Why did Verizon Buy AOL?

Verizon (NYSE:VZ) Communications has entered an agreement to buy AOL (NYSE:AOL) in a $4.4 billion cash deal.  The New York-based companies will combine in an effort to build out a digital advertising business.

At $50 per share, Verizon is paying a 17% premium over Monday’s close of $42.59, but it is a far cry from the $160 billion that AOL paid for Time Warner (NYSE:TWX) in 2000, now known as one of the worst mergers in history.

This time, AOL is the smaller player, with most of its efforts focused on businesses that barely existed 15 years ago.  Under the leadership of CEO Tim Armstrong, AOL has centered its business on video ads and blog content. AOL owns both the Huffington Post and TechCrunch brands.

“We have built one of the best advertising platforms in the world,” Armstrong said in a memo to employees on Tuesday.  “Now it is time for us to fully open up the mobile frontier.”

Analysts say Verizon sees opportunity in AOL’s advertising business because it could support the over-the-top video service that Verizon plans to release later this year. The service would allow broadband subscribers to view premium video content on mobile devices and AOL’s video ad network could help Verizon monetize this business.

“What we are expecting is a Netflix-type streaming platform where people can watch a wide array of movies and shows,” said Roger Entner, analyst at Recon Analytics.  “They are basically buying an advertising platform so they can keep the money themselves.”

“AOL brings a vast amount of premium digital video content to them and at the same time it brings the ability to monetize against that content with advertising,” echoed James Cakmak, analyst at Monness Crespi Hardt.  “What Verizon needed was a way to adapt and stay ahead of the curve and the changing landscape as video moves to mobile.”

The deal, which is expected to close this summer, helps Verizon reduce its dependency on the struggling cable television business. “Cord-cutting” is common amongst millennials and Verizon needs to build out its online and mobile offerings.

“All the cable companies are facing this secular headwind of the cutting of the cord,” explained Cakmak. This is a “move to adapt to the changing times.”

Although Armstrong touted the content brands in the internal memo, many are speculating that Huffington Post, TechCrunch, Engadget and others in its brand portfolio will be spun off.

“I don’t think Verizon has any interest in owning the content that AOL has,” said Walt Piecyk, analyst at BTIG.  If they sell off the content assets, it “lowers the very high price tag they paid for AOL.”

Piecyk is skeptical that the overall deal makes sense for Verizon, at this price point. “Four billion is a lot to pay. I don’t know if AOL is the right company.”

Verizon, whose shares are up nearly 6.5% year-to-date, was trading essentially flat, hovering around $50 per share.  Verizon has a market cap of $204 billion.

Update: Armstrong reportedly told TechCrunch that the tech blog is not for sale. He remained vague about the status of Huffington Post.