Google cements market lead with AOL deal

After flirting for months with Google Inc. competitors, America Online Inc. reached a deal Tuesday with the Mountain View, California, search-engine giant that expands their years-long technology and advertising partnership and ends advances from suitors, particularly Microsoft Corp.

The deal, which calls for Google to pay US$1 billion for a 5 per cent stake in AOL, also plunges Google into the waters of graphical online ads where it has until now only reluctantly dipped its toes. AOL content will also be more readily available to Google’s search engine technology, and Google Talk instant-messaging users will be able to communicate with AOL’s AIM users, the companies said in a joint press release issued Tuesday afternoon.

Additionally, the companies will work together on video search and AOL will receive what the companies called “marketing credits” for its content from Google. Financial terms of the deal other than the $1 billion investment were not disclosed. The deal includes an extension to working agreements between the two companies in Europe.

“For Google, an AOL deal should cement its market lead — in advertising inventory and monetization — and keep competitors such as Microsoft’s MSN at bay,” analysts at Susquehanna International Group LLP wrote in a research note distributed Tuesday.

AOL uses Google’s search engine to power its general Web search service. It also carries paid search ads Google sells to advertisers, and splits the revenue with Google. Through the deal, AOL now can sell search advertising directly to advertisers on AOL-owned properties, according to the companies.

AOL reportedly held talks in recent months with Microsoft, Yahoo Inc. and others, seeking apparently a better deal than the one it had until now with Google.

“It’s pretty much an extension of the status quo, and AOL went with the safe, proven incumbent,” wrote Charlene Li, an analyst with Forrester Research Inc., in her blog Tuesday afternoon after the deal was announced. “Google/AOL is much cleaner and synergistic, as Google is happy to direct traffic to AOL content.”

Yahoo in November acknowledged having discussed a possible deal with AOL, but those talks went nowhere. Ultimately, Microsoft was the only suitor left, but Google evidently managed to woo AOL back and prevent it from straying from their pact by agreeing to new conditions.

Microsoft was reportedly interested in luring AOL into its camp to give a boost to the new MSN AdCenter online ad network it is putting together. Because AOL’s traffic is so substantial, distributing MSN AdCenter ads through AOL properties would make the fledgling ad network very attractive to advertisers.

A Microsoft spokesman declined to comment on Google and AOL’s announcement.

“We look at the loss of AOL as a setback for MSN, which will now face a greater hurdle to catch up in Internet advertising. For Yahoo, we see a Google/AOL deal as a modest short-term positive and potential long-term negative, as AOL’s help would enable Google to build a rival in display advertising,” Susquehanna analysts wrote.

That AOL is seeking more exposure for its Web properties isn’t a surprise. The Time Warner Inc. unit has been moving away from its traditional business model based on subscriptions to a Web portal model based on revenue, similar to Yahoo’s. To that end, AOL has been moving to its free Web sites a significant part of the content and services it reserved to its paying subscribers.

AOL subscriptions, which gives users a dial-up Internet access account along with other premium content and services, have been declining in recent years. But even if they had been increasing, there is a bigger revenue opportunity in being a Web portal, explained AOL Chairman and Chief Executive Officer Jonathan Miller in an appearance at the Web 2.0 conference in October.

Meanwhile, Google is viewed as benefiting from the deal as well. It will retain AOL as a distribution partner for its paid search ads, and it will also get a boost for its until now timid attempts at getting into branded/display online ads. Most of Google’s revenue comes from paid search ads and some experts believe this reliance on a single form of online ad puts the company in a vulnerable position.

Google could also benefit from a tighter collaboration with AOL in the areas of Web mail and instant messaging, where AOL is a leader and Google a new entrant. Google has spent the past two years furiously trying to expand beyond its core search business, to give users more reasons to come and stay on its Web sites.

This is why Google offers the Blogger blog publishing service, the Picasa photo management application, the Orkut social networking service, the Gmail Web mail service, the Google Talk IM service, along with an increasing number of specialized search engine services that complement its original Web search service.

Ahead of the deal, billionaire investor Carl Icahn said this week in an open letter to the board of directors of Time Warner that a deal between Google and AOL would be “disastrous” if it means AOL won’t be able to seek mergers or business deals with other companies.

Also adding to the stridency of the AOL-Time Warner debate is AOL co-founder Steve Case. Case resigned as a Time Warner director this year but remains a large individual shareholder. In a column published this month in The Washington Post, Case said the main goals of the AOL / Time Warner merger he played a key role architecting haven’t been attained, and urged for Time Warner to be broken up into four independent companies, one of which would be AOL.

(Stacy Cowley in New York and Elizabeth Montalbano in Philadelphia contributed to this report.)

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