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Google Does Web Another Favor

Sandy Brown

The $1 billion price Google(GOOG Quote - Cramer on GOOG - Stock Picks) is reportedly about to pay for 5% of America Online strikes some as rich, but richer still could be the benefits that accrue to several Google peers if the deal goes through.

Come Wednesday, the Time Warner board is expected to ratify the sale, which implies an overall value for the online service of $20 billion. The deal has elicited customary protestation from Carl Icahn, who is waging a loud proxy battle with the media company's leadership. Icahn published an open letter to Time Warner warning management about the possible implications of their actions on Monday.

The rest of Wall Street seems less troubled by the transaction.

Goldman Sachs analyst Anthony Noto said in a research note Monday that the potential deal is a net positive for Time Warner, Google(GOOG Quote - Cramer on GOOG - Stock Picks) and even Yahoo!(YHOO Quote - Cramer on YHOO - Stock Picks).

Noto says that while the implied value of Google's 5% stake is at the high end of Goldman's estimate, "a deal may provide AOL with some of the [traffic, tech, search and global] elements that a partner must provide to stop AOL's leaky bucket issue and unlock its option value."

Google and Yahoo! benefit, Goldman says, because the deal will prevent Microsoft(MSFT Quote - Cramer on MSFT - Stock Picks) from doubling its scale in search. (Microsoft had been negotiating for the same stake.) Goldman does and seeks to do business with Google, Yahoo! and Time Warner.

A $20 billion price tag for AOL should be taken with a grain of salt because Google has a strong motive to pursue the stake, other analysts note. Google is willing to pay it "because they don't want to lose the business with AOL to Microsoft," says one.

"I don't think the Street is buying a $20 billion valuation on AOL at this point," the analyst says. "Investors want proof that the service is growing ad revenue by more than mid- to high-single digits."

Either way, the transaction isn't prompting a broad re-evaluation of Time Warner's worth. News of the possible deal only moved the needle slightly last week. Time Warner shares lost a nickel on Monday.

Jessica Reif Cohen, the Merrill Lynch analyst covering Time Warner, values AOL at about $20 billion based on 2006 estimates. Goldman's Noto has previously said, "Time Warner's valuation already had an implied value of $16 billion to $20 billion for AOL." He also points out that "investors might not want to give Time Warner credit for a full $20 billion given only 5% of the asset might be sold at that amount."

AOL, at the heart of what some consider the most dubious merger in the nation's history, got a lift this summer when it orchestrated a strategic relaunch and positioning. Investors, once burned and twice shy, bought the massive problem-solving exercise even as the service shed dial-up customers by the thousands. The competition took notice and now AOL is somewhat of a darling again, given the increased appetite advertisers have for online spends, video services and other offerings.

Merrill's Cohen says that, "While we suggested that selling equity in AOL at current valuations would be a mistake, the small size of the deal (only 5% of AOL and just over 1% of Time Warner's market cap) makes it relatively insignificant from a financial perspective." Reif Cohen believes that the real key is whether the deal will drive operational and financial performance at AOL. She says details of the agreement seem to satisfy the key requirements: securing a long-term technology partner, driving additional traffic to AOL.com and improving the monetization of its current traffic through improved sales.

The Google deal would allow AOL-branded ads on Google and provide search capabilities that Google excels at. Because a heady 2006 online-ad environment seems likely, both firms could prosper significantly from the enhanced joint venture that would see Google provide a boatload of ad inventory to AOL and its affiliates.

It may not prove to go the whole nine yards for Icahn and other parties involved, but at face value it seems like a step forward.

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