Merrill Lynch’s Justin Post thinks that Yahoo! might bid for AOL and that Yahoo! might be a good fit for Microsoft. Indeed both of these scenarios are plausible from afar, but I do not think that Google invested $1 billion for 5% of AOL to sit idle and see someone else come and scoop up AOL from under their nose. I think Google’s investment was defensive in the sense that they wanted to protect the 10% of the revenue that AOL.com drives for Google but also to push Yahoo! and MSFT off.
I would be very surprised to see either one of these deals happen.
MSFT/Yahoo! would not really mess culture-wise, we’ve written in the past about a Yahoo! / Google combination being more realistic, though anti-trust issues are bound to arise, as the unit would have 80% market share in search.
Yahoo/AOL is also not very realistic. It could happen, of course. But AOL drives 10% of Google’s revenue. At a market cap of $140 billion, Google is priced to perfection, any one negative could make it derail quite a bit, 5, 10, 20% correction in one day is something all stocks go through. Losing the AOL deal would be such a negative.
We like to think that Google is untouchable, but people said that about every single stock and it got nailed at some point. I think Google deserves its rich valuation, but with that comes the odd slashing once in a while. In fact, before hitting a new 52 week high (and all time in fact) this month, Google “crashed down” to $340 earlier this year.
But while Google might be vulnerable to externalities, it is not going to be outbid for AOL. Merrill Lynch came out recently and pegged AOL’s value at $13 billion. Last year the $1 billion for 5% deal pegged its value at $10 billion, so a 30% growth in valuation is not an incorrect assessment.
[Added the next day: when I initally wrote this, I wrote $1 billion for 5% is a $10 billion valuation, a Grade 4 student could realize that it’s not, it’s $20 billion. Note to self, don’t add 1,000 blog posts with valuation models when you have 20 minutes between calls! This is even more reason why AOL would probably not be willing to let go of its prized asset for a reduced valuation.]
I’d simply say Google has an enterprise value of $135 billion, AOL generates 10% of Google’s revenue, so you can estimate that AOL is not worth much more or much less than 10% of Google’s market cap, so $13.5 billion (you cannot really do that kind of linear relationship between a leader like Google and a laggard, but AOL and Google are both in the same category in terms of multiples, etc. even if their businesses are different).
So, like we covered yesterday, Yahoo! is too large to be gobbled easily by someone (MSFT notwithstanding) and too small to gobble many companies, including AOL. Acquiring AOL would cause a considerable dilution: Yahoo! is worth $36 billion, AOL is worth $13.5 billion. To buy AOL.com, you would have to add a premium of 10-20% (at least) for Time Warner to give it up, so you would have to pay $15-17 billion, that is almost half of Yahoo!’s valuation. Even worse: Google valued AOL for $20 billion. Clearly, AOL’s price tag is too high for Yahoo!
And, not so fast there cowboy. The reason why I do not see AOL selling is that Google’s mere interest or rumored interest will drive up prices quickly. Once the purchase price gets in the $15-20 billion range, Yahoo! will balk.
That is why while Mr. Post’s comments are interesting and all, they are not going to materialize. When Google bought 5% of AOL, it effectively bought an option - but not an obligation - to block any move that AOL would want to do. It also ensured that Yahoo! and MSFT would never be able to scoop up AOL.com.
For a young company, that shows a level of shrewdness and maturity that gives Google the edge in the boardroom as in the marketplace.
Disclaimer: I own shares in Yahoo! at the time of writing.
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