web page, while Yahoo! had issued a response that acknowledged receipt of the letter, and pledged to review it and discuss it with Starboard.
The two companies are very similar
Both Yahoo! and AOL are portal sites that create and aggregate content, including some high-profile video featuring celebrities. Each owns a number of content brands that create original text and video.
In addition, the two companies each offer email, and have made high-profile acquisitions on which the jury is still out. (Huffington Post for AOL, and Tumblr for Yahoo!). Yahoo! is more of a search player than AOL, but both companies live or die based on ad revenue.
Because the two have so many overlapping areas of interest, the potential savings are larger than when two dissimilar brands merge. For example, if the rumored deal between T-Mobile and DISH Network were to happen, there would be savings in management and accounting, and possibly customer service, as well, but you wouldn't be able to cut a single satellite dish installer, or close a large amount of T-Mobile stores.
In the case of Yahoo! and AOL, the savings would run deeper, and the cross-marketing opportunities would be huge. Yahoo!, for example, would have another huge group of users who might watch interviews by Katie Couric or Community when it premieres new episodes of the cult show. AOL would gain a new audience for content from its brands including HuffPo and TechCrunch.
Better yet, they could share that content while spending less money producing it, because management jobs could be cut, and services like copy editing could be combined and consolidated.
There are huge potential tax benefits
The Starboard letter points out that a merger would allow Yahoo! to divest itself of valuable stakes in non-core businesses -- which include Alibaba and Yahoo Japan -- under beneficial tax circumstances. CNBC explained how the company could potentially divest itself of its stakes those companies while saving $16 billion in taxes.
"A transaction known as a reverse Morris trust, used frequently in the media industry by mogul John Malone, allows companies to harvest stakes in listed companies without triggering a tax bill," according to the financial news site. It's complicated and, perhaps, morally sketchy, but it's legal and would save billions.
Bigger is better, and better is better, too
Both Yahoo! and AOL have struggled to compete with Google and No. 2 player Facebook when it comes to selling ads, and size is certainly a factor there. Yahoo! is bigger than AOL, ranking fourth globally by traffic and third in the United States, according to Alexa, while AOL.com is 30th in the U.S. and 117th globally. Both are major players, and combining their core sites along with their wholly owned brands would give them some much needed heft.
"The reason why Facebook's size and Google's size matters and helps them so much is that they are a one-stop shop for so many advertisers," Pivotal Research Group analyst Brian Wieser told Reuters.
AOL has also invested heavily in programmatic advertising, technology that automates the buying and selling of ads, the news service reported, and that tech could benefit Yahoo!, as well. A combined AOL/Yahoo! would have more ads to sell and would, at least in theory, be better at selling them.
This is a good idea
A united Yahoo!/AOL would create a clear third player behind Google and Facebook. It would also bring two very similar companies together, and allow them to stop competing with each other in order to focus on tackling bigger prey. Being able to exploit a tax loophole that creates $16 billion in value is essentially icing on an already delicious cake.
Daniel Kline has no position in any stocks mentioned. He used to have an AOL dial-up account. The Motley Fool recommends Facebook, Google (A shares), Google (C shares), and Yahoo. The Motley Fool owns shares of Facebook, Google (A shares), Google (C shares), and Yahoo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.