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AOL Spinoff Set In Motion With Debt Shift

4/12/2009 2:00 AM Eastern

Just weeks after finalizing the spinoff of its interest in Time Warner Cable, Time Warner Inc. began setting the wheels in motion for at least a partial spin of its troubled online unit, AOL.

According to documents filed with the Securities and Exchange Commission last Monday, Time Warner is asking bondholders to vote on an exchange of $12.3 billion in debt guarantees to Time Warner's HBO unit, a move that would unlock restrictions on transferring the assets of AOL.

According to the documents, HBO would guarantee about $12.3 billion in bonds, and would pay back the debt in full in compliance with the original terms. HBO, according to the documents, reported $3.7 billion in total revenue in 2008 and has about $11.1 billion in assets.

Time Warner also is soliciting consents from bondholders to amend the indentures governing the $12.3 billion in bonds, offering to pay holders $5 for every $1,000 in principal they hold. That incentive — the debt would remain on the books and bondholders would still be paid in full over the course of their obligations — would work out to be about $61.5 million in cash.

With the two transactions Time Warner is essentially moving the debt off of AOL's books and backing it up with HBO's assets.

Finding the right model for AOL has been a struggle for years at Time Warner. It switched to an advertising-based model from subscriptions in 2006. Last August, chairman and CEO Jeffrey Bewkes proposed splitting out the dial-up access business, a move he said could be completed in early 2009.

AOL, once the undisputed king of Internet access, has been on a steady decline for several years. According to Time Warner's financial statements, the downward spiral continued in 2008 with revenue down 20% to $4.2 billion and an operating loss of $1.1 billion, compared to operating income of $2 billion in 2007.

AOL took a $2.2 billion asset-impairment charge for the year, a one-time charge. But subscribers to the dial-up service have been steadily declining — to 6.9 million in 2008 vs. 9.3 million in 2007 — and advertising has made up the difference.

In mid-March, AOL hired former Google senior vice president Tim Armstrong to head up the struggling unit, fueling speculation that some sort of deal was in the works.

In an April 2 research report — almost a full week before the most recent filing — Citigroup media analyst Jason Bazinet predicted that an AOL spin was likely.

Bazinet cited the high-profile Armstrong hire and Google's decision in January to exercise registration rights for its 5% stake in AOL.

Time Warner now has to pay Google in cash for its interest (about $274 million) in Time Warner stock or spin the AOL division.

“Google has little need for cash or Time Warner shares,” Bazinet noted.

Time Warner said it is currently exploring strategic options for AOL, including spinning off the access and Web-services businesses to Time Warner shareholders; making acquisitions of interests in related businesses; entering into joint ventures or other combinations; or separating out the units in a single or separate division.

The company said it hasn't made a decision yet, but is currently leaning toward a spinoff of one or more parts of the businesses to shareholders.

Time Warner said that in the absence of more favorable strategic opportunities, it anticipates that it “would initiate a process to spin off one or more parts of the businesses of AOL LLC to Time Warner's stockholders, in one or a series of transactions.”

While it expects that it could initiate those transactions without the bondholder consent or the guarantee, receiving them would “simplify the execution of the strategic options available to Time Warner,” according to the filing.

You've Got Losses
A look at AOL operating metrics:

  2008 2007 % Change
SOURCE: Time Warner 10-K Annual Report
Revenue $4.2 billion $5.2 billion (20%)
Operating Income (Loss) ($1.1 billion) $2 billion NM
Subscribers 6.9 million 9.3 million (25.8%)
September