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AOL and Microsoft: 5 Questions
What does this the settlement mean for consumers, the companies and investors?
May 30, 2003: 5:26 PM EDT
ByPaul R. La Monica, CNN/Money Senior Writer

NEW YORK (CNN/Money) - When bitter rivals decide to call a truce, you have to wonder why.

Microsoft and AOL Time Warner agreed Thursday to settle a lawsuit that the world's biggest media company filed last year, claiming Microsoft had competed unfairly to cripple AOL's once-dominant Netscape browser.

Microsoft is paying AOL Time Warner $750 million to end the dispute, which follows Microsoft's agreement to settle the government's landmark antitrust case last November. (For more about the AOL-Microsoft deal, click here).

But the two companies didn't stop there. They also announced that they would cooperate to boost the growth of digital media technology and work together in other areas, too. Exactly how that cooperation will play out will take years to assess, but here's a first look at what the agreement will mean for the companies, their investors, competitors and customers.

Why have the two companies agreed to cooperate? Digital piracy appears to be the main reason. Under terms of the settlement, AOL Time Warner can feature Microsoft's latest version of Windows Media Player on its service as well as Microsoft's digital rights management software, which makes it tougher for users to illegally copy songs and other content.

That is key since New York-based AOL Time Warner owns Warner Music, one of the five major record labels, as well as the Warner Bros. and New Line Cinema movie studios. A secure way to sell its copyrighted library of music and films online could mean a lucrative new revenue stream for AOL, as well as faster adoption of its broadband services. AOL Time Warner also owns CNN/Money.

Michael Cohen, director of research for Pacific American Securities, said that the agreement could also help Microsoft in its efforts to make Windows Media Player the standard software for viewing movies and music. Cohen owns shares of AOL Time Warner but not Microsoft. His firm does no investment banking.

Microsoft competes with RealNetworks (RNWK: Research, Estimates) and Apple Computer in this area. Both companies recently announced online music services that allow customers to buy and download individual songs. RealNetworks' stock tumbled about 10 percent Friday while Apple (AAPL: Research, Estimates) shares edged lower.

What does this mean for consumers? Not much yet, but it could mean a lot down the road.

Microsoft is allowing AOL to feature its Internet Explorer browser for seven years without having to pay a royalty, but that doesn't change much for AOL users since IE is already their default browser.

But later on, Instant Message users could benefit since the two companies have pledged to make their services work together. Currently, someone using Microsoft's IM product cannot send messages to someone using AOL IM.

“ These are two companies that used to have trouble being in the same room. ”
Robert DeVos
Burns Doane Swecker & Mathis

And since AOL will also now have access to technical information about new versions of Windows, and the full source code to Windows, that should allow AOL users to have fewer problems running Microsoft software, which had been an issue in the past.

"These are two companies that used to have trouble being in the same room," so the sharing of information should be great for AOL users, said Robert DeVos, partner with Burns Doane Swecker & Mathis, an Alexandria, Va.- based intellectual property law firm.

Whether the agreement is a win for consumers in general remains to be seen. One analyst said it may give Microsoft room to increase its dominance the market for digital media.

"This is an echo of what we've seen before," said Phil Leigh, an analyst with Raymond James & Associates. "It is a classic case of Microsoft working to establish itself as a de facto standard, now in digital media."

For now, though, Leigh said consumers won't have to worry because there is still a lot of competition in digital media. To that end, AOL has said it will continue to feature media playing software from RealNetworks.

But if the Microsoft-AOL partnership leads to a monopoly situation, then that could mean higher prices for content, he said. Leigh owns a small amount of RealNetworks.

What does this mean for the companies' businesses? This appears to be a win-win. By aligning itself more closely with Microsoft, AOL won't need to spend as much on developing new technologies, such as media-playing software, or secure digital technology.

"This allows AOL to not worry about being as much of a head-to-head software developer," said Cohen.

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And the fact that Microsoft will be distributing AOL software discs with Windows to smaller PC makers could mean AOL will be bundled with Windows on users' desktops.

"You would think that whatever's on the screen is what a user will use, so this could help AOL grow the subscriber base," said Matthew Kelmon, president of Kelmoore Investment Co., which owns about a million shares of AOL Time Warner and a million shares of Microsoft.

For Microsoft, the deal means greater access to AOL's 32 million subscribers worldwide. Microsoft's rival MSN service has about 9 million subscribers. Giving PC makers AOL discs may stunt MSN's growth, but with the online service accounting for only 6.5 percent of Microsoft's total sales, this doesn't appear to be a major concern for the company.

The pact also means that AOL's Netscape will likely become even less than a threat. Although AOL Time Warner Chairman Richard Parsons said Thursday that AOL is not looking to sell or shut Netscape, Nate Eimer, a partner with Chicago-based antitrust law firm Eimer Stahl, said the settlement essentially means the end of Netscape as a competitor to Internet Explorer, since the two companies are cooperating so broadly.

What does this mean for the stocks? Shares of both companies rose Friday, with AOL Time Warner (AOL: Research, Estimates) up 2.5 percent and Microsoft (MSFT: Research, Estimates) stock adding almost 1 percent.

AOL Chairman Parsons said the company would use the $750 million to pay off debt, a plus since AOL's highly leveraged balance sheet is one of investors' biggest concerns about the company.

For Microsoft, the longer-term impact on its stock is less certain. The company will likely record a charge in its fiscal fourth quarter to reflect the cash payment, but that will probably be glossed over by most investors.

What does this mean for Microsoft's other legal challenges? The settlement gets rid of some legal worries for Microsoft, but others remain. Sun Microsystems (SUNW: Research, Estimates) has its own antitrust suit pending against Microsoft.

And two states, Massachusetts and West Virginia, have appealed November's settlement of the federal government's antitrust case. The antitrust lawyer Eimer said the AOL settlement is unlikely to spur either state to settle, adding that Sun, arguably the most outspoken critic of Microsoft, probably won't end its battle either. Sun had no comment about the AOL settlement.

But these cases really don't represent much of a risk for Microsoft, he said, especially since it has more than $46 billion in cash. "Given Microsoft's size, these are not significant legal risks."  Top of page




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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.