Ed. Note: Welcome to the second edition of Inside The Deals, a weekly column about M&A in the media written by veteran business journalist Steve Rosenbush. Steve is based in New York, and previously was the finance writer for BusinessWeek.com, responsible for coverage of M&A. His interests include the evolving business of media. He can be reached at steve AT paidcontent.org.
Long-suffering AOL (NYSE: TWX) may be worth more than some investors think. Last fall, UBS analyst Mark Morris pegged the value of Time Warner’s AOL unit at $13 billion, a mere 2.5 times revenue. That pessimistic view reflects AOL’s declining revenue, which fell 33 percent last year to $5.2 billion.
A lot has changed during the last few months. Oh, AOL’s revenue still is on the decline. But Microsoft’s (NSDQ: MSFT) offer to buy Yahoo (NSDQ: YHOO) for $42 billion has pressured its rivals. That bid, currently worth about six times Yahoo revenue, shows that even mature Internet companies have plenty of appeal to the right strategic buyer. And the pressure on Time Warner to sell AOL never has been greater. Its shares are trading at $14, down from $22 last year.
Perhaps those shifts helped convince Time Warner CEO Jeffrey Bewkes that now is the time to sell. Bewkes, speaking March 10 at the Bear Stearns media conference, told investors that Time Warner was willing to consider “whatever configuration makes it (AOL) the strongest and the most valuable.”
Two days later, AOL announced a deal to acquire social-networking site Bebo for $850 million. More in extended entry…
The acquisition, which the companies hope will close in a few weeks, could make AOL more attractive to prospective buyers. While a distant third in the U.S. to News Corp.’s (NYSE: NWS) MySpace and the independent Facebook, Bebo has a strong following in markets such as the U.K. Bebo is growing fast and benefits from strong user engagement, thanks to a raft of technological features and media partnerships. By combining Bebo with the AIM and ICQ messaging services, AOL has opportunity to gain traction in social networking.
Investors think an AOL sale is a matter of when, not if. “I think the most likely scenario is some kind of transaction, such as a sale or a spinoff with a major investor coming in,” said Ryan Jacob, manager of the $55 million Jacob Internet Fund. (Jacob does not own any Time Warner stock but does hold Yahoo and Google.)
So what would AOL be worth in a sale? It’s unlikely to command a Yahoo-like multiple of six times revenue, according to Ken Marlin, managing partner of media and tech banker Marlin & Associates. That’s because AOL has so much exposure to subscription revenue, which fell 52 percent last year to about $3.5 billion. Advertising revenue is growing a reasonable 18 percent, but still accounts for only about one third of the business. The Bebo deal could help accelerate advertising growth, which would bolster the case for a high multiple. Marlin says a valuation of four to five times revenue, or $20 billion to $25 billion, is possible. “It’s all about supply and demand in a competitive market. And I do believe there would be competition for AOL, if Time Warner were serious about selling,” Marlin said.
He thinks all the large Internet companies with $10 billion or more in annual revenue would have an interest. Google (NSDQ: GOOG) might be a logical partner. It already has paid $1 billion for 5 percent of AOL, in a deal that values AOL at $20 billion. It can afford to pay a good price for AOL thanks to its own stock price, a strong currency with a high multiple. An AOL acquisition also would be a strong countermove against Microsoft’s bid for Yahoo. And AOL’s new Bebo unit would give Google a lift in social networking, an important Internet market it has failed to dominate.
Microsoft and Yahoo, separately or in tandem, are logical partners for AOL, too. AOL’s messaging and social networking capabilities would be good substitutes for their own competing offerings, which don’t match up.
AOL also could be a good partner for ambitious companies such as IAC (NSDQ: IACI) and Disney (NYSE: DIS), which need to flesh out their Internet strategy. Disney, with its focus on mainstream media and shopping, would be a good cultural fit for AOL. And AOL would be a good flagship for IAC, which includes numerous smaller Internet sites such as Evite, Excite, and Ask.com.
Despite its declining revenue, AOL remains a sizable international business with some good assets, such as AIM, ICQ and now Bebo. If Time Warner is ready to sell, there will be plenty of potential buyers.