evercore on aol/yahoo!

8/8/2019 Evercore on AOL/Yahoo!

1/16

United States | Equity Research

Media | Internet

October 15, 2010

AOL, INC.

AOL | $24.95

OVERWEIGHT | TARGET PRICE: $32

Commentary

Ken Sena212 822 [email protected]

Anupam K. Palit, CFA212 497 [email protected]

Please see the analyst certification and important disclosures at the end of this report. Evercore Group L.L.C. and affiliates do andseek to do business with companies covered in its research reports. Investors should be aware that the firm may have a conflict of

interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making theirinvestment decision.

Company Statistics

Market Capitalization $2,521

Enterprise Value $2,198

Average 10-Day Volume 605

52-Week Price Range $19.61 - $29.45

Earnings Summary2009A 2010E 2011E

Revenue (M) $3,207 $2,376 $2,053

EBITDA (M) $1,046 $667 $592

Adjusted OIBDA (M) $1,045 $667 $592

Adjusted EPS $3.54 $1.81 $1.82

EV/EBITDA (x) 1.6x 2.5x 2.8x

P/E (x) 6.7x 13.1x 13.0x

Search Revs Growth % -16% -28% -12%

Ad Revs Growth % -17% -37% -0%

Display Revs Growth % -17% -14% -2%

Sub. Revs Growth % -28% -28% -25%

Adjusted EPS: Q1 $1.15A $0.54A

Q2 $0.97A $0.49A

Q3 $0.78A $0.35E

Q4 $0.64A $0.43E

FY $3.54A $1.81E $1.82E

The Takeout that Makes Most SenseIncreasing Target Price from $30 to $32, Reiterate Overweight

Contrary to recent speculation that AOL, along with a group of privatequity investors, including Silver Lake, could be making a play fo

Yahoo!, we find a reverse scenario, one in which Yahoo! buys AOdirectly, to be the more likely of the two outcomes.

We explain several YHOO and AOL acquisition scenarios and, througthe assistance of outside legal M&A counsel, explain a few potentiroadblocks. As a result of this and other analysis, we believe the onstraight-forward path to consolidation of these two entities is for Yahoo! tbuy AOL.

A combination of AOL and Yahoo! makes sense to us, given thimproving growth prospects in overall display, shared companobjectives, and potential for cost savings. However, recent scenariosuggested, such as AOL partnering with private equity to buy Yahoo! oboth entities getting going private before combining are not reasonabexpectations in our view.

To help sort out the potential upside in these names from a possibtransaction, we provide an expected value analysis in which we assigprobabilities to the various outcome potentials. Based on this analysiwe view 8% of potential takeout upside for AOL ($2 per share) which ware factoring into our newly revised target price of $32 (vs. $3previously). We note that our $32 target price is also supported by opreviously published consolidated DCF.

We continue to view AOL as having attractive valuation, stronmanagement and the right strategic course. The only difference now that we view the likelihood for an AOL takeout by Yahoo! specifically apotentially heightened. We place the probability of this transactiooccurring at ~20% based on our expected value analysis.

Assuming an acquisition of AOL did happen, we estimate that 30% oAOLs branded display expenses could be rationalized over the nexthree years, which would swing our present value estimation of thBranded Display business to $5 per AOL share from negative $presently. We note the street to be imputing over $10 in negative valuper share for this business based on our estimates.

AOL currently trades at 13.7x our 2011 EPS estimate of $1.82 and a9.3x excluding cash. On an EV/EBITDA basis, the stock trades at 2.9Our target price implies that AOL can trade at a 17.5x PE (13.2x ex-cashon our 2011 estimates. Our target price suggests a 15.5% FCF yielwhich excludes cash.

2 Year Price History

1/09 4/09 7/09 10/09 1/10 4/10 7/10 10/1015

20

25

30

600

700

800

900

1,000

1,1001,200

1,300

Source: FactSet Prices

AOL Inc. vs. S&P 500

13-Oct-2008 to 13-Oct-2010 Price (Local Currency)

AOL Inc. (Left)S&P 500 (Right)


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October 15, 2010

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The Takeout That Makes Most SenseContrary to recent speculation that AOL, along with a group of private equity investors,including Silver Lake, could be making a play for Yahoo!, we find a reverse scenario, onein which Yahoo! buys AOL directly, to be the more likely of the two outcomes. In thisreport, we explain several YHOO and AOL acquisition scenarios and, through theassistance of outside legal M&A counsel, explain a few potential roadblocks. We alsoprovide an expected value analysis whereby we assign probabilities to the variousoutcome potentials. Based on our expected value analysis, we view 8% of potentialtakeout upside for AOL ($2 per share) which we are factoring into our revised target price

of $32 per share.

Moreover, we believe a combination of AOL and Yahoo! makes sense, given the improvinggrowth prospects in overall display, shared company objectives, and potential for costsynergies. However, we believe the only straight-forward path to consolidation of thesetwo entities is for Yahoo! to buy AOL outright. Scenarios in which AOL partners to buyYahoo! with the help of private equity or in which AOL and Yahoo! get acquiredsimultaneously are not feasible based on our analysis of the transaction complexitiesinvolved.

We continue to view AOL as having attractive valuation, strong management and the rightstrategic course. The only difference now is that we view the likelihood for an AOL takeoutby Yahoo! as heightened. We place the probability of this transaction occurring at ~20%based on our expected value analysis. Assuming an acquisition of AOL did happen, weestimate that 30% of AOLs branded display expenses could be rationalized over the nextthree years, which would swing our present value estimation of the Branded Displaybusiness to $5 per AOL share from negative $7 presently. We note the street to beimputing over $10 in negative value per share for this business based on our estimates.

Background

According to the Wall Street Journal, AOL is in talks with several private equity firms,including Silver Lake Partners, Blackstone Group, and "two or three other firms" to explorea potential acquisition of Yahoo!. While the WSJ indicated the discussions are preliminaryand do not as of yet involve Yahoo! management, Bloomberg separately reported that thelatter has retained Goldman Sachs to help defend against a possible takeover.

The WSJ specifically mentioned two potential takeover possibilities. The first scenariowould involve Yahoo! divesting a number of assets, including its 40% stake in AlibabaGroup, thereby making the acquisition more manageable for AOL and private equity

investors to absorb. The second scenario would see AOL and Yahoo! combine in a reversemerger, suggesting that AOL management would potentially run the newly combinedentity. In addition, a third scenario was implied by asserting that AOL could also goprivate before being combined with Yahoo!

Combining AOL & Yahoo!: the LogisticsThrough the assistance of an outside M&A legal specialist, we provide a breakdown of themore specific complications associated with each of the scenarios. As a result of theseconversations, we believe the only way to bring AOL and Yahoo! together, something wefeel makes sense for shareholders on both sides, is if Yahoo! buys AOL directly.


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October 15, 2010

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AOL & Private Equity for YHOO is a Non-Starter

Under Delaware law and Business Judgment Rule, there is heightened scrutiny aroundsales of corporate control where the appearance of conflict exists. A sale in which AOLbuys Yahoo! with the help of private equity investors creates such an appearance. Theconflict rests in the fact that AOLs management team would conceivably be allowed to runthe ongoing entity, raising ire with investors over the fact that control has been exchangedfor the sake of empire building by management. We do not see there being anywayaround the so-called appearance issue given that AOL shareholders stake could be

reduced to as little as 8-13% of the NewCo, depending on deal structure, for potentially nopremium.

Figure 1: Examples of AOL Shareholder Dilution Under AOL for YHOO Scenario

2010EAOL - Cash End of Year $865.1

+ Private Equity Cash $16,567.7= Total Yahoo EV (ex OBS Assets) $17,432.8+ OBS Assets (net of Tax) $7,498.7= Total Yahoo EV $24,931.5+ AOL EV $1,647.1= Combined EV $26,578.6

AOL % Share of New Co (x Y! OBS Assets)Combined EV (excluding OBS) $19,079.9- Cash Contributed from Private Equity $16,589.5

= AOL Shareholder Stake $2,490.4AOL % Holding (No YHOO OBS Assets) 13.1%

AOL % Share of New Co (x Y! OBS Assets)Combined EV $26,578.6- Cash Contributed from Private Equity $24,088.2= AOL Shareholder Stake $2,490.4

AOL % Holding 9.4%

AOL % Share of New Co (+ 25% prem on Y! Shares)Combined EV (plus 25% premium on YHOO shares) $30,936.8- Cash Contributed from Private Equity $28,446.4

= AOL Shareholder Stake $2,490.4AOL % Holding 8.0% Source: Company data, Evercore Group L.L.C. Research

AOL & YHOO Rolled Up Together Also Unlikely

Another scenario expressed is that private equity could manage to somehow bring Yahoo!and AOL both private before combining them. We do not see this scenario as likely either.The challenge with taking both companies private at once has to do with shareholder

fiduciary issues, similar to what we described above, and the potential for restrictive andless favorable deal financing terms, given that financing must be done separately for eachof the transactions. From a board fiduciary standpoint, the same conflict appearancestatute still applies. This would be an issue if indeed the plan is to have AOL currentmanagement running the NewCo. While the appearance of conflict is mitigated given theacquisition, it would still likely set into motion a special committee process which wouldtake time and open up the bidding process to shareholders and potentially other suitors. Inother words, as long as management is receiving some additional benefit, the appearanceof conflict is still present.


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October 15, 2010

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Upside Potential Based on Expected OutcomesBy conducting an expected value analysis on the transaction probabilities above, we arriveat a probability-based expected value upside under each scenario. First we place thechances of a deal happening at all at 33%. We view this as reasonable in light of mountingfrustration on the part of Yahoo! shareholders and attractive valuations at both companies.Then, assuming a deal does happen, we assign probabilities as to the type of deal thatwould be most likely. As a result of our outside legal M&A discussions, we assign only a5% chance of AOL and private equity managing to acquire Yahoo!. Then, based on thesesame discussions, we assign roughly a 35% likelihood to a transaction type in which

Yahoo! and AOL are taken out together. We note that multiplying this likelihood by theprobability that a transaction happens at call gets us to a 9% likelihood. As we discussedbefore, under this second scenario, while there is lower "apparent conflict" risk, it does stillpresent certain board fiduciary and financing obstacles that would not be present under astraight merger of Yahoo! for AOL. As a result, we leave the remaining deal type likelihoodas being a Yahoo! takeout of AOL. We note that our 33% probability that a transactionoccurs at all, multiplied by our 60% likelihood assumption that it would be a Yahoo! takeoutof AOL, equals a roughly 20% probability that deal will occur. We view this estimate asreasonable in light of attractive AOL valuation, shared company objectives, and thepotential for cost synergies. Next, we assign purchase premiums in which we roughlyassign Yahoo! and AOL 25% purchase premiums assuming takeout. Then, if we applyprobability weighting to each potential outcome, we reach an expected upside of 8% forAOL and flat upside for YHOO, which reflects the potential takeout upside of Yahoo! beingoffset by the potential that the deal doesnt happen.

Figure 2: Upside Potential Based on Expected Value Analysis

ransaction Analysis

ransaction No Transaction

Overall Transaction Probability 33% 67%

Scenario 1 Scenario 2 Scenario 3(AOL & PE buy YHOO) (YHOO buys AOL) (PE Buys Both)

x Scenario Probability - Assuming Transaction 5% 60% 35%

= Probability Under Each Scenario 1.7% 19.8% 11.6% 67.0%

Estimated Share Price ReactionAOL 0.0% 25.0% 25.0% 0.0%

YHOO 25.0% 0.0% 25.0% -5.0%

Upside Based onExpected Value Adjusted Share Price Reaction Expected Value

AOL 0.0% + 5.0% + 2.9% + 0% = 7.8%YHOO 0.4% + 0.0% + 2.9% + -3% = 0.0% Source: Company data, Evercore Group L.L.C. Research

Why AOL / YHOO Combo Makes SenseWe believe a combination of the AOL and Yahoo! businesses makes a lot of sense giventhe improving growth prospects in overall display, the fact that both companies face asimilar predicament in terms of systemic audience erosion, the companies shared viewthat local and branded content initiatives could be an answer to continued audienceerosion, and the potential for cost savings.

Improving Display Trends

For more information on the potential growth prospects for display, including our long-termforecasts, please see our industry report: Its time to Face the future: Openness, Sharing &Data Is Changing Online Advertising, from September 27

th, 2010. In that report, we walk

the improvements in display targeting and buying efficiencies that are leading to fastergrowth in display advertising overall. For the purposes of this note, we will just summarizea few of the display trends we think are key, including the growth of demand-sideplatforms, real-time bidding, audience targeting, and better ad formats, particularly relatedto video and sponsored mobile.


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We show below how the display buying landscape has shifted from primarily directpurchase to one that is highly interconnected. At each stage of development, advertisersare offered increased buying efficiency and more choice. This is leading to overall growthin display.

Figure 3: Evolution of Display Buying

Publisher

$1.00

$0.80

$0.64

$0.51

$0.41

$0.33

Ad Network1

Ad Network 2

Ad Network 3

Ad Network 4

Ad Network 5

Ad Network 6

PublisherAdvertiser

PublisherAdvertiser

Advertiser

Direct:

(inefficient)

Ad Networks:

(inefficient)

Exchanges:

(efficient)

PublisherAdvertiser

Demand-SidePlatforms:

(More efficient)

Exchange

Ad Network 1

Publisher

Publisher

Publisher

Advertiser

Advertiser

Advertiser

Ad Network2

Ad Network 3Ad Network 4

Ad Network 5

Ad Network 6

Publisher

Publisher

Publisher

Advertiser

Advertiser

Advertiser

DSP

Exchange1

Exchange2

Exchange3

YieldOptimizer

DSPs Capable of Optimizing Across Multiple Exchanges Source: Company data, Evercore Group L.L.C. Research

However, for premium display publishers, such as AOL and Yahoo!, the combination ofgreater choice for advertisers and eroding audience usage, has largely weakened theirhold on display and created doubt around the companies abilities to capture emergingdisplay growth momentum.

Both Companies Face a Similar Predicament

As portals shrink as an overall portion of web views, these companies clearly needreinvention.


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Figure 4: US Online Timespent Share by Category, 2007-1H10

36.7%31.7%

24.6%21.1%

4.1%9.0%

10.0%12.1%

7.3% 8.4% 10.3% 11.0%

3.1% 3.2% 3.1% 3.9%6.1% 5.7% 3.9% 3.6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2007 2008 2009 1H10

%o

fUS

Timespent

News/ Information

Entertainment

Retail

Portals

Conversational Media

57.3% 58.0% 51.9% 51.7%

Source: Company data, Evercore Group L.L.C. Research

Eyeing Same Local and Branded Content Objectives

Both companies are looking to use data to increasingly drive content and advertising, muchas it is done in search. AOL does get additional credit for its vision, however. To this end,CEO Tim Armstrong has shown effectiveness in developing algorithmic content andadvertising technologies, including some separately from AOL, such as AssociatedContent, which Yahoo! purchased for ~$100 million, and Patch, which was purchased byAOL following his arrival. To make up for Associated Content going to Yahoo!, Timlaunched Seed, a similar business, to continue down the algorithmic content path.

Branded and local both represent large pockets of advertising that have yet to move to theweb in a big way, as compared to offline medias. By offering improved content,professional, and locally created, the companies hope to secure some of this shift toonline. Roughly speaking, we estimate that local and branded could represent another $20billion or so in online advertising in the U.S. alone if online can provide advertisers with asgood an experience online as off. As a result, AOL and Yahoo! are both focused on these

areas, but have yet to demonstrate victories in these areas.

Figure 5: U.S. Branded Online Ad Opportunity, 2009A

30%

68%

25%

75%

32%70%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Traditional Average Online Total

National Ad Spend

Local Ad Spend

$118 Bil $24 Bil $142 Bil

~ $10-11 Bil Local

Online Opp'ty


Figure 6: Local Advertising Opportunity, 2009

69%

24%

62%

31% 38%76%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Offline Online Total

Branded Adv ertising

Direct Response

Advertising

$24 Bil$118 Bil $142 Bil

~ $10-11 Bil Branded

Online Opp'ty


Potential for Increased Cost Savings

From a cost savings standpoint, we assume the bulk of the synergy would come out ofBranded display. For simplicity, we assume that half of AOLs branded display expenses,


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October 15, 2010

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in which we note that AOL has a current burn rate in this business of roughly $260 millionby our estimates, could be rationalized. To start, we show below a snapshot of AOLsbranded display business. We estimate in 2011 for this business to spend roughly $800million dollars and that it will breakeven over the course of five years.

Figure 7: AOL Branded Display Business

2011E 2012E 2013E 2014E 2015EBranded Display DCFBranded Display Revenues $607 $617 $624 $633 $637x EBITDA Margin (Implied) -43.7% -30.7% -19.9% -13.6% -9.1%

= Implied Branded Display EBITDA ($265.1) ($189.6) ($124.1) ($86.4) ($58.3)PV of EBITDA (2011-2015) ($559.7)+ PV of EBITDA Terminal Value ($203.9)

= PV of EBITDA (Branded Display) ($763.5) Source: Company data, Evercore Group L.L.C. Research

Assuming a Yahoo! and AOL combination could strip 30% of the expenses out of AOLsbranded display business over three years, the business swings to profitability, and we seean incremental $1.2 billion in branded displays present value, up from negative $700million by our current estimates. We note that our branded display DCF assumes a 12.4%WACC and negative 3% terminal growth rate.

Figure 8: AOL Branded Display Business Synergies

2011E 2012E 2013E 2014E 2015EBranded Display DCFBranded Display Revenues $607 $617 $624 $633 $637- Expenses $872 $807 $748 $720 $695

+ Synergies $87 $161 $224 $216 $209

= Implied Branded Display EBITDA ($177.9) ($28.3) $100.2 $129.5 $150.3PV of EBITDA (2011-2015) $54.6+ PV of EBITDA Terminal Value $525.9

= PV of EBITDA (Branded Display) $580.5

2011E 2012E 2013E 2014E 2015EBranded Display Expenses $872.2 $806.7 $747.7 $719.6 $695.1'x % Savings AOL Branded Display 10% 20% 30% 30% 30%

= Synergies $87.2 $161.3 $224.3 $215.9 $208.5 Source: Company data, Evercore Group L.L.C. Research

In sum, just assuming the two companies can cut 30% of AOLs branded display expensesover three years (without making any such adjustment on the YHOO side), gets thisbusiness to profitability in year three. In fact, our valuation of the Branded Displaybusiness swings from negative $7 per share to positive $5 if this happens.

However, for now, we view the more prudent approach to sizing the takeout opportunity forAOL is to base the upside on the expected value analysis, previously described. In thatanalysis, under exhibit 2, we show that based on all the various scenarios, we find anadditional 8% expected value upside, or $2 per share. Adding the $2 per share to ourunderlying valuation work gets us to a $32 target price.

Figure 9: Adding Another 7.5% Upside to AOL Target Price Based on Strategic Event

% Upside $ per ShareClosing Price (10/14) $25.0DCF Expected Upside 18.8% $4.7+ Expected Value Strategic Event 7.8% $2.0

= Revised Target Upside 26.6% $31.6 Source: Company data, Evercore Group L.L.C. Research

For detail, we provide our SOTP analysis below.


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Figure 10: AOL SOTP Analysis Based on DCF by Business

Search Access

Ad

Networking

Non-

Performing

Branded

Display, Other

Combined

SOTP

PV of EBITDA $1,859.8 $1,606.2 $139.4 ($763.5) $2,841.8+ PV of Capital Expenditures ($861.7) ($861.7)= PV of Est. FCF $1,859.8 $1,606.2 $139.4 ($861.7) ($763.5) $1,980.1

/ EBITDA (2011) $331.1 $510.8 $14.8 ($463.7) ($265.1) $591.6= EV / EBITDA Multiple 5.6x 3.1x 9.4x 1.9x 2.9x 3.3x

.FCF Valuation $1,859.8 $1,606.2 $139.4 ($861.7) ($763.5) $1,980.1

+ Cash (2010 EOY) $843.2 $843.2+ Real Estate $344.4 $344.4= Equity Value (Based on SOTP) 1,859.8 1,606.2 139.4 325.9 (763.5) 3,167.7

/ Shares 106.7 106.7 106.7 106.7 106.7 106.7= Equity Value per Share $17.4 $15.1 $1.3 $3.1 ($7.2) $29.7

= Take Out Premium $2.0 $2.0= Equity Value per Share (Adjusted) $17.4 $15.1 $1.3 $3.1 ($5.2) $31.6


We note that our increased target price to $32 is also supported by our consolidated DCF,which assumes a negative 2% terminal growth rate and a 12.4% weighted average cost ofcapital.

Figure 11: Consolidated DCF of AOL Business

2011E 2012E 2013E 2014E 2015E

CAGR '10E-

'15EEBITDA $591.6 $516.1 $474.7 $441.4 $414.1 (9.1)%Net Income 173.4 170.2 154.8 157.2 171.5 (171.0)%+ Depreciation & Amortization 322.7 259.5 251.0 221.0 176.6 (13.8)%

+ Other Non-Cash Charges (Benefits) 44.3 33.7 47.1 40.6 38.5 (51.4)%+ After Tax Interest Expense (Income) 15.8 20.4 25.1 30.0 34.6 43.3%+ Changes in Operating Assets & Liabilities (51.0) (27.1) (25.5) (12.0) (11.4) (32.6)%

= Cash Flows $505.1 $456.6 $452.6 $436.8 $409.9 (11.7)%- Capital Expenditures 91.3 87.7 86.4 87.7 89.7 (2.3)%= Free Cash Flows $413.8 $369.0 $366.1 $349.2 $320.2 (13.5)%Y/Y % Change (37.5)% (10.8)% (0.8)% (4.6)% (8.3)%

Terminal FCF $314x Terminal FCF Multiple 6.9x= Terminal Value $2,174.4

Weighted Average Cost of Capital 12.4%Perpetual FCF Growth Rate ("G") (2.0)%

2011ENPV of Free Cash Flows $1,314.3

+ Present Value of Terminal Value $1,210.4= Enterprise Value $2,524.8- Year End Net Debt (Cash) 2010 ($843.2)

= Equity Value $3,368.0/ Diluted Shares Outstanding 106.7= Equity Value Per Share $31.57


Valuation & Investment ConclusionWe continue to view AOL as having attractive valuation, strong management and the rightstrategic course. The only difference now is that we view the likelihood for an AOL takeoutby Yahoo! specifically as potentially heightened. We place the probability of thistransaction occurring at ~20% based on our expected value analysis. AOL currently tradesat 13.7x our 2011 EPS estimate of $1.82 and at 9.3x excluding cash. On an EV/EBITDAbasis, the stock trades at 2.9x. Our target price implies that AOL can trade at a 17.5x PE(13.2x ex-cash) on our 2011 estimates. Our target price suggests a 15.5% FCF yield,which excludes cash.


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Figure 12: Comparative EV/EBITDA Multiples, 2010-2012E

GOOG YHOO AOL

10/14/2010 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E

Stock Price $540.93 $15.93 $24.95

x Shares Outstanding 322.8 1,390.6 106.7

= Equity Market Cap $174,618.3 $22,152.5 $2,662.2

Net Debt (Cash) (33,049.8) (4,320.6) (843.2)

+ Other Adjustments 0.0 0.0 0.0

= Adjusted Enterprise Value 141,568.5 17,832.0 1,818.9

- Off Balance Sheet Assets 350.0 7,498.7 0.0

+ Minority Interest 0.0 13.5 0.0

= Enterprise Value $141,218.5 $141,218.5 $141,218.5 $10,346.8 $10,346.8 $10,346.8 $1,818.9 $1,818.9 $1,818.9

/ EBITDA* 13,130.7 15,070.6 17,742.1 1,716.3 2,004.9 2,320.2 703.7 628.6 553.1

= EV/EBITDA Multiple (x-Stock comp) 10.8x 9.4x 8.0x 6.0x 5.2x 4.5x 2.6x 2.9x 3.3x Source: Company data, Evercore Group L.L.C. Research; *EBITDA excludes non-cash stock option expense

Figure 13: Comparative PE Multiples, 2010-2012E

GOOG YHOO AOL

10/14/2010 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012EStock Price $540.93 $540.93 $540.93 $15.93 $15.93 $15.93 $24.95 $24.95 $24.95

/ Proforma EPS (x-Stock comp) 28.64 32.68 38.30 0.60 0.74 0.86 1.81 1.82 1.78

= P/E (x-Stock Comp) 18.9x 16.5x 14.1x 26.7x 21.5x 18.6x 13.8x 13.7x 14.0x

Stock Price $540.93 $540.93 $540.93 $15.93 $15.93 $15.93 $24.95 $24.95 $24.95

YE10 Cash/Share (102.38) (102.38) (102.38) (8.50) (8.50) (8.50) (7.90) (7.90) (7.90)

Stock Price (x-Cash) 438.55 438.55 438.55 7.43 7.43 7.43 17.05 17.05 17.05

/ Proforma EPS (x-Stock comp) 28.64 32.68 38.30 0.60 0.74 0.86 1.81 1.82 1.78

= P/E (x-Stock Comp, OBS & Cash) 15.3x 13.4x 11.4x 12.4x 10.0x 8.7x 9.4x 9.3x 9.6x

PEG 1.3x 1.1x 1.0x 1.6x 1.3x 1.1x n.m. n.m. n.m.

PEG (x-Cash, OBS) 1.1x 0.9x 0.8x 0.7x 0.6x 0.5x n.m. n.m. n.m.

P/E 15.3x 13.4x 11.4x 12.4x 10.0x 8.7x 9.4x 9.3x 9.6x

/ Market Multiple 15.5x 12.8x 12.9x 15.5x 12.8x 12.9x 15.5x 12.8x 12.9x

-1 1 1 1 1 1 1 1 1 1

= Premium (Discount) to Market -1.4% 4.5% -11.0% -19.9% -21.7% -32.7% -39.3% -27.2% -25.4% Source: Company data, Evercore Group L.L.C. Research; EPS excludes non-cash stock option expense


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Figure 14: Comparative FCF Multiples, 2010E-2012E

GOOG YHOO AOL

10/14/2010 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E

= C/F from Ops $11,007.8 $13,170.6 $14,875.7 $1,487.8 $1,726.2 $1,780.9 $757.0 $489.3 $436.2

- CAPEX 1,611.1 2,205.7 2,871.9 585.3 599.2 632.6 100.6 91.3 87.7

= FCF 9,396.7 10,964.9 12,003.8 902.6 1,127.0 1,148.3 656.4 398.0 348.6

/ EBITDA* 13,130.7 15,070.6 17,742.1 1,716.3 2,004.9 2,320.2 703.7 628.6 553.1

= FCF/EBITDA Conversion 71.6% 72.8% 67.7% 52.6% 56.2% 49.5% 93.3% 63.3% 63.0%

Free Cash Flow $9,396.7 $10,964.9 $12,003.8 $902.6 $1,127.0 $1,148.3 $656.4 $398.0 $348.6

/ Shares Outstanding 322.8 322.8 322.8 1,390.6 1,390.6 1,390.6 106.7 106.7 106.7

= Free Cash Flow per Share $29.11 $33.97 $37.19 $0.65 $0.81 $0.83 $6.15 $3.73 $3.27

Stock Price $540.93 $540.93 $540.93 $15.93 $15.93 $15.93 $24.95 $24.95 $24.95

/ Free Cash Flow per Share 29.11 33.97 37.19 0.65 0.81 0.83 6.15 3.73 3.27

= P/FCF Multiple 18.6x 15.9x 14.5x 24.5x 19.7x 19.3x 4.1x 6.7x 7.6x

Stock Price (x-Cash) $438.55 $438.55 $438.55 $7.43 $7.43 $7.43 $17.05 $17.05 $17.05

/ Free Cash Flow per Share 29.11 33.97 37.19 0.65 0.81 0.83 6.15 3.73 3.27

= P/FCF Multiple (x-Cash) 15.1x 12.9x 11.8x 11.4x 9.2x 9.0x 2.8x 4.6x 5.2x

FCF Yield 5.4% 6.3% 6.9% 4.1% 5.1% 5.2% 24.7% 15.0% 13.1%

FCF Yield (x-Cash) 6.6% 7.7% 8.5% 8.7% 10.9% 11.1% 36.1% 21.9% 19.2% Source: Company data, Evercore Group L.L.C. Research; *EBITDA excludes non-cash stock option expense activity


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Financials

Figure 16: AOL Income Statement, 2008-2015E

CAGR2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 10E-'15E

RevenueSubscription $1,929.3 $1,388.8 $1,002.3 $748.5 $585.1 $478.8 $408.4 $353.4 (18.8)%

Advertising $2,044.4 $1,699.7 1,260.9 $1,195.0 $1,179.8 $1,169.3 $1,173.3 $1,185.6 (1.2)%Other $138.1 $118.3 113.2 109.7 112.5 115.3 121.1 121.1 1.4%

= Total Revenue 4,111.8 3,206.8 2,376.4 2,053.2 1,877.4 1,763.4 1,702.8 1,660.1 (6.9)%- Cost of Revenue 2,263.0 1,884.1 1,400.8 1,218.7 1,143.7 1,078.2 1,045.1 1,009.6 (6.3)%

- SG&A 634.4 529.7 518.9 459.7 424.1 405.9 390.9 386.6 (5.7)%- Amortization of Intangible Assets 159.0 137.9 161.3 105.8 52.9 55.5 46.5 26.4- Amounts Related to Litigation, Net 20.8 27.9 0.0 0.0 0.0 0.0 0.0 0.0- Restructuring Costs 16.6 189.2 34.5 0.0 0.0 0.0 0.0 0.0- Goodwill Impairment Charge 2,207.0 0.0 1,414.4 0.0 0.0 0.0 0.0 0.0

- Gain on Disposal of Assets, Net (0.3) 0.0 0.0 0.0 0.0 0.0 0.0 0.0= Operating Income (Loss) (1,188.7) 438.0 (1,153.5) 268.9 256.6 223.7 220.4 237.4 (172.9)%

Other Income (Loss), Net (4.2) (2.4) 5.9 20.0 27.1 34.3 41.7 48.4 52.6%

= Income (Loss) from Continuing Operations (1,192.9) 435.6 (1,147.7) 289.0 283.7 258.0 262.1 285.9 (175.7)%- Income Tax 395.9 198.3 (186.0) 115.6 113.5 103.2 104.8 114.4 (190.7)%= Income from Continuing Operations (1,588.8) 237.3 (961.7) 173.4 170.2 154.8 157.2 171.5 (170.8)%

Discontinued Operations, Net 62.2 11.2 13.4 0.0 0.0 0.0 0.0 0.0

= Income Before Cum Change in Accounting (1,526.6) 248.5 (948.3) 173.4 170.2 154.8 157.2 171.5 (171.0)%Cum Effect of Accounting Change 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

= Net Income (Loss) (1,526.6) 248.5 (948.3) 173.4 170.2 154.8 157.2 171.5 (171.0)%Net Loss Attributable to Noncontrolling Interests 0.8 0.3 0.0 0.0 0.0 0.0 0.0 0.0

= Net Income (Loss) Attributable to AOL (1,525.8) 248.8 (948.3) 173.4 170.2 154.8 157.2 171.5 (171.0)%/ Diluted Shares Outstanding 105.8 105.8 106.7 107.2 108.3 109.4 110.5 111.6 0.9%= Diluted EPS Attributable to AOL ($14.42) $2.35 ($8.89) $1.62 $1.57 $1.42 $1.42 $1.54 (170.4)%

= Diluted EPS from continuous operations ($15.02) $2.24 ($9.01) $1.62 $1.57 $1.42 $1.42 $1.54 (170.2)%

GAAP & Non-GAAP ReconcialitionIncome from Continuing Operations ($1,588.8) $237.3 ($961.7) $173.4 $170.2 $154.8 $157.2 $171.5 (170.8)%

Stock Comp Expense, net of tax $11.8 $7.5 $22.2 $22.2 $22.2 $22.2 $22.2 $22.2Restructuring Costs, net of tax $22.3 $130.3 $20.7 $0.0 $0.0 $0.0 $0.0 $0.0Goodwill Impairment Charge, net of tax $2,207.0 $0.0 $1,111.7 $0.0 $0.0 $0.0 $0.0 $0.0Gain on Disposal of Assets, Net of tax ($0.2) $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0

= Net Income (x 1x items) $652.0 $375.1 $192.9 $195.6 $192.4 $177.0 $179.4 $193.7 0.1%/ Share Outstanding - Diluted 105.8 105.8 106.7 107.2 108.3 109.4 110.5 111.6= Adjusted EPS - Diluted $6.16 $3.54 $1.81 $1.82 $1.78 $1.62 $1.62 $1.74 (0.8)%Adjusted EBITDA (Incl. Restructuring) $1,516.4 $856.0 $614.6 $591.6 $516.1 $474.7 $441.4 $414.1

Y/Y % Change

RevenueSubscription (30.8)% (28.0)% (27.8)% (25.3)% (21.8)% (18.2)% (14.7)% (13.5)%

Advertising (8.3)% (16.9)% (25.8)% (5.2)% (1.3)% (0.9)% 0.3% 1.0%Other (14.9)% (14.3)% (4.3)% (3.1)% 2.5% 2.5% 5.1% 0.0%

Total Revenue (20.6)% (22.0)% (25.9)% (13.6)% (8.6)% (6.1)% (3.4)% (2.5)%Cost of Revenue (14.7)% (16.7)% (25.7)% (13.0)% (6.2)% (5.7)% (3.1)% (3.4)%

SG&A (34.2)% (16.5)% (2.0)% (11.4)% (7.8)% (4.3)% (3.7)% (1.1)%Amortization of Intangible Assets 65.8% (13.3)% 17.0% (34.4)% (50.0)%

Operating Income (Loss) (164.1)% (136.8)% (363.4)% (123.3)% (4.6)% (12.8)% (1.5)% 7.7%Other Income (Loss), Net (450.0)% (42.9)% (344.1)% 241.8% 35.3% 26.7% 21.5% 16.3%Income Tax (38.3)% (49.9)% (193.8)% (162.1)% (1.8)% (9.0)% 1.6% 9.1%

Income from Continuing Operations (230.9)% (114.9)% (505.3)% (118.0)% (1.8)% (9.0)% 1.6% 9.1%Adjusted EPS Diluted 10.2% (42.5)% (49.0)% 0.9% (2.6)% (8.9)% 0.4% 6.9%Adjusted EBITDA (43.6)% (28.2)% (3.7)% (12.8)% (8.0)% (7.0)% (6.2)%

% of Revenue/MarginsSubscription 46.9% 43.3% 42.2% 36.5% 31.2% 27.1% 24.0% 21.3%

Advertising 49.7% 53.0% 53.1% 58.2% 62.8% 66.3% 68.9% 71.4%

Other 3.4% 3.7% 4.8% 5.3% 6.0% 6.5% 7.1% 7.3%Total Revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of Revenue 55.0% 58.8% 58.9% 59.4% 60.9% 61.1% 61.4% 60.8%Gross Margin 45.0% 41.2% 41.1% 40.6% 39.1% 38.9% 38.6% 39.2%SG&A 15.4% 14.7% 21.8% 22.4% 22.6% 23.0% 23.0% 23.3%Restructuring Costs 0.4% 5.9% 1.5% 0.0% 0.0% 0.0% 0.0% 0.0%

Amortization of Intangible Assets 3.9% 4.3% 6.8% 5.2% 2.8% 3.1% 2.7% 1.6%Operating Margin (28.9)% 13.7% (48.5)% 13.1% 13.7% 12.7% 12.9% 14.3%

Other Income (Loss), Net (0.1)% (0.1)% 0.2% 1.0% 1.4% 1.9% 2.4% 2.9%Income Tax 9.6% 6.2% (7.8)% 5.6% 6.0% 5.9% 6.2% 6.9%Income from Continuing Operations (38.6)% 7.4% (40.5)% 8.4% 9.1% 8.8% 9.2% 10.3%

Tax Rate (33.2)% 45.5% 16.2% 40.0% 40.0% 40.0% 40.0% 40.0% Source: Company data, Evercore Group L.L.C. Research


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Financials

Figure 17: AOL Balance Sheet, 2007-2015E

2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Assets

Current Assets:

Cash $151.9 $134.7 $147.0 $865.1 $1,168.3 $1,459.6 $1,779.7 $2,087.3 $2,368.2Accounts Receivable 583.6 500.2 462.4 378.3 347.4 336.4 333.6 330.7 330.7Receivables from Time Warner 90.3 39.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0Prepaid Expenses and Other Current Assets 190.7 33.5 33.3 26.3 22.5 21.0 19.9 19.4 19.2

Deferred Income Taxes 269.4 25.8 44.7 33.1 28.6 26.2 24.6 23.7 23.1Assets Held for Sale 0.0 6.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0Total Current Assets $1,285.9 $740.4 $687.4 $1,302.8 $1,566.8 $1,843.1 $2,157.7 $2,461.2 $2,741.2

Property and Equipement, Net 906.5 790.6 704.8 615.4 504.8 393.4 288.1 203.1 143.4Long-Term Receivables from Time Warner 55.3 37.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0Goodwill 3,527.4 2,161.5 2,184.2 829.8 874.8 897.3 908.6 914.2 917.0Intangible Assets, Net 395.7 369.2 224.7 83.4 (7.4) (52.8) (104.5) (149.1) (174.6)Long-Term Deferred Income Taxes 634.3 734.2 136.8 184.6 180.0 183.3 172.2 166.3 162.1Other Assets 58.0 27.7 25.2 24.6 26.4 28.8 31.5 34.7 37.9Total Assets $6,863.1 $4,861.3 $3,963.1 $3,040.6 $3,145.4 $3,293.2 $3,453.5 $3,630.2 $3,827.2

Liabilities and Stockholders' EquityCurrent Liabilities:

Accounts Payable $86.4 $52.2 $100.5 $88.1 $78.9 $76.9 $76.0 $77.6 $79.8Accrued Compensation and Benefits 198.7 51.1 91.4 59.5 47.2 40.6 35.2 31.3 27.8Accrued Expenses and Other Current Liabilities 433.7 302.4 413.6 314.4 261.5 236.7 217.6 206.7 198.0Deferred Revenue 164.1 140.1 113.5 84.1 72.7 66.4 62.4 60.3 58.8Payables to Time Warner 212.2 58.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0Current Portion of Notes Payable and Cap Lease Obligations 74.3 25.0 32.4 16.3 7.4 0.0 0.0 0.0 0.0Total Current Liabilities $1,169.4 $629.6 $751.4 $562.4 $467.6 $420.6 $391.3 $375.9 $364.3

Notes Payable and Capital Lease Obligations $24.7 $33.7 $41.5 21.8 10.9 0.0 0.0 0.0 0.0Long-Term Obligations to Time Warner 327.2 377.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Restructuring Liabilities 16.7 9.0 28.3 28.3 28.3 28.3 28.3 28.3 28.3Deferred Income Taxes 6.8 11.5 9.3 9.3 9.3 9.3 9.3 9.3 9.3Other Liabilities 48.8 62.8 69.7 304.2 341.2 376.7 411.6 446.5 483.5Total Liabilities $1,593.6 $1,123.6 $900.2 $926.0 $857.4 $834.9 $840.5 $860.0 $885.4

Stockholders EquityCommon Stock $0.0 $1.1 $1.1 $1.1 $1.1 $1.1 $1.1 $1.1Divisional Equity $5,474.1 4,038.6 0.0 (948.3) (774.9) (604.7) (449.9) (292.6) (121.1)Additional Paid-In Capital 0.0 3,355.5 3,355.5 3,355.5 3,355.5 3,355.5 3,355.5 3,355.5Accumulated Other Comprehensive Income (206.9) (302.4) (275.1) (275.1) (275.1) (275.1) (275.1) (275.1) (275.1)Retained Earnings (206.9) 0.0 (20.4) (20.4) (20.4) (20.4) (20.4) (20.4) (20.4)Total Stockholders' Equity/Total Divisional Equity $5,267.2 $3,736.2 $3,061.1 $2,112.8 $2,286.2 $2,456.4 $2,611.2 $2,768.5 $2,940.0

Noncontrolling Interest 2.3 1.5 1.8 1.8 1.8 1.8 1.8 1.8 1.8Total Equity $5,269.5 $3,737.7 $3,062.9 $2,114.6 $2,288.0 $2,458.2 $2,613.0 $2,770.3 $2,941.8Total Liability and Stockholders' Equity $6,863.1 $4,861.3 $3,963.1 $3,040.6 $3,145.4 $3,293.2 $3,453.5 $3,630.2 $3,827.2 Source: Company data, Evercore Group L.L.C. Research


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Financials

Figure 18: AOL Cash Flow, 2007-2015E

2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

OPERATING ACTVITIESNet Income (Loss) $1,395.4 ($1,526.6) $248.5 ($948.3) $173.4 $170.2 $154.8 $157.2 $171.5

Adjustment for Non-Cash and Non-Operating ItemsCumulative Effect of Accounting Change, Net 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Depreciation and Amortization 498.6 477.2 406.2 371.4 322.7 259.5 251.0 221.0 176.6

Asset Impairment 16.2 2,240.0 23.1 1,414.4 0.0 0.0 0.0 0.0 0.0

Gain on Disposal of Assets and Consolidated Businesses (682.6) (0.3) 0.0 0.0 0.0 0.0 0.0 0.0 0.0Equity-Based Compensation 32.3 19.6 12.5 37.0 37.0 37.0 37.0 37.0 37.0Amounts related to Litigation 171.4 20.8 27.9 0.0 0.0 0.0 0.0 0.0 0.0Other Non-Cash Adjustments (6.7) (1.7) 7.7 0.6 (1.8) (2.4) (2.7) (3.2) (3.3)Deferred Income Taxes 102.2 (49.5) (6.7) (36.2) 9.1 (0.9) 12.7 6.8 4.8

Changes in Operating Assets and Liabilities (510.2) (245.9) 189.0 (81.9) (51.0) (27.1) (25.5) (12.0) (11.4)Net Cash Provided by Operating Activities $1,016.6 $933.6 $908.2 $757.0 $489.3 $436.2 $427.4 $406.8 $375.3

INVESTING ACTIVITIESInvestments and Acquisitions, Net ($881.4) ($1,035.4) ($18.1) ($100.0) ($75.0) ($37.5) ($18.8) ($9.4) ($4.7)Proceeds from Disposal of Assets 1,034.8 126.9 0.0 187.5 0.0 0.0 0.0 0.0 0.0Capital Expenditures and Product Development Costs (280.2) (172.2) (135.8) (100.6) (91.3) (87.7) (86.4) (87.7) (89.7)Investment Activities from Discontinued Operations 261.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Other Investment Proceeds 8.0 8.4 2.1 0.0 0.0 0.0 0.0 0.0 0.0Net Cash Used in Investment Activities $142.2 ($1,072.3) ($151.8) ($13.1) ($166.3) ($125.2) ($105.2) ($97.0) ($94.4)

FINANCING ACTIVITIESDebt Repayments ($25.9) ($54.0) $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0

Principal Payments on Capital Leases (36.1) (25.1) (31.1) (35.8) (19.8) (19.8) (2.1) (2.1) 0.0Excess Tax Benefit on Stock Options 34.4 2.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0Net Contribution from (Distribution to) Time Warner (1,390.3) 210.4 (709.3) 0.0 0.0 0.0 0.0 0.0 0.0Other (7.4) 1.5 (9.2) 10.0 0.0 0.0 0.0 0.0 0.0

Cash Provided (used) by Financing Activities ($1,425.3) $134.9 ($749.6) ($25.8) ($19.8) ($19.8) ($2.1) ($2.1) $0.0

Increase (Decrease) in Cash ($266.5) ($3.8) $6.8 $718.1 $303.2 $291.3 $320.1 $307.7 $280.9

Effect of Exchange Rates 16.9 (13.4) 5.5 0.0 0.0 0.0 0.0 0.0 0.0Cash at Beginning of Period 401.5 151.9 134.7 $147.0 $865.1 $1,168.3 $1,459.6 $1,779.7 $2,087.3

Cash at End of Period $151.9 $134.7 $147.0 $865.1 $1,168.3 $1,459.6 $1,779.7 $2,087.3 $2,368.2 Source: Company data, Evercore Group L.L.C. Research


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ANALYST CERTIFICATION

The analysts Ken Sena, Anupam K. Palit, CFA primarily responsible for the preparation of this research report attest to the following: (1) that theviews and opinions rendered in this research report reflect his or her personal views about the subject companies or issuers; and (2) that no partof the research analysts compensation was, is, or will be directly related to the specific recommendations or views in this research report.

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This report may include a Tactical Call, which describes a near-term event or catalyst affecting the subject company or the market overall andwhich is expected to have a short-term price impact on the equity shares of the subject company. This Tactical Call is separate from theanalysts long-term recommendation (Overweight, Equal-Weight or Underweight that reflects a stocks forward 12-month expected return), is nota formal rating and may differ from the target prices and recommendations reflected in the analysts long-term view.

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Ratings Definition and Distribution

Our recommendation system is based on a stocks expected total return relative to the analysts coverage universe over the next 12 months. Wedivide stocks under coverage into three categories, each defined by a prospective rate of return:

Overweight the stock is expected to outperform the average total return of the analysts coverage universe over the next 12 months.

Equal-Weight the stock is expected to perform in line with the average total return of the analysts coverage universe over the next 12months.

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Coverage Universe Investment Banking Services/Past 12 Mos.

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Overweight 30 48% 4 13%

Equal-Weight 24 38% 0 0%

Underweight 9 14% 0 0%

For disclosure purposes, in accordance with FINRA requirement, our Overweight, Equal-Weight and Underweight ratings may be viewed asBuy, Hold and Sell, respectively.

As of September 30, 2010

Issuer-Specific Disclosures & Disclosure Legend (as of October 15, 2010)

Company Disclosures

AOL, Inc.Yahoo! Inc.

44

Research Disclosure Legend1. Evercore or an affiliate has acted as a manager or co-manager of a public offering of securities by this subject company in the last 12

months.

2. Evercore or an affiliate beneficially owns 1% or more of common equity securities of this subject company.3. Evercore or an affiliate has performed investment banking services and received compensation from this subject company in the last 12

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8. The analyst(s) or a member of his or her household has a financial interest in the securities of this subject company (this may include,


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without limitation, whether it consists of any option, right, warrant, future, long or short position).

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