What the AOL Merger Means for Verizon Stock (VZ, AOL)

The word that best describes Verizon Communications Inc’s (VZ ) $4.4 billion acquisition of AOL, Inc. (AOL) is “confusing.”

aol-stock-logo-185At first, media reports argued that the acquisition made perfect sense. Verizon could use AOL’s content to differentiate itself in the increasingly competitive wireless market where the company’s only pathway to growth lies in stealing customers from its rivals.

Then came a story from RE/Code’s Kara Swisher which said: “AOL has also been in advanced discussions with a number of parties to spin off its flagship Huffington Post content unit.”

According to Swisher, a veteran observer of the tech world, German media conglomerate Axel Springer and several private equity firms had expressed an interest in Arianna Huffington’s site.

AOL has denied Swisher’s story, but given her track record I am willing to believe her.

BuzzFeed tried and failed to confirm Swisher’s scoop but managed to find out that Verizon wanted to retain AOL sites such as TechCrunch, Engadget, MapQuest, Moviefone, CrunchBase, and Alpha.

So, why take on those sites but not Huffington Post? There could be several reasons.

For one thing, while Huffington Post has added pizzazz to the stodgy AOL brand, its financial contributions to the New York-based Internet portal have been underwhelming.

The company’s latest quarterly results underscore this point. Profit in the Brand Group, which includes HuffPo was $12.9 million, roughly 10% of the earnings of AOL’s most profitable business. That title goes to AOL’s its Membership Group — its dial-up Internet business. However, Brand Group revenue rose 8% on a year-over-year basis to $193.4 million, topping the $182.6 million earned by the Membership unit.

Part of the problem with Huffington Post may be its namesake founder, who has been a focus of some backstage drama at AOL. It’s no accident that Huffington Post operates independently of the rest of AOL. According to Swisher, Huffington has spoken to bankers about how to buy back her company from AOL. Huffington has also hosted discussions about spin-offs. None of these talks have gotten anywhere, but most have annoyed CEO Tim Armstrong.

What Verizon Stock Stands to Gain With AOL

Nonetheless, I can see why Verizon would prefer AOL’s non-Huffington sites. They appeal to small but passionate audiences that advertisers covet. AOL also is investing in original programming featuring such high-price talent as James Franco, Steve Buscemi, Sarah Jessica Parker and Zoe Saldana.

Verizon stock could benefit from boostomg spending on these expensive shows and license others. But keep in mind that content costs remain a dangerous game — the sky is the limit. In its latest quarter, Netlix, Inc. (NASDSAQ:NFLX) disclosed that it has had $9.8 billion in “streaming content commitments.” Verizon doesn’t want to chase those kinds of costs.

The other selling point for the deal has been advertising technology, an area which has been a focus of CEO Tim Armstrong with offerings such as One by AOL, which lets advertisers buy ads across online and traditional platforms such as TV. AOL’s Platforms Group saw its sales surge by 21% to $279.8 million in the last quarter. However, the segment still lost $10 million.

Keep in mind the cherry on top for VZ is programmatic advertising, which is a fancy way to describe automated advertising auctions.

I have always thought that when markets become more efficient, prices go down. A recent article in Ad Week, however, takes the opposite view. Or, at least, a much more complicated view.

“[ChoiceStream VP of marketing, Bill] Guild said it can be tricky to draw conclusions from pricing data. For example…ads in the home and garden segment swung from well above average to well below; it’s not clear why.”

If I owned Verizon stock, that wouldn’t make me feel too confident.

But, because VZ has a market cap topping $200 billion, it can afford to take a chance on AOL and Armstrong, who may be able to grow his business under the wireless company’s ownership faster than he ever could on his own.

As of this writing, Jonathan Berr did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/05/aol-merger-verizon-stock-vz/.

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