December 19, 2005 AOL and Google Kissing in a Tree

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December 19, 2005 AOL and Google Kissing in a Tree TABLE OF CONTENTS AOL and Google 1 Q Portfolio Week In Review 2 Q Model Portfolio 5 AOL and Google Kissing in a Tree I'm under the gun this morning as I write this. It’s Sunday morning, the sun is shining, and my wife and kids are putting ornaments on the tree downstairs (I'm Jewish, so I’m excused from participating). But I just lost two crowns and I'm afraid that at any minute the pain is going to start. So let’s get right to it. Last week was a busy one for Internet stocks, and everyone is trying to get in deals before the end of the year. Perhaps topping the list was the news at Friday’s close that Time Warner (TWX:NYSE) and Google (GOOG:Nasdaq) are in the final stages of exclusive talks to conclude a deal. Here are the terms that have been leaked so far: Google will pay $1 billion cash for a 5% stake in AOL, implying an overall valuation of $20 billion. AOL’s rumored valuation was $10 billion to $12 billion earlier this year when it began talking to Microsoft (MSFT:Nasdaq). A few weeks ago, I wrote that the final number would more likely be $20 billion, and it was. This significantly improves the valuation picture for Time Warner because its AOL stake, considered worthless only 18 months ago, will most likely end up being worth $30 billion to $40 billion when Time Warner eventually spins it out in an IPO. Google will have a new ad category where it features AOL sites related to the search category. These results also will include the AOL logo, marking the first time Google puts graphics in its ads. Google will provide technical advice to the AOL network of sites to help them rank higher in Google search results. People pay top dollar for search-engine optimization, so AOL is receiving extremely valuable information. I've said before that if I were to start an Internet service business right now, it would be in search-engine marketing. AOL will be able to sell its clients ads (note: AOL owns ad network Advertising.com, which it bought for $400 million last year) across Google's AdSense network. Time Warner will become the first media company that can sell ads across every medium, including the Internet and Internet search. It’s interesting that Time Warner sold only 5% of AOL. Parsons is definitely keeping control of AOL. He’s not letting those Internet guys hoodwink him again. So why Google and not Microsoft (MSFT:Nasdaq)? There appear to be several reasons. Google has already been generating $430 million in revenue for AOL; it clearly knows how to place search advertising. It would have been a disaster for Parsons if he had switched to Microsoft and Microsoft somehow had dropped the ball. December 19, 2005 TheStreet.com Internet Review December 19, 2005 Microsoft might have been trying to pawn off MSN on AOL in order to clear up monopoly concerns about the integration of Internet features into the new Vista operating system. Again, this would have been the end of Parsons’ career. (Who would've thought that the new saying would be, "I can't get fired if I use Google.") Apparently the negotiations with MSN were getting too complicated. This deal with Google is fairly simple. It must have been interesting when Parsons dialed the 206 area code to get Microsoft CEO Steve Ballmer on the phone. Ballmer is worth more than $12 billion as of Friday's close. Parsons, given his background with the Rockefellers, his Dime Savings Bank experience and his 630,000 shares of Time Warner, is probably worth about $50 million. Yet Ballmer probably cried like a baby when Parsons told him the news. Can't these guys just go fishing and enjoy life for once? Meanwhile, we have other action to recap. E*Trade (ET:NYSE): Raised its 2006 earnings forecast to $1.30 to $1.45 a share, better than analysts’ estimates of $1.29 a share. The company adjusted its sales forecast up to $2.2 billion to $2.4 billion, topping analyst expectations for $2.08 billion. E*Trade attributed the upside to its recent acquisitions of Harrisdirect and BrownCo, as well as strong operating efficiency. Shares are up about 5% this week. I have to say that ET is one of my all-time favorite companies. From 2001 to 2003, ET stock fell to the low-single digits because the founder took a big paycheck (big deal) just as stock trading was plummeting to low levels. But ET quietly was building its mortgage lending business as the housing boom was kicking in. And now what is the company doing? Becoming the leader in discount trading, of course! Just in time for the next stock boom. Global Payments (GPN:NYSE): Announced that 11 more U.S. casinos have signed contracts for its VIP LightSpeed suite of products. VIP LightSpeed is an Internet-accessible, PC-based platform that provides traditional and electronic check cashing, ATM check cashing, credit- and debit-card cash advances, player histories and credit reports. It also provides management reporting tools that speed transaction processing and reduce the risks associated with check- cashing and cash advance services. The stock is flat on the week. InPhonic (INPC:Nasdaq): Launched its new mobile-content service for ring tones, wallpapers, games and related services under the mFLY brand. According to industry experts, mobile content is the fastest-growing segment of the telecommunications market and is expected to remain so for the foreseeable future. Worldwide revenue is projected to hit $35 billion by 2010. David A. Steinberg, InPhonic's chairman and CEO, said: "We see this new business unit and mobile-content offering as a key extension to our current services, and both an exciting and significant opportunity for us to leverage the millions of customers and online shoppers that already use InPhonic-powered sites for their wireless needs." InPhonic is flat on the week. iPass (IPAS:Nasdaq): Agreed to acquire GoRemote (GRIC:Nasdaq) for $76.5 million in cash. This offer represents a 23% premium above the previous Friday’s closing price. GoRemote is a good acquisition because it serves a different market and will bring iPass new customers. That will enable it to cross-market and benefit from economies of scale. This should reduce costs and improve cash flow. The deal should be consummated by the end of the first quarter in 2006 and be accretive by the second. iPass is down 6% on the week. 2 TheStreet.com Internet Review December 19, 2005 Microsoft: Sales of the Xbox 360 are off to a sluggish start in Japan. Microsoft raised its quarterly dividend by a penny, to 9 cents a share, a 12.5% increase. Adding to the whole patent-infringement craze, Microsoft was sued by Visto Corp., a maker of mobile email technology. The suit states that Microsoft has infringed on three patents related to how information is handled between servers and handheld devices. This suit is very much like the dispute between NTP and Research in Motion (RIMM:Nasdaq). I should point out that NTP has acquired an equity stake in Visto and signed a patent licensing deal with it. Maybe NTP wants to get into the handheld business after all. Microsoft also announced a partnership with MTV to develop an online music service to launch in early 2006. The new service, dubbed URGE, will be integrated into the Windows Media Player and will offer more than 2 million tracks for sale. This will undoubtedly put pressure on RealNetworks (RNWK:Nasdaq). Microsoft is down 2% on the week. Palm (PALM:Nasdaq): Palm has had a nice run-up this week, gaining about 8%. This is most likely because of the continued speculation on the RIM patent case. While I continue to be bullish on Palm for other reasons, prepare to act quickly if you are in the stock only for a short- term trade. RealNetworks: Google has unveiled a new music search that will return information about artists, albums and where you can purchase music. RealNetworks is one of the providers linked to this search. This should increase the flow of traffic to its site. Oppenheimer & Co. downgraded RealNetworks shares to neutral from buy, saying Microsoft's efforts would ultimately be competitive with RealNetworks’ Rhapsody subscription music service. RealNetworks is down 6% this week. I think Oppenheimer is making a big mistake because Microsoft is contractually required to drive business to RealNetworks. Google is bigger than Microsoft, and its music search goes straight to RealNetworks. E.W. Scripps (SSP:NYSE): Reported that revenue at its networks business is up 21% in November from a year ago. Also, Scripps Networks was the No. 1 site in Nielsen's Home & Fashion category for the month of November, drawing more visitors than eBay Home, Kraft Foods, Sears or The Home Depot. GUS Plc of London acquired PriceGrabber.com, a comparison shopping Web site. It paid $485 million, less than the $570 million Scripps paid for Shopzilla. I believe that GUS either overpaid or Scripps got a great deal. Shopzilla has roughly twice as many unique visitors as PriceGrabber but cost only 18% more. Scripps is down 1% this week. Tom Online (TOMO:Nasdaq): Has been selected by Red Herring magazine as one of the inaugural Red Herring Small Cap 100 stocks. Shares are down 10% this week. I’m not sure why, but I’m keeping watch. Time Warner: I commented on this company above, but after all the attention it was paid, it’s worth the time to read Steve Case's missive earlier in the week: Although I played a key role in bringing AOL and Time Warner together six years ago, it's now my view that it would be best to "undo" the merger by splitting Time Warner into several independent companies and allowing AOL to set off on its own path.
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