Could an AOL Sale Hurt Google?

Google’s 5 percent stake in Time Warner’s AOL unit may be worth less than the $1 billion the Web company paid for it in 2006, Google warned in a regulatory filing on Thursday.

“We believe our investment in AOL may be impaired,” Google (NASDAQ: GOOG) said in its latest quarterly financial filing with the U.S. Securities and Exchange Commission.

Google said it would continue to review its investment for impairment, and financial write-downs could be required in the future.

In a deal announced in December 2005 and which closed the following year, Google paid $1 billion in cash for a 5 percent indirect equity stake in AOL.

The deal by the Mountain View, California-based company gave AOL a theoretical valuation of $20 billion at the time.

In return, Google secured renewal of its search advertising deal with AOL, its largest ad partner, at least until Google’s recent partnership with Yahoo takes effect in coming months, analysts say. Google’s original pact with AOL in 2002 was the landmark deal that legitimized Google’s advertising services.

Preparing to split

The formal admission by the Silicon Valley Internet giant that the value of its investment may have fallen follows recent moves by Time Warner (NYSE: TWX) to shape up AOL for a possible sale.

Time Warner, which has been considering how it might dispose of AOL in order to focus on its core media properties, said on Wednesday it plans to split AOL’s dial-up unit from its advertising business by early 2009.

The move is a major step toward the eventual sale of one or both of the businesses, and would allow Time Warner to move beyond the troubled legacy of its 2001 mega-merger with America Online, which was then hailed as the “Deal of the Century.”

On July 1, Google received the right, but not the obligation, to force the media conglomerate to bring its Internet unit to the market, under terms of their 2006 deal.

But at current market valuations, Google stands to lose an estimated $500 million if AOL is spun off, analysts estimate.

AOL’s $20 billion valuation, established at the time by Google’s $1 billion investment, has been cut by roughly half to as low as $10 billion by some published projections.

In the six quarters ending last December, AOL shed nearly half of its total subscribers, as 8.3 million cancellations left it with 9.3 million paying members.

Falling price

Working in AOL’s favor has been the growing value of its advertising assets. According to a February report by brokerage Sanford C. Bernstein, less than 35 percent of AOL visitors are members, suggesting it is less reliant on dial-up subscribers. The report estimated at the time that AOL’s advertising and media business alone could be worth as little as $10.1 billion and its dial-up access business worth about $3.7 billion.

For more than a year, Time Warner has been in informal talks with partners ranging from Yahoo (NASDAQ: YHOO) to News Corp. on potential deals involving its AOL unit, sources have previously told Reuters.

To put the $1 billion investment in perspective, Google had $12.7 billion in cash as of June 30. It generated $1.77 billion in cash from operations in the second quarter from sales of advertising sold alongside search results on and affiliated Web sites such as AOL, MySpace and

Google also gets an estimated $70 million to $80 million annually from AOL by providing search ad services, and is unlikely to want to risk AOL taking its business to rivals, analysts say.

Google’s investment in AOL allowed it to keep its long-standing ad partnership with AOL and deprived rival Microsoft from winning the deal during negotiations in 2005.

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