Dear Yahoo, Please Don't Buy AOL

Includes: AOL, YHOO
by: Adam Muller

What a week for Yahoo (NASDAQ:YHOO).

On Tuesday, September 6, the company fired its CEO, Carol Bartz. While the action was not a surprise to investors, the timing felt sudden.

Then on Thursday, September 8, activist hedge fund Third Point filed a Schedule 13D, indicating that it has a 5.1% interest in the company and, in a letter accompanying the filing, is highly critical of Yahoo’s management and board, and calls for massive changes.

Then Friday morning news hit that Yahoo had hired Allen & Co. to advise it on its strategic review. Given that the company has become the target of a seasoned activist in Third Point, it is not surprising that Yahoo rushed to hire bankers to help it consider its options and mount a defense.

Friday afternoon, rumors swirled that Yahoo and AOL (NYSE:AOL) were discussing a potential merger. In fact, however, given Yahoo’s market capitalization of $18 billion versus AOL’s of $1.5 billion, any deal, if it happened, would likely be structured as an acquisition of AOL by Yahoo. The article suggests that, post-deal, Tim Armstrong, the current CEO of AOL, could lead the company.

AOL has not really been hitting it out of the park either. After announcing earnings on August 9 AOL’s stock fell 26% and is down over 30% as of the market close on Thursday, September 8. Investors' concern with AOL is its spending. The company acquired Huffington Post, which is eating up a lot of capital. Its local site initiative, called Patch, does not seem to have a clear path to profitability. Further, its Project Devil advertising initiative does not seem that original. In Huffington Post it feels like Tim Armstrong may have swung for the fences: The ball is in the air, but it is not yet known if it can clear the fence or just become an easy catch for a bored outfielder. A combination of two broken companies results in a larger broken company.

Hopefully before Yahoo makes any move, the board speaks with Third Point and takes its analysis to heart. Yahoo has some valuable assets; its problem has been monetizing them. Acquiring AOL and making Tim Armstrong the new CEO does not address any of the problems Yahoo faces. If, on the other hand, Yahoo brought in an experienced, competent CEO focused on shareholder value, acquired AOL, got rid of Huffington Post, closed down Patch, monetized Yahoo’s Asian assets tax efficiently, and sold the remainder of the business to private equity, that scenario could make sense.

Disclosure: I am long YHOO, AOL.