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It's Time for AOL to Embrace Its Inner Takeover Target

AOL stock has taken such a beating that it has become a potential target for private equity firms that might want a door into the online industry, according to a Bloomberg analysis. With a current market cap of $1.5 billion, it turns out to be the biggest bargain of any significantly sized U.S. Internet company.

Which is an interesting enough point, but why restrict the universe of potential acquirers to private equity? AOL has its problems, but its digital assets could prove valuable to a number of companies, including Google (GOOG), Yahoo (YHOO), Microsoft (MSFT), or News Corp (NWSA). The right deal could make a lot of sense and get AOL, and CEO Tim Armstrong, out of a tight squeeze.

AOL's hot water
Even with all the recent pain on the stock market, AOL has taken even more of a beating than Nasdaq, as this chart from Yahoo Finance shows (click to enlarge):

Why is AOL a whipping boy? Two factors make investors wonder whether the company can keep enough money rolling in to keep the lights on. Starting as a pure tech company, AOL made its money as a dial-up Internet connection provider. Not glamorous, but the people who still have their accounts (often because they don't realize they don't need them anymore) provide 37 percent of overall revenue.

Unfortunately, the number has dropped by close to 25 percent year-over-year for a number of quarters. Ad sales aren't growing anywhere near fast enough to make up for it. Free cash flow is down 43 percent year over year. At the end of June, the company had $458.7 million in cash and cash equivalents, down from $801.8 million the year before.

Buying Huffington Post and pouring money into growing Patch are major reasons. But the fact remains that as the (probably high-margin) subscription business drops, so does free cash. Unless something changes, AOL will be burning through cash by late next year, setting the countdown to implosion. Investors and analysts are getting uncomfortable, no matter how much Armstrong declares his confidence in the company's future.

Profit? We don't need no stinkin' profit
Concern has driven AOL's market cap to net assets ratio into the basement for any U.S. Web-based company with revenue of $500 million or more. Like the original fabled Filene's Basement in Boston, you head downstairs to find the bargains.

The problem for a private equity firm is that AOL's business might decline so quickly that, in the next three years, investors wouldn't be able to extract the cash to pay off the purchase price. The problem for AOL is that the process would likely vacuum out the resources necessary to build the company into something sustainable.

That's where big media-related companies come in. Look at some companies in roughly the same business, according to Google Finance, and then compare market caps:

Google, Yahoo, Microsoft, News Corp, and Baidu are all much larger and could come up with the resources to buy AOL at a slight premium of $1.5 billion. That's not a full year's revenue, even with the decline the company is seeing this year.

Any of these companies could purchase AOL for the Web properties, write off the subscriber business, cut expenses by using their own business infrastructure, and likely drive improved ad sales with their existing sales groups.

Buying AOL would give one of these companies a top property in Huffington Post. Patch, while still far from secure, could be a huge jumpstart for any of them into the hyperlocal market and a potentially strong take on daily deals, which a number of them already are pursuing.

Time to bail out
For Armstrong, personally, it could be a real windfall. According to AOL's last proxy statement, he owns 2.7 percent of the company. On a $1.5 billion acquisition, that would be $40.5 million, not counting the $13.4 million he would get for a change of control termination, making a total of $53.9 million.

That's even better than the roughly $15.3 million in compensation that he got last year for heading the company as it kept circling the drain. And given the way the stock has gone, his awards and options probably aren't what they were worth a few months ago, so that figure is probably a lot lower.

Hey, Arianna Huffington, better be ready to take that last act of yours on the road, because I have a feeling you'll have to.


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