In its all-out battle to defeat Google, Microsoft may be reaching out to a former nemesis. The Redmond company is reportedly close to buying...

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In its all-out battle to defeat Google, Microsoft may be reaching out to a former nemesis.

The Redmond company is reportedly close to buying a stake in America Online or at least expanding a partnership they reached in 2003.

AOL is cash-strapped and losing customers, while Microsoft is cash-rich and investing heavily to expand its presence in Internet search and services.

AOL, based in Dulles, Va., also happens to be Google’s largest customer and accounts for about 12 percent of the search company’s sales. But their relationship may be changing as Google continues offering new services that compete directly with AOL, including an instant-messaging service Google unveiled last month.

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The intrigue began yesterday when the New York Post tabloid, citing anonymous sources, reported the two companies were engaged in talks.

It said Time Warner is negotiating to sell a stake in its AOL division to Microsoft and perhaps merge the division with Microsoft’s MSN group. It said Time Warner is also talking to Google and Yahoo! but Microsoft is the preferred buyer.

Representatives of the companies declined to confirm the report, but analysts said it’s likely that some sort of deal is under way.

What remains to be seen is whether Microsoft is simply expanding its technology-sharing partnership with AOL or making a bolder move that could rearrange the relationships of consumer Internet-service giants.

“There’s some credence to what’s going on, it makes some sense,” said analyst Jonathan Rudy at Standard & Poor’s in New York.

But Rudy said it’s too soon to say what exactly is happening or what effect it will have on Microsoft stock. Microsoft closed at $26.27 yesterday, down 4 cents, and Time Warner was up 3 percent, closing at $18.50.

“They’re anti-Google, that’s for sure, and they’re gunning for them,” Rudy said of Microsoft. “I’d like to see the t’s crossed and the i’s dotted before I start speculating on what it could be.”

The time is ripe for something to happen. MSN and AOL are both trying to refresh their businesses and reclaim users and ad sales they’ve lost to Google in particular.

Microsoft executives told analysts in July that they’re increasing the pace of merger activity and stepping up their fight against Google. The company is now preparing to roll out a new search-advertising platform and it’s working on upgrades to its free Hotmail e-mail service that’s being challenged by Google’s Gmail.

Meanwhile, Time Warner is under pressure to improve its performance. On Monday investor Carl Icahn called on the company to divest its cable business and auction shares to increase the company’s value.

$13 billion in debt

Time Warner is $13 billion in debt and facing costly shareholder lawsuits stemming from its ill-fated, $124 billion merger with AOL in 2001. The company is now settling more than $3 billion worth of shareholder lawsuits and federal investigations into improper accounting at AOL.

AOL and MSN have had a long and rocky relationship. Early in the Web era they were partners, when AOL agreed to use Microsoft’s Web browser in exchange for valuable real estate on the Windows 95 desktop.

“It’s not unprecedented for Microsoft and AOL to work together,” said former MSN chief Brad Chase, who negotiated the Windows 95 deal.

Later the companies competed fiercely for subscribers, spending heavily on discounts and free services, as they raced to build the biggest online portals in the late 1990s.

Their rivalry peaked after AOL bought Netscape Communications in 1999 and became involved in the landmark Microsoft antitrust case. AOL sued in 2002 and won a $750 million settlement in 2003 from Microsoft.

The settlement may have laid the groundwork for the talks now under way between the companies. In addition to the payout, Microsoft agreed to a seven-year technology-sharing partnership.

One area the companies may be exploring is linking their instant-messaging services. Microsoft may also be trying to get AOL to stop using Google search technology at its site and instead use the new MSN search platform.

AOL is Google’s largest customer and accounted for about $382 million of Google’s $3.2 billion in sales last year.

Both AOL and MSN have shifted their business models to emphasize selling ads more than Internet access. They have lost subscribers in recent years as consumers abandoned their dialup services and moved to high-speed broadband services. But AOL still has 27 million subscribers in the U.S. and Europe, and MSN has 9.1 million.

In position to buy

Google, based in Mountain View, Calif., is also in a position to buy a stake in AOL, if it’s available. Yesterday Google sold $4.2 billion worth of additional stock. It’s being cryptic about its plans for the cash, but acquisitions are one option the company listed.

Also unclear is how long AOL will continue using Google’s search technology. In October 2003 the companies announced a “multiyear” agreement but yesterday both declined to say when it expires.

“Google and AOL have a healthy global partnership and AOL remains a valued partner,” Google spokesman Mike Mayzel said.

Mayzel also declined to say whether Google is trying to buy a stake in AOL.

“As a public company we can’t ever comment on rumors about acquisitions or potential investments,” he said.

Brier Dudley: 206-515-5687 or bdudley@seattletimes.com