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Originally published December 20, 2005 at 12:00 AM | Page modified December 20, 2005 at 8:07 PM

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Google to pay dearly for AOL

Google's agreement to buy a stake in Time Warner's America Online (AOL) values the Internet company at $20 billion, twice as much as Wall...

Bloomberg News

Google's agreement to buy a stake in Time Warner's America Online (AOL) values the Internet company at $20 billion, twice as much as Wall Street estimates.

Fetching such a high price from the world's most popular Internet search engine may bolster Time Warner Chief Executive Richard Parsons as he faces pressure from billionaire investor Carl Icahn to raise the stock price or split the company.

"This will require all of us on the sell side to revalue the AOL piece of Time Warner," said Laura Martin, an analyst at Soleil Securities, in Pasadena, Calif., who has a "buy" rating on Time Warner and values AOL at $14 billion.

Google last week agreed to pay Time Warner $1 billion for a 5 percent stake in AOL, according to a person familiar with the matter.

Most analysts have valued AOL at $10 billion to $15 billion, said JP Morgan Securities' Spencer Wang. Merrill Lynch analyst Jessica Reif Cohen, ranked first among her peers by Institutional Investor magazine, values AOL, the biggest U.S. Internet service provider, at $20 billion.

The accord snatched AOL away from Microsoft, which had been in partnership talks for almost a year.

Aside from winning a victory against Microsoft, Google will retain its largest search customer and gain access to AOL's content and video search features.

Parsons needs Google's search and advertising technology to bolster AOL's ad revenue and counter a loss of paying subscribers.

"This allows Time Warner to retain the strategic upside of AOL," Martin said. "It retains for Google a major part of their revenue. It's a win-win for both companies."

Time Warner spokesman Ed Adler declined to comment, as did Google spokeswoman Lynn Fox. Stacy Drake, a spokeswoman for Microsoft, also declined to comment.

A value of $20 billion on AOL may make it harder for Icahn, who has pressed for changes at Time Warner since August, to claim Parsons isn't reaping value from AOL.

In an open letter Monday, Icahn said Time Warner's deal tying AOL to Google may be "short sighted" if it precludes other transactions involving the unit.


Icahn "was asking for a transaction that put a stake in the ground on valuation. It looks like he's going to get that," said Rob Sanderson, an analyst at American Technology Research in San Francisco who rates Time Warner shares a "buy" and doesn't own them. Sanderson commented before Icahn issued his letter today.

AOL founder Steve Case, who orchestrated the $112 billion combination between America Online and Time Warner in 2001, last week joined Icahn in calling for Time Warner to be broken up.

A venture with Google doesn't prevent AOL being spun off later, Sanderson said.

The price paid by Google also illustrates the lengths the company will go to win a battle with a rival, this time Microsoft. It shows the value Google places on retaining a slice of the ad revenue AOL brings in, and access to content from AOL, such as entertainment videos and news.

"From Google's standpoint, there has been and there continues to be more fear from what Microsoft could do just because of their vast resources," said Martin Pyykkonen, an analyst with Hoefer & Arnett in Denver, who has a "buy" rating on Google.

Parsons, 57, Time Warner chief executive since 2002, and Google CEO Eric Schmidt, 50, hatched the agreement late Thursday in New York, said the person familiar with the discussions, who declined to be identified because the talks are confidential.

Parsons phoned Microsoft CEO Steve Ballmer the next morning to tell him AOL was pursuing a deal with Google, that person said.

The deal will be presented to Time Warner's board in New York today, the person said.

The decision is a setback to Microsoft, which introduced its new search-engine technology in February after spending 18 months and more than $100 million to develop the system. The MSN unit trails Google and Yahoo! in the worldwide share of Web searches.

"This deal makes it more difficult for MSN to develop a strong advertising network, as scale is very important in order to attract advertisers," Imran Khan, JP Morgan's Internet analyst, wrote last week.

AOL will account for 9 percent of Google's revenue this year and 7 percent in 2006, said Scott Kessler, an analyst at Standard & Poor's in New York, who rates Google shares "hold" and said he doesn't own them. He does own shares of Time Warner.

AOL likely chose Google over Microsoft because Google's online advertising systems can wring two to three times more revenue from each Internet search, said JP Morgan's Khan, who rates Google shares "overweight."

Google's purchase is 10 times AOL's expected 2006 earnings before interest, tax, depreciation and amortization, of about $2 billion, Khan said.

Under their 2002 agreement, Google supplied the complex algorithms that power most of AOL's online search functions.

The companies share sales of advertising that appears next to search results. AOL provided 11 percent of Google's revenue of $2.64 billion in the first half, according to a Google filing with the Securities and Exchange Commission.

"Google can be a very powerful partner in terms of helping deliver broader audience, non-subscription audience to AOL," American Technology's Sanderson said.

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