AOL Reincarnated as Digital Ad Powerhouse Entices Yahoo Activist

Blooberg - AOL Inc. (AOL), once on the verge of becoming an Internet relic, has reinvented itself as a competitor in the digital-advertising industry and a potential merger target for Yahoo! Inc. (YHOO)

Just four years after the Web portal’s failed marriage with Time Warner Inc. ended in a spinoff, Chief Executive Officer Tim Armstrong has transformed New York-based AOL into a different company. A series of investments in ad technology have brought growth, with the promise of profits not far off. The old subscription business -- “You’ve got mail!” -- now represents only 25 percent of sales.

The makeover has long led to speculation that AOL could join forces with Yahoo, another Internet pioneer that has struggled to stay relevant. Now an activist shareholder, Starboard Value LP, is pushing Yahoo to pursue that merger, even if it means AOL is put in charge of the combined company.

“We trust the board and management will do the right thing for shareholders, even if this may mean accepting AOL as the surviving entity in a combination, should that be the best and most tax efficient structure,” Starboard said in a letter to Yahoo Chief Executive Officer Marissa Mayer, according to a statement yesterday.

Spokesmen for Yahoo and AOL didn’t respond to requests for comment on Starboard’s suggestion.

The AOL that Armstrong inherited in the Time Warner spinoff was a shadow of the company whose $124 billion combination triggered record losses, becoming a business-school case study in mergers gone bad. Armstrong winnowed AOL down further, cutting thousands of jobs and raising $1.06 billion in a patent sale to help him start fresh.

Advertising Acquisitions

AOL shares have climbed 78 percent since the 2009 spinoff, keeping pace with the Standard & Poor’s 500 Index. Time Warner has fared even better, more than doubling in value.

Armstrong, 43, has revamped AOL through acquisitions, and most of his biggest bets have been on advertising. His largest transaction was last year’s $418 million purchase of Adap.tv Inc., which matches advertisers and video publishers through an exchange. This year, he spent $98.5 million on Convertro Inc. and $82.4 million on Gravity for more ad technology.

The strategy is to make AOL a company advertisers use to automate their purchases of placements on websites and online videos across the Web. While ads are everywhere online, marketers have found it difficult to ensure their messages are getting in front of their ideal audiences, a dilemma AOL’s technology is meant to address.

Profits Coming

The business has been AOL’s fastest-growing, climbing 60 percent last quarter from a year earlier to $194 million -- almost one-third of total sales. What’s more, the unit’s loss narrowed to $5 million and will be profitable in the second half of the year, Chief Financial Officer Karen Dykstra said in August.

Armstrong’s forays into online journalism have been less successful. Sales at the brand group, including properties such as the Huffington Post and TechCrunch, shrank last quarter, partly because of the exit from a venture Armstrong had championed, the local-news site Patch.

Display advertising, such as the banners on top of websites, has struggled in particular, dropping 1 percent last quarter to $144.1 million. AOL and Yahoo lose money in display and could save as much as $1 billion a year by merging, reducing their costs and overhead in the business, Starboard said in its letter to Mayer.

Debt Deal

“The combined entity would be able to more successfully navigate the ongoing industry changes, such as the growth of programmatic advertising and migration to mobile,” Starboard said. “A combination could also lead to revenue growth opportunities given the broader user base, higher quality content, better technology assets and enhanced relationships with advertising agencies.”

Armstrong has been positioning AOL as a buyer, not a seller. The company sold $330 million in convertible bonds in August, giving it funding for acquisitions, share repurchases or other transactions.

Armstrong took AOL’s top job at 38 when Time Warner spun off the company, coming to the company from Google, where he spearheaded the ad-sales division. Mayer was also one of Google’s star executives when she left in 2012 to take charge of Yahoo. Neither is likely to want to cede control, said Brian Wieser, an analyst at Pivotal Research Group.

“While AOL would fit well with Yahoo on paper given our criteria, we are skeptical that any such arrangement would ever materialize,” Wieser said yesterday in a note. “It seems difficult to contemplate the circumstances under which either management team would agree to sell itself to the other.”