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AOL and Yahoo: A Merger That Doesn't Even Look Good on Paper

Those rumors about an AOL and Yahoo combination of some sort just won't go away, which makes it time to point out that, whatever the investment bankers think, this is a really dumb idea. Not only are both companies struggling, but they're doing so for the very same reason: the business they both used to be leaders of -- portals -- isn't what it used to be. So, combining two companies in a dying business isn't a solution -- unless it buys time until the two figure out a direction that looks forward, not back. Where's the action? Social.

Figuring out exactly what's going on is a moving target, but here's a recap: reports first surfaced a few weeks ago that AOL might be reaching out to Yahoo about a strategic alliance or merger. Then, yesterday, the WSJ reported that AOL had "hired financial advisers to explore various strategic options for the company, one of which includes a possible tie-up with bigger rival Yahoo." (Most of the story is behind a firewall.) Those advisers are said to include Bank of America and boutique investment firm Allen & Co.

Meanwhile, the New York Post is reporting today that KKR & Co. is also circling Yahoo, independently of a potential AOL deal. But that's not all. If you read all of the press about the two in the last few weeks, other financiers, including Goldman Sachs, Blackstone and Silver Lake have all been mentioned.

That's lots of interest, but if potential investors look closely, this is what they'll find: two companies whose traffic and advertising revenue are at the very best ho-hum at a time when other players -- particularly in social and search -- have had no trouble reaping the benefits of a market that was up 11.3 percent over the first half of the year. According to the Interactive Advertising Bureau, the first six months of the year were also record-setting, with $12.1 billion going online. And, no, it wasn't just search. All forms of display were up by almost 16 percent.

But at AOL, which just announced third-quarter earnings, ad revenue was down 27 percent -- slightly more than overall revenue, which was down 26 percent. (Unbelievably, the company still receives hundreds of millions in revenue from subscribers.) Next to AOL, however, Yahoo looks like a positively thriving concern. In the third quarter, its marketing services revenue was up four percent, display was up 17 percent and overall revenue was up by two percent. Promising, right? Well, uh, not so much. ComScore released figures today showing that Facebook served up 297 billion display ads in the third quarter, doubling its market share from last year to 23.1 percent. Yahoo served 141 billion to come in at a distant number two.

In a sense, the problems at Aol and Yahoo are all about Facebook -- because the dominance of Google in search was long ago baked in to whatever one thinks of the two companies. Social is where it's at -- and not just from a revenue perspective. One of the more telling statistics of the year came in June U.S. audience measurement statistics from Nielsen. They showed a 43 percent increase in time users spent within social networks -- or 22.7 percent of all online time. Portals, meanwhile, showed a 19 percent decline, only accounting for 4.4 percent of time spent.

So, combining two portals? Not a great idea. Whatever their individual problems, the market they primarily play in is the core difficulty. Of course, the fix would seem to be social, but that's harder than it looks. Social is all about the glue that connects people, and those people seem to mostly be on Facebook. So, rather than turning to one another, AOL and Yahoo need to turn to Facebook -- and hope that Facebook would be interested at looking back in their direction.