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Verizon’s $4.4B Deal for AOL Is a Win-Win

It’s hard not to snicker, but Verizon Communications Inc.’s (NYSE:VZ) decision to buy AOL, Inc. (NYSE:AOL) for $4.4 billion or $50 a share isn’t all that dumb. It’s at least defensible.

Verizon's $4.4 Billion Deal for AOL Is a Win-WinAOL is a far different company than the one party to the worst merger in history — that would be the $180 billion debacle that was AOL and Time Warner Inc (NYSE:TWX).

AOL has tried to reinvent itself repeatedly since then, and the latest identity looks to have stuck. The internet pioneer has transformed itself into a company with expertise in the automated selling and placement of digital ads.

This programmatic ad technology is Verizon’s sole interest in AOL, which is building out its streaming video service. With AOL ad tech infrastructure in house, it will be easier — and presumably cheaper — for VZ to sell video ads against the content it’s streaming.

As for AOL’s content businesses themselves — Huffington Post, Engadget, TechCrunch, etc. — Verizon probably couldn’t care less. In meeting with AOL staffers, CEO Tim Armstrong gave some lukewarm reassurances that HuffPo will remain in the fold, but that seems unlikely. There’s no definitive word so far on what fate will befall HuffPo and the rest of the content businesses, but it’s a good bet that they will be sold or spun off.

VZ’s disinterest in these unprofitable assets helps explain why AOL commanded only a 15% premium to its recent average price.

That makes the deal look like a bargain for VZ. And even if it goes down like the Hindenburg, the actual purchase price is so small relative to VZ’s resources that it’s a low-risk move. After all, VZ paid $130 billion to buy out Vodafone Group Plc (ADR) (NASDAQ:VOD) stake in Verizon Wireless.

Furthermore, VZ, which will pay with cash and commercial paper, generates tremendous free cash flow (that’s what telcos do). After paying interest on its debts, VZ had $11.5 billion in free cash flow last year. This is a deal it can easily afford, even if it turns out to be a dud.

AOL Makes a Good Exit

As for AOL shareholders, the VZ deal represents a decent — if not great — out since being spun off from Time Warner in 2009. A sale of AOL was always the most likely end game for the company, if only because it’s small and obviously interested in being a target.

The VZ deal saves long-time AOL shareholders from some pretty lame long-term gains. Before AOL stock soared on the deal news, shares were up 85% from the spinoff price of $27. The broader market gained 93% over the same time.

The deal spike has AOL stock trading at more than double its debut price.

That saves shareholders from a loss in terms of opportunity cost, but it’s hardly a windfall. AOL is going for $50 a share, but its all-time high of $53-and-change happened only four months ago.

If you’re a holder of VZ stock, there’s actually nothing to see here. VZ is making strategic investments in infrastructure, which is what telecoms are supposed to do.

If you’re a holder of AOL stock, the market is betting that a slightly better bid comes along, but you shouldn’t. Sell now and be happy with whatever upside you get.

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

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