What’s in Netscape for AOL?

News that AOL is in the market to acquire Netscape for $4 billion had investors bidding up the stocks of both companies today and reporters singing the praises of what they termed a substantial challenge to Microsoft. But although the Internet economy often appears to operate by its own strange set of rules, in the case of mergers and acquisitions the offline and online rule is exactly the same: In general, acquisitions are bad news for everyone except the acquired company’s shareholders. And while AOL has done a great job of turning unpredictable moves into unexpected successes, the economics of this deal seem questionable.

The question to ask about this deal is the same question you have to ask about any merger: “What does buying a company let AOL do that it couldn’t do otherwise?” And the answer to that question remains somewhat unclear. Even if AOL were to replace Microsoft’s Internet Explorer as its default browser with Netscape’s Navigator (something it says it won’t do), it doesn’t have to acquire Netscape to do so. Netscape’s Web site, Netcenter, is supposedly on its way to becoming a portal, and generates a lot of business traffic. But if AOL wants to build its brand name on the Web, it could invest heavily in, which is already one of the most heavily trafficked sites.

Netcenter does have the great advantage of being the site to which Navigator automatically directs users. But that hardly seems like a long-term competitive advantage, especially since Microsoft is bundling (or whatever you call it) Explorer with every copy of Windows. More to the point, AOL is itself a portal to the Internet, and spending $4 billion to establish itself on the Web seems somewhat at odds with its basic business strategy.

Consolidation in the portal industry is probably in the cards. But the portal strategy, built as it is on advertising, is hardly a surefire success, and the minuscule profits being earned by even the most popular sites are a healthy reminder of how up-in-the-air all this remains. AOL is the best Internet company in existence because it has a steady stream of revenues from its users and because it’s figured out a way to leverage those users into income from advertisers, content providers, and retailers. But both sides of that equation are essential to its success. With Netcenter, the first part of the equation–the subscription fees–will disappear. Will what’s left be enough to justify the price tag?

Maybe. Things are fluid enough on the Net to make every judgment provisional. But we know that companies tend to overpay for acquisitions, that they underestimate the difficulty of fitting companies together, and that they overestimate the synergistic benefits. AOL President Bob Pittman has done a brilliant job turning AOL into a dominant business. But is this really the best way AOL has of spending $4 billion?

(Click here for a report on how the deal was spun at the Microsoft trial.)