Sun and AOL’s vehement denials that the highly complex AOL/Sun/Netscape ‘strategic alliance’ is simply a back door acquisition of Netscape’s server business by the Unix veteran, now intent on calling itself the ‘.com’ software company, has done little to quash speculation that this is, in fact, Sun’s end game. It’s a joint takeover bid for Netscape with Sun as the silent partner for now, says David Wu at ABN AMRO. It’s like Poland when Russia and Germany divided it between themselves but the difference is that Sun wants total control of Poland [Netscape] and is probably going to get it.
Although the accounting terms under which the AOL-Netcape deal was struck prevent the purchaser from selling the acquired business on, M&A advisors argue that in time the ‘pooling of interests’ rules under which the deal was cut can be side- stepped.If a company wants to ‘pool’ then it can’t sell that business immediately but two years is a safe harbor. There’s no reason why a year and half from now AOL won’t be able to off-load Netscape’s server software to Sun and keep the business portal it was interesting in all along [Netcenter], says Steve O’Leary at Broadview.
The linchpin on which pooling hangs is intent, according to O’Leary. If AOL was able to persuade accounting regulators that it had no intention of divesting itself of Netscape’s internet/e- commerce software at the time the terms of the agreement were set, then it would be allowed to account for the deal as a pooling transaction, write-off a portion of the price in purchased R&D, and in so doing engineer the acquisition to go straight to its bottom line. It obviously managed to do that and, therefore, will make every attempt to distant itself from any speculation of a later divestment that would jeopardize the benefit ‘pooling’ provides.
Of course, AOL would argue that its inexperience in selling enterprise software is glaringly apparent and that is the reason why the on-line services giant sought out Sun to shoulder the burden of developing and marketing Netscape’s web and e-commerce software. But the moNAIry commitment that Sun has prepared to invest in the alliance would suggest an ulterior motive. Sun wants access to Netscape code and this alliance will give it just. In order to pay more than lipservice to the concept of being a ‘.com’ software company, Sun needs more web software and a wider complement of e-commerce servers. The alliance provides it with some highly regarded product as well as the potential to co-own any code, and therefore, product that is jointly developed by itself and AOL.
Over the next three years, Sun will pass on a phenomenal $1.4bn in revenues to AOL, which will primarily come from current Netscape e-commerce product sales plus any jointly developed products. According to Sun’s February SEC filing this sum comprises $975m in revenues from existing and co-developed Netscape software plus $278.5m in licensing fees for software and trademark rights granted to Sun by AOL, approximately $75m in marketing and advertising fees plus a further $30m in so-called marketing co-op fee for the right to market and sell its own products plus those collaboratively developed.
Effectively, therefore, Sun is reimbursing AOL one third of the $4.5bn stock value assigned to the deal when it was first announced on November 23, 1998, which is a massive 989.4% premium over Netscape’s book value of roughly $475m on October 31, 1998. Our pre-paid obligation to AOL has increased our debt quite significantly, Ed Zander, Sun’s CFO, told investors on a third quarter conference call last week.
So what will Sun get in return? Although AOL and Sun SEC filings have been carefully edited to mask the total revenues that will show up on their respective balance sheets, the details that are revealed show that AOL’s financial commitment to Sun is but a fraction of that. It will pay Sun a total of $596m over the coming three years, $500m of which will come from purchasing Sun hardware and services, $1m a month in technic
al support and $5m a quarter to license Sun technology.
Going forward, the organizational structure AOL and Sun have together devised for Netscape make it easier for Netscape to be split apart and the server business to be sold off separately. The ultimate responsibility for heading up the server software organization rests with a Sun executive, Mark Tolliver, who is general manager of the 2,000 strong organization. AOL has established a separate organization for Netscape’s browser software that reports to one of its own executives, Barry Shuler. Sun executives contend that the AOL/Netscape deal will be neutral to earnings this year and accretive in the second and third year. But at what cost? And will the deal be restructured to enable Sun to gain total control of Netscape code before then?
