Home > Stock Analysis

Don't 'Buy' The Yahoo-AOL Rumor

Posted: Oct 10, 2008 08:01 AM by Ben McClure

Tickers in this Article: TWX, MSFT, YHOO, GOOG

Rumors of merger talks between Yahoo (Nasdaq:YHOO) and AOL are back again. Details are emerging that the web players are quietly ironing out a deal that, according to TechCrunch and other industry news outlets, could come as early as the end of October.

Get Free Stock Analysis By Email

Here's the Scoop
To some observers, a Yahoo acquisition of AOL makes sense. The new company would have the most instant messenger users, the busiest celebrity news site (AOL's TMZ.com), a leading business and investment site (Yahoo Finance), along with a popular technology blog (AOL's Engadget). AOL and Yahoo are two of the biggest players in online display advertising. Together, they could create a display ad behemoth. (To learn more, read Analyzing An Acquisition Announcement.)

Still, as great as that outcome may sound, a Yahoo-AOL merger leaves me cold. Investors please ask yourselves, does it make any sense to combine what are, essentially, two struggling ad businesses? It's hardly clear that shareholders of either Yahoo or AOL parent Time Warner (NYSE:TWX) would benefit from a tie-up.

Analysts expect that worsening economic conditions will slow spending for online display advertising in 2009. According to eMarketer, display ads account for 62% of Yahoo's net U.S. revenue. Yahoo's growth rate is less than that of the U.S. online ad market. In the first half of 2008, U.S. net revenue for Yahoo grew 11% from the same period a year ago compared to 15.2% for the overall market for internet ad revenue.

Slow Growth x 2
Sure, AOL offers a bunch of nice web content that produces display ad sales, but like Yahoo, its growth is slower than the overall market, too. What's more, AOL doesn't give Yahoo what it really needs most to prosper - search advertising revenue. Yahoo continues to lose market share to paid search leader Google (Nasdaq:GOOG), which is expected to scoop nearly three quarters of the $10.4 billion that U.S. advertisers will spend on search this year. Yahoo's focus should be focused on increasing sales in search.

Putting together two slow growing companies might create an opportunity for some cost savings. But with both companies' growth strategies adrift, it remains to be seen whether the two struggling companies can successfully jumpstart their business by joining forces just as web advertising sales are stalling.

With just over $2 billion in cash reserves, Yahoo will surely push for an all-share offer for AOL, but this will be tough to pull off. Time Warner is looking to shore up its balance sheet, which is weighed down by nearly $40 billion in debt. It would love to offload its floundering AOL unit to a willing buyer, but I'm not sure if shareholders will be happy getting Yahoo stock instead of cash. (For related reading on this analysis, see Testing Balance Sheet Strength.)

Threesome Anyone?
Yahoo shares are now priced under $12 a piece. That's a far cry from few months ago when Microsoft (Nasdaq:MSFT) was offering to buy Yahoo for $33 per share. With the shares now at a five year low, it's hardly an apt time for Yahoo to be using them as currency for a major acquisition.

Of course, some folks think a combined Yahoo-AOL might prove irresistible to cash-rich Microsoft. A three-way deal would create an even bigger email, instant messaging and ad display business. But don't forget, merging the three companies' various platforms and systems could be an integration nightmare. At the very least, such a tie-up would raise the eyebrows of the world's antitrust watchdogs.

Bottom Line
At this stage, rumor of a Yahoo-AOL merger is just that, rumor. But even if the idea it turns out to be true, little suggests it's a good one.

By Ben McClure

Ben McClure is director of McClure & Co., an independent research consultancy. Before founding McClure & Co., Ben was a highly-rated European equities analyst at London-based Old Mutual Securities. He also spent several years as a business/technology journalist at the Economist Group. McClure graduated from the University of Alberta School of Business with an MBA.

Rate this Article: Your Rating: Overall Rating: Vote Now!

MORE STOCK ANALYSIS