AOL Bidding: Give Me Liberty

Traders trying to play the AOL sweepstakes might consider an under-the-radar contender.
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This column was originally published on RealMoney on Nov. 15 at 3:35 p.m. EST. It's being republished as a bonus for TheStreet.com readers.

Gaming the winners and losers of a potential deal for AOL is a two-step process. You need to first understand what is being fought for, and second, who is fighting for it.

Here then are the "crown jewels" of AOL that people are willing to pay upward of $15 billion for in aggregate.

Narrowband subscribers

: This portion of AOL probably is worth a small amount of the eventual sale price, because it's a severely declining business despite the tremendous cash flows generated. Broadband subscribers are less attractive, as they are not a very competitive pie, and

Time Warner

(TWX)

has never aggressively pursued this as much as it could have. For instance, why did it take so long for them to do a deal with AOL and Time Warner Cable?

Advertising

: Clearly all of the major players are making a land grab for search-engine advertising revenue. AOL makes up approximately 11% of

Google's

(GOOG) - Get Report

revenue, and that revenue is all up for grabs if AOL does a deal with

Yahoo!

(YHOO)

or

Microsoft

(MSFT) - Get Report

.

Voice over Internet Protocol

: AOL is the No. 1 instant messaging service. Yahoo! and MSN's agreement to let IM be interoperable, as well as Yahoo!'s acquisition of Dialpad and MSN's acquisition of Teleo, make this a hot area, particularly with

eBay

valuing Skype at upward of $2.6 billion. Google has fallen a bit flat with its Google Talk service. A Google/AOL deal would catapult Google to No. 1 in the IM/VoIP space -- an area from which Google has been surprisingly absent, even if you include its municipal WiFi initiative as a step in this direction.

Content

: This one is big. Let's look at the extremes on the content spectrum. You have Google, which has some content beyond search -- Google Maps and Google News -- but it's nothing compared with what companies like Yahoo! (Personals, Jobs, Finance, etc.) and

News Corp.

(NWS) - Get Report

(MySpace has a millions of blogs, band pages, etc.) offer. But really, AOL takes the crown here. It has all of Time Warner's content at its disposal, and I, for one, am in heaven over the planned In2TV effort to bring classic TV shows from my childhood to broadband. (Note to AOL: please make this iPodable). Does anyone care about content in a peer-to-peer dominated universe? I think the answer is "yes," but that's just speculation.

Playing the Players

So to recap, the players here are Google, Microsoft, News Corp. and

IAC/Interactive

(IACI)

. And although Yahoo! is thought to be out of it, I wouldn't bet the house on that fact. So this is really a two-step exercise: first identify what's at stake, and then determine what is ultimately the best trade.

At first glance, the one clear winner is Time Warner. CEO Richard Parsons is very smart at how he is playing this. First, the rumors of a Microsoft-AOL deal put Google on edge and probably got players like Terry Semel or Barry Diller intrigued. The first numbers talked about were in the $10 billion range, but now the rumor leaked out last week that Yahoo! was talking about $13 billion, and this was even rejected by Time Warner.

And if someone doesn't pay $15 billion today, they are going to be paying $20 billion-plus tomorrow.

AOL got religion when it did the Live 8 concert online. This In2TV broadband service is going to be a success as well. Content is still king, and the benefits of the AOL/Time Warner partnership finally are kicking in. They might not add back the $100 billion writeoff, but those benefits will add back something. Not only will AOL get the valuation it wants, but it will keep control and it will keep consolidating the growth in AOL's earnings on the Time Warner balance sheet. Look for Time Warner's to float to $20 and then hit a range of at least $20-$25 once a deal gets done.

But whether or not Microsoft or Yahoo! or Google win I don't know if one could game the short-term effects on their stocks. There are pros and cons that ultimately balance each other out.

The negatives include there being no way to avoid paying full price, inevitable integration issues (look at what happened to Time Warner when it bought AOL!), and that the winner is inheriting the narrowband business.

On the plus side, the winner will be getting the jewel of the search engine advertising business and will dominate its peers on IM, VoIP and content.

That's why my favorite play in this game is a little off-kilter:

Liberty Media

(L) - Get Report

. There's a more than outside chance Interactive Corp, or News Corp., could make a run for AOL. News Corp. is less likely given the historical tension between it and Time Warner, particularly over things like the Fox News Channel, and the ongoing animosity between Turner and Murdoch. That said, AOL would complement nicely News Corp.'s MySpace acquisition, and would make it the No. 1 choice for demographics ranging from 10-year-olds to the boomers.

IAC/InteractiveCorp's Barry Diller has never met an acquisition he didn't at least consider, and yet, surprisingly, very little has been mentioned of Diller's chances in this battle. Imagine if AskJeeves were pulled off the backburner (anyone remember Excite?) to power the AOL search. Not to mention the travel offers and home shopping network clips that could be placed all over AOL.

Owning AOL would be a homerun for either News Corp. or IACI, so why not buy those stocks at a discount. Liberty Media is almost like a closed-end fund of media assets, run by great investor and operator John Malone, and these two stocks happen to be Liberty's biggest holdings.

Liberty trades at book value at the moment, giving little credibility to its ongoing businesses which generated $1.6 billion in EBITDA last year. A bet on Liberty is a bet on serious dark-horse contenders in the race for AOL, but you get to make that bet at a discount.

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of

Trade Like a Hedge Fund

and

Trade Like Warren Buffett. At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback;

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