AOL Suitors Face a Vexing Split-Up
WSJ, October 17, 2005
As suitors line up for a piece of America Online, one vexing issue has arisen: how to separate AOL's shrinking Internet-access business from its more attractive Web-content assets.
None of the companies known to be expressing interest in taking a stake in AOL -- Microsoft Corp., Google, which is working loosely with Comcast, and the most recent prospective bidder to emerge, Yahoo -- has much interest in investing in the entire company, which is a unit of Time Warner.
AOL is essentially two intertwined businesses: One is the traditional Internet-access business, which provides Internet connections mostly via telephone dial-up to 20 million subscribers for a monthly fee; the other is a programming arm. AOL as a whole is valued at about $20 billion in the talks, divided roughly evenly between its two businesses.
Suitors want a piece of the programming arm, which operates a network of free Web sites -- including AOL.com, Mapquest and Moviefone -- and provides content and features for the AOL Internet-access business. When paying subscribers log onto AOL, everything they see, such as the home page, instant messaging, news articles and stock quotes, is operated by the programming arm.
The programming business is attractive because its content draws a big audience and it holds about a 10% share of the fast-growing Internet advertising market. About 110 million unique visitors viewed AOL content in September, including 50 million visits by paying AOL subscribers, according to comScore Media Metrix.
The traditional Internet-access business is of less interest to the potential bidders for an AOL stake. While it is hugely profitable -- estimated to earn more than $1 billion in profit on revenue of $7.5 billion last year -- it is losing customers at a rate of two million a year.
Given the close ties between the two arms, splitting AOL won't be easy. If Time Warner strikes a deal involving AOL, it will have to carve off the programming arm into a separate company, which would likely license its content to the Internet-access business.
But it would likely be a complex licensing agreement that would need to include a formula for sharing advertising revenue and assurances that the Internet-access business would continue to steer viewers to AOL's Web properties, a person familiar with the situation said.
Even with a licensing agreement, potential problems may arise once the two sides of AOL are separated. Michael Nathanson, an analyst at Sanford C. Bernstein & Co., said the programming part of the business might be hurt if the Internet-access side cuts back on customer service, causing subscribers to defect. That may reduce the number of people viewing AOL's content, thereby hurting ad sales for the programming side. He also raised the possibility that the programming side might offer free AOL.com email addresses, causing massive cancellations of AOL accounts at the subscription business.
He said these kinds of concerns about how such a deal would work are one reason Time Warner stock has barely budged on the news reports of deal negotiations. In 4 p.m. New York Stock Exchange composite trading Friday, Time Warner stock was up 41 cents at $18, around where it has traded for several months.
Further complicating the situation, one of the suitors, Comcast, wants the right to market to AOL's access subscribers, according to people familiar with the negotiations. But AOL doesn't want to grant this right unless Comcast buys a stake in the access business, said a person close to the negotiations. Comcast declined to comment.
Of all the suitors, Microsoft, whose on-and-off talks involving AOL were revived recently, may be the only company with any interest in buying into AOL's access business. Microsoft owns a similarly declining dial-up access business, which had 2.7 million customers as of June 30. One possibility, say people close to the negotiations, is the two companies could combine their access businesses and spin them off to a private-equity firm while retaining control of their combined Web properties.