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US Report: Key issues for the Netscape-AOL merger

Given that Wall Street is on watch for the America Online and Netscape merger, investors should keep their eyes open for a few potentially major issues before getting euphoric about AOL shares.
Written by Larry Dignan, Contributor

Those details include: earnings dilution, profits, integration, regulatory concerns and a few other things that could really throw a wrench into the AOL machinery. Since we're primarily concerned with the bottom line, here's something that should be jumping out at you right away -- it's an all-stock deal.

Translation: Earnings dilution.

Sure AOL shares have been bullet-proof, but the Netscape acquisition could put AOL back into the loss column. How this deal is structured will be key, especially since the Securities and Exchange Commission has be cracking down on huge one-time charges. AOL is already an SEC favourite. Luckily, AOL's currency -- its stock -- has never been in better shape.

So far so good on the valuation front. Netscape said yesterday that AOL was offering .45 an AOL share for one Netscape share, or about $3.8 billion (£2.3billion). That price is below Netscape's closing price on Friday. AOL's profit outlook will also be worth watching. When will this Netscape deal boost earnings. Netscape has revamped itself and broke even last quarter, but certainly hasn't completely turned the corner yet. Netscape was expected to report earnings after the bell. Wall Street is looking for earnings of 3 cents a share.

The profitability question shouldn't be underestimated. Although Internet companies haven't been exactly cash cows yet, AOL has a predictable, steady earnings model. Now that the bottom line is out of the way, there are a lot of broader issues that should be evaluated.

For starters, what is AOL really getting out of Netscape. The short answer is a lot more reach, another portal to attract business users and a formidable browser. The really long answer may be a lot of headaches. Does AOL really want a browser that is arguably losing market share to Microsoft Corp.'s Internet Explorer? Does AOL really want to pay another party -- Sun Microsystems Inc. -- to reportedly market Netscape's e-commerce applications. AOL is now even more on Microsoft's turf -- not a fun place to be.

Another potential issue is the integration of Netscape. The history between AOL and Netscape is interesting. AOL was one of the reasons Netscape was in trouble in the first place. AOL chose Microsoft's browser as its primary vehicle and gave Internet Explorer a lot of reach and credibility. Netscape was supposed to be "the next Microsoft," but strategic blunders and the real Microsoft ended that talk. Will Netscape employees feel like they can win the holy war against Microsoft by aligning with AOL?

Aside from the usual issues regarding mergers, AOL would have four potential portal properties to manage -- Netcentre, AOL, ICQ and CompuServe. Two of those cater to the same demographic -- business users. CompuServe and Netcentre could be combined, but the move is likely to alienate some users. By acquiring Netcentre, AOL would gain access to business users to complement its base of home users. AOL would also be tops in terms of reach.

But to make all this work, AOL has to play hands-off with its acquired parts. If everything begins to look like AOL, users could rebel. So far, AOL has stayed away from heavy tinkering with ICQ, but it's still too early.

And finally there are regulatory concerns. The government is likely to give this merger a close look. Will AOL's acquisition of Netscape stifle innovation by creating two Microsofts?

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