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MSN Plus AOL Is a Negative for Google

A merger would be a boon for Microsoft and Time Warner.

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The gloves are off.



has figured out a new way to compete with



and a new chapter is potentially opening in the search wars.


New York Post

reports on a rumor that Microsoft's online service, MSN, is looking to either buy AOL outright from

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Time Warner


, or become an equal partner with Time Warner.

The ramifications of this are immense. Consider:

  • AOL subscribers are down but that's not where the win is with AOL. While subscription revenue is down ($3.5 billion in the last six months vs. $3.8 billion in the year-ago period), advertising revenue is growing at a fast clip ($631 million in the last six months vs. $435 million in the year-ago period). This boost in ad revenue is coming from search, the same sector that is powering the boost in ad revenue across the entire industry. Who powers AOL's search engine? Google.
  • MSN powers its own search engine. Advertising-based revenue has gone from 30% of MSN's revenue to 57% in the past three years. Last quarter, advertising revenue was at $337 million, up from $288 million in the year-ago period. Getting AOL's traffic, saving on AOL's Google costs, and powering the context-sensitive search could potentially double or triple the combined ad revenue of both companies.
  • It's worth noting that the Google deal with AOL, initially negotiated in May 2002, was what ultimately drove the biggest boost in traffic for Google, catapulting it toward its IPO. The significance of that event was underscored by the fact that the stock Overture (now owned by Yahoo! (YHOO) ) fell 36% on the day the Google-AOL deal was announced. Overture had previously been powering AOL's search. The length of the initial AOL-Google deal was never announced, but it was renewed 17 months later, in October 2003. Assuming that deal was for 2 or 3 years, it's time for renewal either one month from now, or one year from now.
  • AOL had presumably been talking with Yahoo! and Google. Having this inside knowledge of what was about to happen in the landscape of search suggests why now was the right time for Google to do a $4 billion secondary offering at $295 a share.
  • Google dominates 36% of the search market, according to the latest report by comScore. Yahoo! clicks in at 30% and MSN at 15%. It's unclear what part of Google's 36% is from AOL, but any change in the AOL-Google relationship toward MSN will definitely lead to an evening of the score.
  • This is happening right when AOL was planning a relaunch of its portal to make it more widely available to non-subscribers. It is adding a lot more content to the portal that was previously behind the subscriber wall.
  • As part of its initial deal with Google, AOL received 7.4 million shares of Google. They finished selling those shares, at an average price of $185. The fact that they are no longer a stockholder of Google might've had some role here in the decision making.
  • AOL IM has 54 million users. MSN Messenger has 23 million users. In third place is Yahoo! with 21 million users and in a distant fourth is ICQ (owned by AOL) with 1.8 million users. With 90 million users under its belt, and the chance of a move into contextual advertising, the instant message platform is going to spike revenue and earnings for a combined MSN-AOL.
  • Consider this line from the "risks" section of Google's recent S-3 filing detailing its secondary: "Our agreements with a few of the largest Google Network members account for a significant portion of revenues derived from our AdSense program. In addition, advertising and other fees generated from one Google Network member, America Online, Inc., primarily through our AdSense program, accounted for approximately 12% and 11% of our revenues in 2004 and in the six months ended June 30, 2005, respectively" The italics are mine
  • I don't think Time Warner would outright sell AOL. It's too valuable at these levels and the market is still discounting it when compared with its peers because of the stigma left over from the SEC investigations started in 2002. However, I do think a partnership with MSN, essentially handing over the technology work and combining efforts on search and instant messaging would be a 1+1 = 5 solution for AOL and would also go a ways toward appeasing shareholders like Carl Icahn. From Icahn's DFAN14 filing from Tuesday: "The combination of Time Warner's traditional content assets (Warner Bros, New Line, Turner Networks, HBO, Time Inc.), new media assets (AOL) and distribution assets (Time Warner Cable) present an overly-complicated investment decision."

What It Means (for Now)

First off, this is still just a rumor, but it clearly shows that this landscape is in flux. Despite the fact that all of the entrants in the game (Google, Time Warner and MSFT) are established companies, every revenue stream can be called into question.

The winners in an MSN-AOL transaction would clearly be Time Warner and Microsoft. I have written about both companies, calling for

Microsoft to move into a trading range in the $30s and for

Time Warner to move to the $25-$30 area. I think an AOL transaction between the two would speed that process up for both stocks.

While long term I consider Google an amazing company that will continue to succeed, I do believe that its shares are going to take a break while it regroups and seeks maturity.

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

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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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