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Thanks!GOOG Loses out to Mr. Softee on AOL Linkup

Microsoft Pushes to Seal AOL Advertising Linkup
http://online.wsj.com/article/SB113385364578814970.html?mod=home_whats_news_us
Deal Aims to Widen Share Of Growing Online Market;

By JULIA ANGWIN and KEVIN J. DELANEY
Staff Reporters of THE WALL STREET JOURNAL
December 7, 2005; Page A1

The battle to seal an advertising alliance with Time Warner Inc.'s AOL intensified as Microsoft Corp. pushed to hammer out final details of a partnership that could boost the online ad reach of both and pose a challenge to Google Inc. and Yahoo Inc.

People familiar with the matter said that under the proposal being discussed, AOL, whose current ad partner is Google, would switch to using Microsoft's search engine, and the two companies would set up a joint venture to sell online advertising across both AOL and Microsoft's MSN portal. The services would remain under control of their respective owners, but their ads would reach many more online customers than they do now, these people said.

But Google remained in its own partnership talks with Time Warner late yesterday and still could emerge on top, these people cautioned. A sticking point so far has been its reluctance to guarantee Time Warner a minimum amount of revenue, which Microsoft has done, said one person familiar with the talks.

The contest for AOL demonstrates the increasingly high-stakes push to grab larger pieces of the quickly expanding Internet advertising pie. Internet advertising is the fastest-growing advertising medium by far; in the three months ended Sept. 30, online sales rose 34% to $3.1 billion from a year earlier, according to PricewaterhouseCoopers LLP.

Search-ads are the biggest segment of the online advertising market. The search-ad systems such as those run by Google and Yahoo display ads when users type key words in queries or when the words appear in the texts of Web sites. Advertisers bid in an auction system to have their ads displayed alongside specific phrases, such as "digital camera." Advertisers like the system because they pay only when a consumer clicks on an ad.

By joining their two systems, Microsoft and AOL could sell ads that would reach as many as 140 million Americans each month -- or about 80% of all U.S. Internet users. That compares with roughly 122 million recent monthly users of Yahoo and 86 million for Google, according to comScore Media Metrix, an online market-research firm.


A combined search-related ad system also could aggressively compete with Google and Yahoo -- and potentially siphon off advertising dollars they would otherwise receive.

The prospect of an AOL-Microsoft linkup yesterday reignited discussion about possible threats to the stratospheric rise of Google, as well as possible challenges to Yahoo's leading position in sales of online brand advertising. Investors are particularly sensitive to any specter of increased competition for Google, whose shares have more than doubled this year to more than $400 a share. A Microsoft-AOL deal would coincide with ad-related pushes by other Google rivals.

"Suddenly the competitive landscape looks a lot less favorable to Google for next year at this time compared to last year at this time," says Scott Kessler, an analyst at Standard & Poor's in New York. "It would be a mounting threat to Yahoo" as well, he says.

After surging earlier, Google shares were down $1.31 to $404.54 at 4 p.m. in Nasdaq Stock Market trading, while shares of Time Warner were up two cents at $18.25 on the New York Stock Exchange and Microsoft was down 16 cents at $27.69 on Nasdaq.

At a news conference yesterday, Time Warner Chairman Richard Parsons said the company is in discussions with "multiple parties" about partnerships with AOL. A Microsoft spokeswoman declined to comment. A Google spokeswoman declined to comment beyond saying, "AOL is a valued partner, and we look forward to continuing to work with them."

Using Google's search technology, AOL currently keeps about 80% of the ad revenue generated by searches conducted by its users. AOL reaped about $300 million in revenue last year under the arrangement, which expires next year. The original AOL deal forged in 2002 played a major role in Google's growth, but today Google's commissions from selling ads on AOL are a small fraction of its revenue.

A deal with Microsoft could help solve a vexing problem for AOL: It essentially can't offer advertisers a chance to buy ads that appear alongside search results, since Google currently handles that for AOL. As part of its campaign to challenge Yahoo more effectively, AOL wants to offer advertisers a package of ads that includes ads among search results, as well as ads on AOL's online service and Web properties such as Moviefone.com.

It also would come at a difficult time for Time Warner, where hedge-fund investor Carl Icahn has stepped up his dissident campaign to replace a majority of the media giant's directors. Mr. Icahn last week threatened to personally sue the Time Warner directors if they sold AOL for too low a valuation.

Microsoft also has experienced frustrations around online advertising. The software giant's key tool for grabbing part of that swelling ad market is MSN. But the online unit, despite efforts to build a competitive search engine, continues to lag behind Google in market share and in its ability to woo large Internet advertisers onto MSN. MSN's search ads are currently sold by Yahoo.

Teaming with AOL could address that problem by bringing more advertisers to an online ad system, dubbed AdCenter, that Microsoft is testing outside the U.S.

Executives at Microsoft's MSN unit pointed to the importance of scale to competing with Google in an internal strategy paper they drafted this year that was reviewed by The Wall Street Journal. They noted that aggregating greater ad spots and advertisers increases ad revenue markedly, partly by increasing the prices for each ad generated by an online ad auctioning model.

"If you plan to make your money from advertisers, volume is everything," they argued in the paper, which was presented to Microsoft Chairman Bill Gates. AOL and Microsoft combined handled roughly 20% of all U.S. search queries in September, compared with 45% for Google and 23% for Yahoo, according to researcher Nielsen/NetRatings.

Yahoo is in the middle of overhauling its own search-related ad system in an attempt to improve its effectiveness at delivering ads. IAC/InterActiveCorp, whose Ask Jeeves search site currently runs ads provided by Google, has said it will consider other options, including its own ad system, when the Google agreement expires at the end of 2007.

An AOL-Microsoft tie-up would vault past Yahoo, the largest seller of Internet ads, in terms of unique U.S. visitors that advertisers can target in one place, and thus could be a challenge to the Web portal, analysts said. In October, AOL attracted 88 million unique visitors to its online properties, compared with 100 million at MSN and 122 million at Yahoo, according to comScore Media Metrix.

"Yahoo so far is the must-buy for brand advertisers," said Youssef Squali, an Internet analyst at Jefferies & Co. in New York. "By having AOL and MSN putting their reach together, all of a sudden they become the de facto network to buy traffic on." A Yahoo spokeswoman declined to comment.

It is unclear whether AOL and MSN would be able to effectively match Yahoo's infrastructure for wooing advertisers and relationships with them. The risk is that AOL would replace the growing search-ad stream provided by Google with a fledgling system that is less potent. Also unclear is whether Google and Yahoo advertisers would shift some ad buying to an AOL/Microsoft system.

Some Google advertisers have grown disgruntled with the company's automated ad-sales systems and opacity around issues such as how it handles search-ad fraud, feelings that AOL and Microsoft could try to tap into.

Talks between Time Warner and Microsoft began early this year, when Microsoft approached AOL about switching its search-engine alliance to MSN from Google. Around April, the talks began to focus on the idea of putting together a joint venture between AOL and MSN that the companies believed might have had a publicly traded value of more than $40 billion, according to one person briefed on the discussions. Those talks broke down in late summer as the two sides battled over details of the complicated proposal.

When news of the talks leaked to the media in September, Google emerged to try to save its relationship with AOL. Google was willing to buy a stake in AOL at a $20 billion valuation, according to people close to the negotiations. The Google deal was not a joint venture, though, and simply involved a deepening of the existing relationship between AOL and Google, these people said.

By Thanksgiving, Time Warner was considering several proposals from Microsoft and a single proposal from Google. Around that time, Time Warner concluded the larger joint venture with Microsoft would be unworkable.

After Thanksgiving, the media giant renewed conversations with Google about its simpler deal. But last week, Time Warner executives were leaning toward a smaller deal with Microsoft, swayed by its offer of a large guaranteed minimum amount of yearly revenue, according to a person briefed on the negotiations.

--Robert A. Guth and Peter Grant contributed to this article.

Write to Julia Angwin at [e-mail] and Kevin J. Delaney at [e-mail]