When Does Two Plus Two Equal Zero? The Proposal to Merge Yahoo and AOL

History is notably short on examples of the additional value created by combining two under-performing organizations.

That, however, has never stopped anyone, especially anyone in the mergers and acquisitions business and most especially anyone who happens to own stock in a company whose performance has rendered said investment returns somewhere in the aspirational to illusory category.

The good news for optimists is that Wall Street loves a good story. And if that story is accompanied by the potential for conflict and maybe a tax advantage or two, well, performance is made to be improved.

There are, however, those enterprises whose prospects are so dismal, leadership so discounted and finances so shaky that even the most venal and craven are discouraged.

Yahoo and AOL would appear to be a text book example of that sort of potential combination. You know you should lock your wallet away when the promoters focus on cost-savings or - that dreaded word, synergies - and say little or nothing about the combined upside. Not that that will prevent anyone who thinks they can make a buck on the deal (if not the surviving entity) from trying. JL

Brad Stone reports in Business Week:

The tech and non-tech worlds are full of mergers between large companies that have destroyed tremendous value.
Activist shareholders with an apparent dual interest in unlocking shareholder value and generating Wall Street drama are again agitating for a Yahoo-AOL merger. It’s a combination, talked about since at least 2008, that some analysts think is a terrible idea.
This morning Reuters reported that two of Yahoo’s (YHOO) largest shareholders are so impatient with the turnaround and low valuation of the Web portal’s core business that they have asked AOL (AOL) Chief Executive Tim Armstrong to explore a merger. Armstrong, according to the article, is amenable but would consider only an amicable deal—a highly unlikely scenario.
No official talks are currently under way between the companies, but as a development that involves one of Silicon Valley’s flashiest leaders and most visible companies, it’s news today. A Yahoo spokesperson declined to comment on the report.

Yahoo stock has risen appreciably under Mayer, although most investors attribute that growth to its successful investment in Chinese e-commerce juggernaut Alibaba (BABA). Last month Yahoo delivered measurably improved third-quarter results, and Mayer trumpeted her progress with an aggressive acquisition strategy, a renewed focus on mobile apps, and revenue that is finally rising a bit. Today the company’s stock surpassed $50 for the first time since the early 2000s.
Yet that isn’t enough for the skeptics, who apparently have lost patience—or never had it in the first place—with what was always destined to be a long-term climb.
In September, activist investor Starboard Value published a letter to Mayer disclosing its stake in the company and arguing that Yahoo was “deeply undervalued relative to the sum of its parts.” The investor than reintroduced the idea of a merger with AOL, trumpeting a host of tax benefits and the possibility of bringing AOL’s video ad technology to Yahoo.

Some analysts have viewed this as a bad idea. Combining the two organizations, which are headquartered on opposite coasts, would generate massive challenges at a time when both companies are racing desperately to keep up with Google (GOOG) and Facebook (FB) in display and mobile advertising. “The tech and non-tech worlds are full of mergers between large companies that have destroyed tremendous value,” wrote Cowen & Co. analysts John Blackledge and Thomas Champion in a September research note.
Brian Weiser, a senior research analyst at Pivotal Research Group, agreed with some of the logic behind Starboard’s proposal but acknowledged enormous practical problems that a merger would face. A proxy fight, he speculates, may be the only way it could happen:

“There is significant industrial logic behind a combination [of AOL] with Yahoo, although it always seemed unlikely that one of the management teams would step aside to make a transaction work. Moreover, among the two, AOL is the one which made the right calls in terms of how to evolve a legacy portal/ad network business into one positioned to maintain relevance with the advertising community. However, Yahoo has had greater capital resources, limiting the potential for AOL to pursue anything directly.”

Yahoo is also plunging ahead on its own to develop new video ad tools. On Tuesday it announced it was buying 8-year-old video advertising service BrightRoll for $640 million in cash, another sign that Mayer is not slowing down and prefers to bring in talent from fast-moving startups.

The new investors lobbying for an AOL merger believe a combined company could generate $1.5 billion in cost savings, partly from reductions in the sales force while expanding the online audience that it sells ads against. The history of such combinations suggest that the savings, while significant, are hardly guaranteed. The new company would probably end up spending a small chunk of that in payments to branding and PR firms to try to spin the new entity as something other than a horrible mess.