What's the big deal? AOL-Netscape could have seismic impact

Earlier Monday, both companies confirmed the negotiations, which sent their shares soaring. The proposed deal involves a stock-for-stock, pooling-of-interests transaction worth about $3.8 billion. Netscape (Nasdaq:NSCP) would receive 0.45 shares of AOL for each share of Netscape.

The impact of an AOL/Netscape merger cannot be overstated: It holds the potential to reshape the direction of cyberspace.

Even as federal government prosecutors continue to press their case against Microsoft for using its existing software business to create an advantage on the Internet, a combination of AOL and Netscape would create a single entity capable of wielding enormous power over the online world.

Incentive for both
There's incentive for both companies to do a deal.

While Netscape's hold on the browser market has slipped over the past year, 45 percent of the traffic on the Web today is viewed through Netscape's browser software, according to figures released today by ad management firm AdKnowledge Inc.

Combine that with the sway that AOL now holds with the 13 million subscribers to its flagship online service, the more than 2 million users of its CompuServe brand and the millions more using AOL-brand instant messaging "buddy list" services on the Web, and you have a company that has the potential to touch the overwhelming majority of users going online, whether they're at work or home.

America Online also operates CompuServe, Digital Cities, a local Internet service in 58 North American cities, ICQ, its recently acquired Internet chat system used by roughly 10 million active users and AOL International in Europe, Japan, Canada and Australia.

Keeping Microsoft at bay
What's more, both companies have a common interest in keeping Microsoft at bay as electronic commerce becomes increasingly important. Microsoft recently rejiggered its MSN online service as a pure Web play. There is strength in numbers and an AOL-Netscape alliance will have a better chance of successfully handling any challenge from Redmond.

The alliance would create cross-marketing opportunities that Microsoft can only dream about. While Microsoft must be careful of the way it cross-promotes its services to keep from running afoul of government antitrust regulations, AOL could use its market position to drive traffic to a single Web portal destination.

If AOL so chooses, it could default users from its AOL service and users of Netscape's browser software to the same online navigation hub, creating an online media giant that could rival any online entity.

At the same time, AOL could use its existing position as a purveyor of media services to promote usage of specific software, such as the Netscape browser.

Sway
While the tight integration of Microsoft's Internet Explorer browser into recently released versions of AOL user software may prevent an immediate conversion of AOL to Netscape, the combined companies would hold the power to significantly sway market usage in Netscape's favor in succeeding versions of the AOL interface.

The market position also would give AOL tremendous leverage in determining winners and losers in the Internet software space. Earlier this year, for instance, it agreed to distribute streaming media software developed by RealNetworks Inc. Replays of that software alliance are possible with AOL now able to integrate outside applications into both its leading consumer online service and the heavily used Netscape browser.

Separate homes
"There are two aspects to Netscape's business, a media component and an enterprise (software business) component. Were something to happen, they would have to find separate homes," said Daniel Rimer, an analyst with Hambrecht & Quist in San Francisco, who tracks Netscape.

Sun Microsystems, which is also rumored to figure into this deal, would in turn gain access to Netscape's popular software used to run server computers to power Web sites as it seeks to extend the reach of its Java programming language, already a staple on the Internet for animating Web pages.

Sources said that Sun (Nasdaq:SUNW) is considering an arrangement under which it would partner with the acquired Netscape to distribute the Netscape software that runs and manages the server computers that power Web sites.

Separately, Netscape said it will report earnings Tuesday. Wall Street is looking for earnings of 3 cents a share. In the third quarter, Netscape broke even and showed signs that it's headed in the right direction.

Users of Netscape's Navigator browser are unlikely to see major changes as a result of the alliance, according to Shelly Theophano, an online service market analyst with the Gartner Group's Datapro subsidiary in Delran, N.J.

AOL is also likely to offer its users both browsers, instead of just Microsoft's Internet Explorer, as is now the case, Theophano said.

Other industry observers said the deal would have little immediate impact on the all-in-one Internet sites that compete with Netcenter. But they said it would bolster America Online's top position in the online world.

"We've been saying for the last couple of months that it's hard for anybody to move the needle in the portal business at this point, through marketing and that sort of thing, and acquisition is the only way to do it," said Barry Parr, an analyst with International Data Corp. "We've been expecting a merger between one or more players among the seven or eight portals... so it makes a lot of sense."

The most important part of the possible pact could be Netscape's Internet developer talent, according to Alexis dePlanque, an analyst with Meta Group, who said AOL's underlying system architecture remained weak.

"It doesn't scale, and it's so slow... because their applications are crappy," he said. "It could be they're buying the experienced developer staff to improve that."

ZDNN with Contributions from Charles Cooper, Steve Vonder Haar, Will Rodger, Maria Seminerio.