Should AOL and Yahoo! Merge?  

Speculation is brewing about whether Yahoo! (NASDAQ: YHOO) might use some or all of the $5 billion windfall it will get from the Alibaba (NASDAQ: BABA) IPO to purchase AOL (NYSE: AOL). It’s an interesting proposition. But should it happen? More importantly, will it happen?
In most people’s minds, Yahoo! and AOL are essentially the same thing. They are buffets of content.
People visit the sites because the content is presented in relatively short form and is easily digestible – though without much insight or depth. In my mind, Yahoo’s content is vastly superior to AOL’s. It has a real news division and a real finance division.
The fortunes of these two businesses, however, rest mostly on advertising. And there’s plenty of competition for advertising dollars from the likes of Google (NASDAQ: GOOG) and Facebook (NASDAQ: FB). Both companies need to evolve, and on that count, Yahoo has the upper hand, having invested more into buying intriguing start-ups.
Let’s take a look at the numbers, and the quality of those numbers, and see if there is financial sense to a Yahoo-AOL merger.
AOL’s last quarter showed a 14% year-over-year increase in unique visitors; a big increase in programmatic revenue, lifting that segment to 37% of non-advertising revenue; an 18% increase in global ad revenue; a 44% increase in third-party platform revenue, and still generated $153 million from subscription services.
AOL’s operating income tripled to $48 million. Free cash flow, which is really what the online business is all about outside of visitors, grew 57% to $101 million and $178 million year-to-date. Total advertising revenue for the first nine months was $1.35 billion. And company has $457 million of cash.
Overall, AOL is growing much faster than I thought it was.
Meanwhile, Yahoo saw a mere 1% increase in revenue to $1.2 billion last quarter. Revenue trends since the first quarter of 2013 have been essentially flat, although there was a nice lift in Q4 last year. Operating income is down 10% to $156 million. Free cash flow fell 11% to $212 million.
The number of paid clicks was flat, but that’s because the same quarter last year saw a 21% surge. Click-driven revenue rose 17%. The number of ads sold increased 24%, but the price-per-ad declined by 24%.
So Yahoo’s core business of advertising is rather weak and maybe that’s why the CEO sold shares. Where it is strong, however, is its equity ownerships. Alibaba didn’t just provide IPO proceeds. Yahoo! has a 15% interest so it gets ongoing revenue from the company, to the tune of $2.56 billion in Q2, up 47% YOY. Yahoo Japan provided $964 million. Net earnings amount to about a billion dollars each year.
It also has $12.2 billion of cash on its balance sheet.
From this somewhat limited perspective, there is a lot to like about a possible merger. AOL is doing better in advertising. Yahoo’s improving content would enhance the more meat-and-potatoes approach of AOL. Yahoo’s cash position would bring further stability to AOL, while AOL’s more diverse revenue streams would help Yahoo.
Will a merger occur? That’s harder to say. Certainly it would mean a lot of layoffs. Together, however, these two stagnating companies would probably fare better against the competition if they joined forces.

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