NEW YORK ( TheStreet) -- AOL ( AOL) CEO Tim Armstrong's reported meeting with top shareholders to push the idea of a merger with Yahoo! ( YHOO) begs the question of whether it's the best option for Yahoo!, which is undergoing a review of ways to unlock shareholder value. According to the report by Reuters on Thursday, Armstrong's pitch was that merger of AOL and Yahoo! could drive $1 billion to $1.5 billion in cost savings through synergies between data centers and news sites. Armstrong is trying to build shareholder support for a merger with Yahoo! as an alternative to being a standalone company, Reuters said. Similarly, to put in place the foundation for stronger growth - or shareholder returns, Yahoo has been exploring asset sales, acquisitions and even a sale of the company. Yahoo's been reportedly looking to a spin its Asian assets that include a 40% stake in Chinese eCommerce giant Alibaba and a 35% stake in Yahoo Japan, sell itself outright, undergo a management buyout, or as recently as yesterday--take itself private in an LBO with private equity firms, company founders or Asian partners. Yesterday's reports about Armstrong fan previous speculation of a Yahoo-AOL merger. On Sept. 9, Bloomberg reported Armstrong was in talks with private equity firms and investment bank Allen & Co. to assess a merger with Yahoo! after it fired its CEO Carol Bartz. According to the report, Yahoo!, with a market cap of roughly $20 billion would buy smaller AOL with a market cap of $1.45 billion and leave its CEO Tim Armstrong on to run the combined media, search and dial up Internet conglomerate. Allen & Co. is also advising Yahoo on a strategic review of ways to boost shareholder value. Though the two struggling internet giants have different revenue bases, both company's face similar challenges, chiefly replacing declining revenue at traditional businesses with ad and display revenue. The question is whether it's in Yahoo's best interest to double down on its display bet with an AOL purchase when neither has seen particularly strong results.
In an email to TheStreet, Clayton Moran an analyst at Benchmark rebutted the logic of a merger. "An acquisition of AOL does not appear compelling as AOL's access business is not complementary and is declining rapidly, while AOL's content business does not change Yahoo's current course," wrote Moran. AOL's annual revenue has fallen at a staggering pace of more than $1 billion a year, making the company's current annual revenue of $2.42 billion as of 2010 a fraction of the $7.79 billion it earned in 2006. The fall comes primarily from a slowing of demand for the dial-up internet service it offers. The company's struggled to replace its subscription base with display ads in the face of growing competition from Google ( GOOG)and Facebook. To combat falling internet connectivity subscription services, in 2009 the company hired former Google sales executive Tim Armstrong to be chief executive and lead a push to bolster its advertising revenue. After becoming CEO, Armstrong launched, among other things, a Project Devil ad revenue campaign, a build out of Patch.com local online news coverage and a $315 million acquisition of the popular news blog The Huffington Post -all which are visible on aol.com today. The goal is to create content to draw users to aol.com and to also maximize ad revenue once visitors arrive at the website. Armstrong said in a second quarter earnings call with analysts, "I think there is this general notion that people don't like portals. It's exactly the opposite." The comments came after AOL reported a loss in its most recent quarter on less than expected advertising growth, shares fell sharply. Advertising revenue at AOL has fallen roughly 21% on average over the past two years according to data compiled by Bloomberg, making the transition of revenue away from ISP subscriptions a still unclear proposition. Yahoo's narrative is similar. The company hired short-lived chief executive Carol Bartz to run a re-organization of the company to make it simpler. She also favored a larger focus on content and, consequently, online display ad revenue -and downplayed the importance of its search business. "We're not a search company." Bartz once said. The company consistently stresses the prominence of its web domains in the U.S. and internationally.
Since 2006, its annual revenue has fallen nearly 2% from $6.43 billion to $6.32 billion and that decline seems here to stay. In its most recent quarter ended June 30th, Yahoo reported a 17.5% decline in revenue from $1.6 billion to $1.23 billion. Search revenue plummeted 45% and display revenue, an area that the company was looking to bolster significantly, has grown only modestly in the first 6 months of the year. The board fired Bartz this September as a result of a lack of proof from earnings that display revenue could replace that of search --and a spat with Asian partners. After the firing, Yahoo! confirmed in a letter to employees that it had hired advisers to consider strategic alternatives maximize shareholder value - code word for potential sales. In the letter, Yahoo co-founders Yang and David Filo and Chairman Roy Bostock wrote to employees that, "What Yahoo! needs to do better -- and we've talked about this -- is accelerate innovation, reignite inspiration, and give our users what they want now -- great content that is engaging and easy-to-use on any device and provides an experience in which they can participate and contribute. Perhaps most importantly, we need to anticipate what they will want next. That is the path to enhancing the value of Yahoo! for all of its stakeholders." The problem for Yahoo! is that there is a big difference in the plan Yang, Filo and Bostock expressed to employees -- reinvigorating the core search and display business -- and what analysts think is in the best interests of shareholders, who've been burned in the past by the board's decision to decline repeated bids by Microsoft's, including a $31 a share offer. Many analysts think the company would be better off pursuing a sale of itself to a capable partner that could grow Yahoo's existing businesses. In an
earlier article , analysts pointed that Microsoft or Yahoo's Asian partners like Alibaba or Yahoo Japan might see more value in unlocking the company's assets than whatever current management could provide. It's to be seen whether Yang, Filo and Bostock view an AOL takeover as the boost in web content that will propel its existing businesses, which contain second leading search business and most viewed webpages in the U.S.
If Yahoo were to seriously pursue an AOL merger, it might put a potentially value maximizing asset or company sale on hold. Responding to a question about what an AOL merger would do to potential Yahoo sales, Moran of Benchmark wrote, "if the Yahoo Board of Directors chooses to pursue an AOL purchase, it would unlikely accompany a sale of Yahoo. Buying one company to sell the combined companies is counterintuitive and complicated." Though merger and sale rumors are emerging from the weeds in an almost daily basis, the company said in its letter to employees, "This process will take time. Months, not weeks." For shareholders, it may be time to decide whether it's a merger and a doubling down on display revenue growth or asset sales that will maximize the value of their holding in the company's stock. -- Written by Antoine Gara in New York