Summary:

Any search deal with AOL (NYSE: AOL) would start with the same given: search-advertising revenue will continue to decline as it loses access…

Tim Armstrong
photo: AP Images

Any search deal with AOL (NYSE: AOL) would start with the same given: search-advertising revenue will continue to decline as it loses access subscribers. But AOL CEO Tim Armstrong says the deal with Google to extend their search partnership through 2015 should make each search it does get more lucrative — and the expansion into mobile and video makes it a better deal than the current one.

“This is a better deal for us on a per search basis. It should be a better search and better monetized,” Armstrong told paidContent in an interview after this morning’s surprising announcement. He’s frank about the situation — “Search decline is going to continue and part of our search revenue will go down.” But he’s also optimistic that the improvements can help AOL make enough money from the “free web” to make a difference. “At some point in the future they should even out,” he said.

AOL attributed a large part of its 28 percent Q2 decline in revenue from search and contextual to a 25 percent drop in domestic subs. Through the first half of 2010, AOL has made $209 million from the current Google (NSDQ: GOOG) partnership.

Armstrong knows this deal from both sides of the table. The former head of Google U.S. ad sales led the last negotiations and was part of the team that started the relationship in 2002. Last time, he helped engineer a deal that both companies thought made sense at the time but in a couple of key aspects didn’t work for either. Time Warner wanted a big win and a valuation for AOL; it got $1 billion from Google for 5 percent of the portal. Google wound up writing most of that investment down.

“The Time Warner part of the investment was really not trying to align the companies philosophy-wise. It didn’t work well for AOL because the money went to Time Warner (NYSE: TWX). On the Google side, it didn’t end up being a great investment,” Armstrong said. Removing those elements from the deal shifted the focus. “It aligned us. We’re focused on strength areas — search, mobile search, YouTube.” Until now, AOL has been handling its own mobile search.

Why stay with Google? Familiarity plays a role; the two have been partners now for eight years and AOL can avoid the disruption of a complete change. Armstrong also said it was the best deal after discussions with a half dozen suitors. For all its highly publicized woes, AOL still commands a hefty amount of traffic and would have been a significant win for Microsoft (NSDQ: MSFT) and Bing. Armstrong wouldn’t discuss specific offers but said “the other deals were not at the same level of scale or magnitude. … There was a significant enough gap for us in the overall value of the deal that made it reasonable to close the negotiations down months before the deadline.”

What’s different with YouTube? AOL already has content on YouTube but this adds a contractual relationship. Armstrong explained: “The YouTube arrangement is a more highly incentivized reason for AOL to put higher quality content on YouTube.” Asked for an example, he mentioned AOL Sessions, the music series. Instead of sporadic posting to YouTube, “we would work to make sure they’re all on YouTube.” That means wrapping YouTube rights into negotiations on the front end; AOL doesn’t have those rights for all the sessions. He didn’t mention AOL Seed, which would seem to be a natural given Demand Media’s lucrative presence there, instead emphasizing “high quality.”

Getting the deal out of the way removes a distraction from Armstrong’s struggle to change AOL’s fortunes and should accelerate some of the efforts to improve the search payoff. His closing words: “This is a very specific steppingstone for us in turning around AOL, a very big accomplishment.”

Now he has to make it actually pay off.

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