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Google Trumps Microsoft to Get 5 Percent Stake in AOL

Posted on: Saturday, 17 December 2005, 15:00 CST

By Michael Bazeley, San Jose Mercury News, Calif., San Jose Mercury News, Calif.

Dec. 17--In its biggest financial deal so far, Google has beaten out rival Microsoft for a 5 percent stake in America Online, strengthening its partnership with its biggest customer.

A source familiar with terms of the $1 billion deal said Friday that AOL will be able to sell ads on Google's behalf directly to advertisers -- and share the revenue -- expanding Google's already dominant reach in online advertising. In addition, Google will break new ground by allowing AOL to place advertising with images alongside its search results. Until now, Google's search engine has been devoid of image ads.

The deal is a blow to Microsoft, which was AOL's initial suitor and had been trying to hammer out various partnerships with the company for the past several months. Microsoft Chief Executive Steve Ballmer learned of the Google-AOL deal Friday in a phone call from Time Warner Chief Executive Richard Parsons. Microsoft declined to comment.

"I think the last thing Google wants to see is Microsoft making a splashy debut with their former best customer," said Standard & Poor's Internet analyst Scott Kessler, whose firm does not own any Google stock. "I think to some extent it's a land grab."

As of Friday evening, the deal was not yet final. The source characterized it as a "handshake agreement over a term sheet" agreed to Thursday night in the offices of Time Warner, AOL's parent company.

But the source said both parties planned to hammer out the final details over the weekend in the hopes of making an announcement Tuesday. Time Warner's board of directors is scheduled to meet Tuesday to discuss the deal.

Google did not return a phone call seeking comment.

This marks the second time Google has swooped in to steal away an AOL partnership from a competitor. In the fall of 2004, Yahoo appeared to have won a contract to provide ads for AOL's European business, but Google stole the contract with a last-minute bid. In the latest instance, Microsoft was in serious negotiations with AOL, but Google prevailed after asking to enter talks.

The agreement keeps Google as the sole provider of search technology to AOL. That partnership was set to expire next year but will be extended for five years. The partnership has already made AOL Google's biggest customer, responsible for about 10 percent of Google's advertising revenue.

Although losing AOL as a partner would not have significantly hurt Google's financial bottom line -- AOL was a shrinking proportion of Google's ad revenue -- it would have been a public embarrassment for the company, several observers said.

"I think this has more to do with stature than economics," said Ellen Siminoff, chief executive of search marketing company Efficient Frontier. "I think it was shrewd of Google to go after it, because it doesn't allow anyone else to come after that business."

As a 5 percent owner of AOL, Google also shares in any of the company's profits.

Under Google's current partnership with AOL, Google powers all the search technology on AOL's site. Google serves ads alongside the search results, and the two companies split the revenue.

With the new deal, AOL will be able to sell the search result ads itself, as well as Google ads that appear on a wide network of third-party Web sites. By combining the Google ad services with its other ad programs, AOL will be able to offer advertisers a broader array of services.

"We can go into conversations with advertising partners and offer everything Yahoo does and more," said a source with knowledge of the agreement.

Steve Berkowitz, chief executive of Emeryville search company Ask Jeeves, said the agreement validates the importance of Internet search and advertising. And it may help AOL's relationship with advertisers. But he said it does little to change the status quo.

"I don't think anything changes for Google," Berkowitz said. "At the end of the day, they end up with the same deal. Google gets to keep its partner and not allow Microsoft any rope."

AOL will also get a chance to feature its content more prominently on Google. AOL will convert its inventory of video content into a format that is compatible with Google's video search engine. Google is also giving AOL an allotment of advertising on its search engine that will allow it to promote its content with special "eye-grabbing" ads in the column alongside search results, the source said.

If a person searches on Google for pop singer Madonna, for example, he might see an image ad that sits below the traditional text ads and links to AOL's video page.

Microsoft had proposed two partnerships with AOL, including one that would combine some of the two companies' business units.

But the two companies could not agree on how to make the partnerships work. Although Microsoft is disappointed at not having signed a deal with AOL, the company went into negotiations "with eyes wide open," a source said, realizing that Google had an advantage.

Google's stock closed up 1.8 percent to $430.15 on the Nasdaq stock exchange. Time Warner shares closed up 0.9 percent to close at $18 a share.

Contact Michael Bazeley at mbazeley@mercurynews.com or (408) 920-5642, and read his blog at www.siliconbeat.com.

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Copyright (c) 2005, San Jose Mercury News, Calif.

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Source: San Jose Mercury News

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