Online Ownership - 2006 Annual Report

Perhaps the biggest story of the online world in 2005 was the competition for a stake in AOL, a battle that ended in mid-December when a deal was announced that would give Google 5% of AOL for an estimated $1 billion.

The deal occurred after a period in which Time Warner’s declining stock value declined amid uncertainty over the future of AOL. The activist shareholder Carl Icahn and AOL’s co-founder, Steve Case, who resigned from the company’s board but remains one of its largest shareholders, urged the company to “liberate” AOL from Time Warner, in the words of Case.6

With speculation mounting, news reports in mid-September that AOL and Microsoft, supposedly “humbled” by the surging fortunes of Google and Yahoo’s success in online search advertising, were discussing a sale that could ultimately drive up AOL’s value.7 Comcast, Google, and Yahoo were also rumored to be interested in an AOL deal. But in December, AOL said it had abandoned its plans to sell a minority stake and wanted to enter a more limited partnership. As of mid-December 2005, only Google and Microsoft remained as potential partners.

Each company expressed interest in a deal with AOL for different reasons. Google’s motives appeared to be mainly defensive as it looked to maintain its dominance in the online advertising industry. AOL, which uses the Google search engine on its site, accounted for 11% of Google’s revenues, or $291 million, in the first half of 2005. Moreover, AOL was appealing to Google because it had the capacity to showcase rich text ads that contain audio and video that marketers are increasingly seeking to buy. Google had been reluctant to place such ads on its own site, fearing they could slow down Web pages. Some analysts said losing AOL to MSN could have hurt Google’s ability to provide marketers with a platform for distributing rich text ads.8

Google may also have had an interest because of AOL’s original content as well as that from Time Warner, which owns CNN, HBO, Time Warner Cable, People magazine, and Sports Illustrated. Google’s strong interest in offering more video through its search technology has been hampered by resistance from television companies, which have balked at Google’s attempts to digitize their content. Access to that original video content could also help Google compete with Yahoo, which has intensified its efforts to provide more original video programming in 2005.

For Microsoft, last in the search industry among the major players, adding AOL’s sites would have helped it compete with the other portals that were far ahead both in number of searches conducted and search advertising revenue. MSN was also interested in AOL’s instant messaging service.9

Comcast was in talks with Google to bid for AOL as a joint venture. An alliance with Google would have provided Comcast with an opportunity to invest in a traditional media company, something it had failed on when it unsuccessfully bid for Disney in 2004, the Wall Street Journal reported in October.10

In mid-November, Yahoo announced it was no longer a bidder. In addition to augmenting its own original video programming with that of AOL and its access to Time Warner, Yahoo’s interest was in improving its position in the search advertising business (it is currently a strong second to Google) but also in the potential that AOL’s instant messaging service provides. According to The Economist, instant messaging, where AOL is the current leader, has not been yet been a lucrative asset, but holds promise “since it is one vehicle for free Internet telephony and tends to make its users fiercely loyal.”11

The December deal will not only affect AOL and Google, but probably Microsoft and Yahoo as well. First, AOL has secured a long-term technology partner and will likely be able to increase traffic, since the agreement allows AOL-branded ads to appear on Google’s sites, including banner ads.12

Meanwhile, Google will be able to retain the search revenue it receives from its existing partnership with AOL and will have new opportunities to develop potential revenue streams from video, an area where AOL is seen as an emerging leader.

And Yahoo may ultimately benefit as well from the agreement — mainly at the expense of Microsoft, which could have rivaled Yahoo and Google if it had been successful in its bid to buy AOL.