Saturday, December 17, 2005

AOL rebounding

Aided by a spiky kick in the posterior from Carl Icahn, AOL is rebounding. But Google’s deal with AOL appears to undervalue AOL significantly.

The deal with Google blocks Microsoft from gaining control of AOL and gives AOL advertisements special placement on Google’s site. By agreeing to change its business practices for this deal, Google blocked a potentially significant challenge from a combination of AOL and Microsoft and temporarily secures Google’s leadership in search advertising.

The deal reminds me of how far AOL has fallen from its peak. Google’s $1B deal for 5% of AOL values AOL at $20 B – an 88% decline from AOL’s $166 B valuation six years ago. At 20 million, AOL has roughly the same number of subscribers
now as it did in January 2000. Back then, AOL was valued at $8,300 per subscriber, today’s deal values those subscribers at an 88% discount of $1,000 per subscriber. But since its low of $8.70 in July 2003, the company’s market capitalization has more than doubled.

Carl Icahn has alleged that he would sue AOL’s board if it does a deal that undervalues AOL and called this deal
a travesty. With TWX stuck at roughly Icahn’s basis, it has become clearer that Icahn’s bark is worse than his bite. However, he and his colleagues may have increased AOL’s sense of urgency.

While Icahn may be overstating his case, the Google deal appears to undervalue AOL. How so? Based on an estimate of
110 million unique monthly visitors (UMV), the Google deal values AOL at $181/UMV. While not perfect comparisons, Yahoo, with 169 million UMVs, trades at $355/UMV, is worth roughly twice the implied valuation of AOL based on the Google deal. Google, with 88 million UMVs, is worth $1,477/UMV, over eight times AOL.

That a deal happened at all may be a testament to Icahn’s influence. But this potential valuation gap will give Icahn another spike with which to prod Parsons.

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