It's finally time to merge Yahoo, AOL

The two flawed companies have a much better chance as one.

By InvestorPlace May 17, 2012 9:43AM

By Jonathan Berr

The case to join Yahoo (YHOO) and AOL (AOL) -- two deeply flawed companies whose prospects are full of uncertainty -- is stronger than ever.

Though CEO-challenged Yahoo recently named Ross Levinsohn as its interim chief executive, AOL CEO Tim Armstrong is a better choice for the job. Levinsohn's biggest claim to fame was being part of the team at News Corp. (NWS) that overpaid for MySpace. The media conglomerate bought the pioneering social network for $580 million in 2005 and sold it for $35 million last year.

Armstrong, on the other hand, has made progress in transforming AOL into a 21st century Web publishing company. In the last quarter, New York-based AOL reported that profit climbed more than fourfold as advertising sales rose. Earnings exceeded analysts' forecasts, as they did at Yahoo. Those earnings "beats," however, should be looked at in context because expectations for both companies were rather low.

Shares of the Huffington Post and TechCrunch parent have soared more than 75% this year as Wall Street cheered its recent $1 billion patent sale to Microsoft (MSFT), while Yahoo has slumped about 5%. (Microsoft owns and publishes Top Stocks, an MSN Money site.)

Still, Wall Street figures the good times won't last at AOL. The average one-year price target on the stock is $27, about where it trades now. Analysts estimate that Yahoo could reach $17.49 during the next 52 weeks, about 14% higher than where it currently trades.

Given the huge issues facing Yahoo, however, the odds of the stock reaching that target are pretty slim.

Both companies are vestiges of the early days of the Internet when websites tried to be all things to all people. In an ideal world, Yahoo and AOL would go private and fix their flaws outside the harsh light of Wall Street. Given the dynamics of both companies, I don't see that happening.

A merger, though not a perfect solution, is a decent way for both companies to bolster their strengths and address their weaknesses. Yahoo could easily afford to purchase AOL with the windfall from any Alibaba or Yahoo Japan deal. A merger would attract antitrust scrutiny, but given that Yahoo's share of the display advertising market should fall to 7.5% in 2014, it would likely pass legal muster.

By joining forces, AOL and Yahoo could offer advertisers unprecedented access to millions of Internet readers in various demographic groups ranging from the hip 20- and 30-somethings who read AOL's music blog Spinner to the baby boomers who rely on Yahoo Finance to track their investments. Yahoo's investment in original content in areas such as sports and politics stands in contrast to AOL's decision last year to shutter 30 of its blogs in the wake of its $315 million Huffington Post acquisition.

AOL has said it plans to invest more in its tech blogs TechCrunch and Engadget, which have been gigantic headaches for Armstrong. Last year, TechCrunch founder Michael Arrington was pushed aside after a dispute with Arianna Huffington. Two top editors at Engadget quit after a row with Arrington. Given that Yahoo's offerings, such as Tech It Up, are less well known than their AOL counterparts, both companies would gain additional leverage to attract technology news readers and advertisers by working together.

The sites have tried for years to tap into the local advertising market, where they're losing ground to new rivals such as Yelp (YELP) and Groupon (GRPN). AOL launched Patch in 2009 and now has more than 800 "hyper-local" news sites in its network. Armstrong has said the service will bring in $50 million in sales this year and be "run rate" profitable in 2013. Starboard Value LP, an activist investor now in a proxy fight with AOL, has raised concerns about Patch, which it estimates loses about $150 million a year.

Yahoo Local, which as of last year had pages covering about 400 places in California, Illinois, Michigan and New York, also seems to be floundering. Yelp has crushed that site and IAC/InterActiveCorp.'s (IACI) Citysearch in recent years. Zhongmin Wang, an economics professor at Northeastern University, has argued that both sites got complacent and "simply waited for anonymous reviewers to fall from cyberspace."

Indeed, Yahoo and AOL are have withered as independent companies and will continue to do so for years to come. Together they could more effectively compete against rivals both new and old than they could alone.

Jonathan Berr is a former AOL contract writer. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @Jdberr

More from InvestorPlace:

May 17, 2012 5:02PM
will be good only when the drop facebook  for good the don't need it
May 17, 2012 2:26PM
I don't understand how Yahoo is not a front runner and a major income earner on the web.Perhaps the company does not realize its' own potential.   Maybe they are like the medical practicioners in the days of Leuwenhoek who thought that the only people with any brains all went to some accepted College or University.
May 17, 2012 10:44AM
What a sales job. Keep forming monopolies.
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