Fortune
 Fortune editor at large
February 1 2008: 1:13 PM EST
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AOL's options darken with Microsoft's Yahoo bid

Once heavily courted, Time Warner's Web portal starts to look like a wallflower.

By Richard Siklos, editor at large

jeff_bewkes_tw.03.jpg
Microsoft's offer for Yahoo challenges AOL and gives Jeff Bewkes, Time Warner's new CEO, his first big test.

NEW YORK (Fortune) -- Two years ago, AOL was the belle of the Internet ball as its owner, Time Warner, entertained teams of suitors hoping to cozy up to the once-dominant Web portal. Microsoft offered to buy half of AOL, but the board of Time Warner demurred. Yahoo offered to acquire the company with stock, which was also a non-starter. In the end Time Warner settled on a deal under which search giant Google invested $1 billion in AOL in exchange for running its search business.

At the time, it seemed like a savvy move because Google's investment gave AOL a value (on paper at least) of $20 billion and kept the company's options open for a better deal down the road, most likely with Yahoo. Now, AOL may be looking like a wallflower at the prom as Microsoft (MSFT, Fortune 500) seeks to swallow Yahoo (YHOO, Fortune 500).

"If Time Warner wants to sell AOL, their problem is that AOL can only be in play if there's a buyer for it, and this is the most logical buyer: Yahoo or Microsoft," says Terence Kawaja, a partner at investment bank Savvian Advisors.

At the same time, it's hard not to conclude that a potential deal between its two nearest rivals -- both Yahoo and Microsoft's MSN network vie closely with AOL and Google for the most visited sites online -- puts AOL squarely in play. "I now think that they pretty much have to sell, and they also have to sell really quickly," posits a senior executive at one of AOL's rivals. "I don't see what else they do."

In early trading, Time Warner (TWX, Fortune 500) stock was up 1%, hardly an indication that one of the company's most-watched operations was in play. (Fortune and CNN are also owned by Time Warner.) Time Warner declined to comment. But one person close to Jeff Bewkes, the company's new chief executive, said that internally the Yahoo offer was being viewed as a validation of AOL's strategy to focus on building up its capabilities as an online advertising platform.

If an MSN-Yahoo merger were to go ahead, the thinking goes, AOL's Platform-A advertising would stand as a clear alternative to Microsoft and Google in a rationalizing market. "With consolidation of the online ad networks, this creates more air in the room for AOL to be competitive to advertisers," said Kawaja.

Two of the Web's giants might be busy elsewhere, but there could be a few other potential candidates to take a hard look at AOL, particularly among cable and telephone companies.

As cable companies generate more of their cash-flow from selling broadband services and look to adding Web-like capability to place ads on television screens, an ad network like AOL's could be appealing. (Similarly, Rupert Murdoch's News Corporation (NWS, Fortune 500) could be interested in AOL's ad business to help drive revenue at his MySpace and other online properties.) Comcast had expressed an interest in participating in the round of AOL talks two years ago.

And the Microsoft deal also makes unclear the fate of an alliance that Yahoo just last week struck with AT&T (T, Fortune 500), which has made bringing online advertising to its mobile platform a priority. Indeed, of all the potential buyers of AOL, AT&T, with a $231 billion market capitalization, would be able to buy it without blinking. (It could, of course, also prove a white knight for Yahoo.)

It is also conceivable that Time Warner Cable, which is widely expected to be separated from Time Warner at some point in the next year, could take all or part of AOL with it as part of the bargain.

And, although it might not be interested in the content side of AOL's business, Google might still feel like it needs to own AOL because it accounts for a small but lucrative share of its search business. Google's current deal with AOL expires in 2010.

Whichever way this goes, it's clear that the Microsoft bid for Yahoo has presented Bewkes with his first big test as Time Warner's CEO since taking over January 1. Part of the reason Time Warner did not sell two years ago -- when Microsoft's offer valued it at $18 billion, according to one person familiar with the proceedings -- was the hope that by hanging in it could be worth substantially more. Now the value of AOL, once the ruler of the Web, is once again open to debate. With a relatively new management team and some of its latest strategies unproven, this would probably not have been the moment of Bewkes choosing.  To top of page

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