AOL, Yahoo: Smart Buys for Savvy Giant

The unintended consequences of Yahoo (YHOO) and AOL (TWX) repositioning themselves as online content companies and magnets for television advertisers is that they will be targets for acquisition or strategic partnerships in an improving economy.

Yahoo and AOL could be choice assets to savvy players that are better at integrating and utilizing than Time Warner's debacle with AOL. It may be unthinkable to suggest that AOL should enter a new corporate relationship after an agonizing decade. But it is difficult to imagine AOL -- or Yahoo, for that matter -- flourishing long-term as stand-alone entities, even if they succeed in adjusting to their new business models. Here's why:

• Both companies command valuable online audiences that can be better monetized by a smart partner. AOL's audience is valued at around $1.7 billion, based on Yahoo's audience valuation of $11 billion, according to Credit Suisse analyst Spencer Wang.
• Both companies are limited in value they can create from their audience base over the next five years.
• Including its access service, Wang figures AOL's overall stand-alone value is at least $4 billion. (Compare that to AOL's $161 billion value when it merged with Time Warner in 2000 and its $20 billion value when Google paid $1 billion for a 5% stake in 2005.)
• AOL's total revenues are expected to stagnate just below $3 billion through 2014, when its adjusted operating income (before depreciation and amortization) is expected to decline to about $600 million from $975 million this year, Wang estimates.
• Yahoo's revenues will decline 13.5% to $4.7 billion this year, and average only 4.8% through 2014. Its operating income will decline 11% to about $1 billion in 2009 and grow an average 11% to $1.7 billion by 2014 -- due largely to aggressive cost management, Wang says. Yahoo's $22 billion equity-market cap is the lowest of its Internet peers, half of which is comprised by its 40% stake in Alibaba Group and 35% stake in Yahoo Japan.

Still, Yahoo and AOL have heavily invested in original and third-party content, making them more valuable to larger media players. While both companies continue new initiatives -- such as improved home and search pages, mail, mobile connections and content categories -- none are game-changing enough to do more than generate incremental gains. Yahoo continues its longtime lead in news, sports and finance, while AOL is making good strides with its robust content verticals.

Both companies also are more aggressively pursuing advertisers, especially from newspapers and television. At its first analyst day since 2007 on Oct. 28, Yahoo executives discussed their holistic approach to ad sales targeting audiences across its search, display and mobile platforms.

Yahoo is chasing what it estimates as a $30 billion revenue opportunity by closing the 2-to-1 gap between the amount of time consumers spend online and the amount of ad dollars spent online. But Yahoo's biggest opportunity is outside the U.S., where 75% of its total users generate only 27% of its overall revenues. Less than 3% of its total ad revenues come from emerging markets. By comparison, AOL India -- a portal that eventually may prove valuable -- will continue to be owned by Time Warner.

Clearly, what is missing from Yahoo and AOL is a broader leadership vision of what the companies should look like in five years and how to generate sustainable double-digit growth. All emphasis is on short-term rebuilding.

Yahoo's analyst day was "long on feel-good factor but short on substance and numbers," Bernstein analyst Jeffrey Lindsay writes in a client report. "CEO Carol Bartz started the day on a contrite note, acknowledging that Yahoo had lost the respect of advertisers and investors and was keen to win it back."

That's not a vision -- it's a survival strategy.

Unfortunately, there also does not appear to be much strategic or innovative vision at larger companies on how to use Yahoo or AOL to expand their online content and advertising business. Other media and entertainment companies are unclear about their own futures, thus unwilling to place bets on companies with troubled deal track records.

That doesn't mean AOL and Yahoo won't be acquired or engaged in joint ventures, as they represent scare good-sized publicly traded Internet names with online content and advertising potential.

A lingering scenario is that Microsoft's (MSFT) announced search advertising deal with Yahoo opens the door for a three-way arrangement with AOL. An alliance works even if Microsoft (with $31 billion cash) acquires Ask.com search from InterActiveCorp prior to taking over management of Yahoo search in 2011. The overriding notion is that the three companies could accomplish more working together than individually in search, advertising and content.

Yahoo or AOL also could be a strategic play for a traditional pure content company such as CBS (CBS) with many overlapping niche interests in news, sports and finance. With CBS' $1.8 billion acquisition of CNET nearly integrated and bolstering the company's coverall Internet profile, a Yahoo or AOL acquisition or alliance could be a surprisingly good fit.

Such speculation will accelerate if Comcast (CMCSA) successfully acquires a majority stake in NBC Universal from General Electric (GE). The $35 billion deal, which could be announced by mid-November, hinges on French-owned Vivendi getting enough money from GE for its 20% stake in NBCU.

The willingness and need of Vivendi and GE to unload their relative stakes in NBCU, despite plummeting valuations, could have a domino effect in a 2010 deal market expected to be led by traditional ad-supported media and the Internet.

UBS estimates some 200 media and tech-related companies are targets for acquisition or partnerships driven by economic recovery, accelerating legacy structure pressures for established players, consolidation cost savings, and the need for private equity and other investors to cash out.

The list of likely global deal candidates is topped by DirecTV (DTV), DreamWorks (DWA), Netflix (NFLX), Scripps Networks (SNI), Take Two (TTWO), and ValueClick (VCLK). The list also includes AOL and Yahoo.

Disclosure: Author does not directly own any internet or media stocks.