AOL: The ideal Microsoft deal-breaker for Yahoo?

Over the weekend, reports surfaced that Yahoo's new financial advisors want it to chase down a merger with AOL to counter Microsoft's multi-billion-dollar bid. But can AOL parent Time Warner afford Yahoo's financial freight?

After Yahoo gave a definite "no" to Microsoft's multibillion dollar buyout bid on Friday, indications emerged over the weekend that AOL might come to the rescue as Yahoo's fabled white knight. But after just turning in less-than-stellar fourth quarter 2007 financial results, can Time Warner, AOL's parent company under newly anointed CEO Jeff Bewkes, afford to take on Yahoo's freight?

On Sunday, The Times Online (UK) reported that pursuing an AOL merger is the top choice now being recommended by Yahoo's investment bank advisers at Goldman Sachs and Lehman Brothers.

Meanwhile, during TW's fourth quarter 2007 financial earnings call on February 7, AOL officials discussed several moves afoot to raise TW's stock price, including spinning off AOL's long-time Internet access operations from its more lucrative AOL.com audience and advertising business, plus a change in the ownership of TW's cable business and layoffs of about 100 people and other cost cutting measures.

AOL is now "working on separating AOL's access and audience businesses so we can run them independently," said CEO Bewkes during the call. "This should significantly increase AOL's strategic options for each of these main business sectors."

Could a Yahoo merger suddenly be turning into one of those new "strategic options"? Certainly, this possibility seems a lot more viable than the rumors making the rounds about Amazon as a potential Yahoo suitor.

As some observers see it, the combined forces of AOL and Yahoo could be a very tough duo for Google to beat in the Web-based display advertising arena, where Google is competitively weak. Such a deal might also give AOL ownership of search technology that many are comparing favorably to Google's.

But aside from Yahoo's tremendous presumed asking price -- which is apparently going up -- there could be a lesser impediment to the deal.

AOL is already involved in a search partnership with Google, noted TW CFO John K. Martin during the Thursday call, in response to a question posed by an analyst about AOL's "search strategy." Martin described that strategy as to "grow usage, increase the number of searches, drive overall engagement, and then drive monetization."

But after rather pointedly mentioning AOL's partnership with Google, Martin appeared to leave AOL somewhat on the sidelines of what he termed the current "consolidation" in the search market -- referring, evidently, to the center stage action of Google, Yahoo, and Microsoft.

"[As] the search providers in the industry consolidate -- that could also prove beneficial fo us, as it could flash the value, so to speak, with respect to our scaled audience," Martin said.