AOL Stock Purchase Enabled by $1 Billion Microsoft Patent Deal

It was less than two weeks ago that AOL announced that it completed a $1.056 billion patent transaction with Microsoft Corporation (NASDAQ: MSFT). At the time of the announcement of the Microsoft transaction AOL explained that the company expected to provide additional details to shareholders by the end of June.  Earlier today, AOL Inc. (NYSE: AOL) announced that it has commenced a modified Dutch auction tender offer to repurchase shares of its common stock up to an aggregate purchase price of $400 million, making good on its earlier promise to shareholders.  Indeed, this announcement is being touted by the company as a first step in returning 100% of the proceeds of its recent patent transaction to its shareholders by the end of calendar 2012.

The Microsoft patent transaction included the sale of over 800 AOL patents and their related patent applications, and granted Microsoft a non-exclusive license to its retained patent portfolio for an amount totaling $1.056 billion in cash.  AOL continues to hold a significant patent portfolio of over 300 patents and patent applications spanning core and strategic technologies, including advertising, search, content generation/management, social networking, mapping, multimedia/streaming, and security among others.

The tender offer begins today, June 28, 2012, and will expire at 5:00 p.m., New York City time, on August 2, 2012, unless extended or earlier terminated by the Company. Under the terms of the proposed tender offer, AOL’s shareholders will have the opportunity to tender some or all of their shares at a price within the range of $27.00 to $30.00 per share. On June 27, 2012, AOL’s stock closed at a price of $27.31.  As of the time of writing AOL’s stock is currently at $28.20.

If the tender offer is fully subscribed, then shares having an aggregate purchase price of $400 million will be purchased.  AOL estimates that this will result in between 14.2% and 15.8% of share outstanding as of June 14, 2012 will be purchased pursuant to this tender offer. AOL’s directors and executive officers reportedly do not intend to tender their shares in the tender offer.

“The closing of this transaction represents another major step for AOL in increasing value for our shareholders,” said Tim Armstrong, Chairman and CEO, on June 15, 2012, the day AOL announced the completed Microsoft transaction. “As our track record has shown, you should expect us to continue our momentum of creating and unlocking shareholder value through continued operational improvements and executing on our strategy.”

This latest AOL announcement of the $400 million purchase of shares of common stock will allow the company to take a portion of the Microsoft proceeds to repurchase stock.  A stock repurchase plan is where a company uses cash on hand to buy shares of its own stock.  The repurchased stock is then retired so that fewer shares in the company remain, which theoretically will make each remaining share more valuable. See Understanding Stock Repurchase Plans.

“Today’s announcement is an important first step in returning 100% of the proceeds from our patent transaction as expediently and tax efficiently as possible,” said Armstrong. “AOL is focused on continued execution and operational improvement. Concurrently reducing our shares outstanding at attractive prices underscores both financial prudence and our significant belief in the opportunity in front of AOL.”

“Today’s announcement is a necessary first step in the return of capital to our shareholders,” said Artie Minson, CFO of AOL and President of AOL Services “Over the course of the remainder of this year, we will continue the full return of the patent proceeds as well as the $40 million left in our current repurchase authorization and we will do so in a manner which we believe will drive value for shareholders while preserving the value of AOL’s substantial tax assets.”

One problem with stock repurchase plans is caused when a company commits too much of its available cash to repurchase shares, thereby leaving insufficient funds for ongoing business operations.  Given that the repurchase will be capped at $400 million and the Microsoft “new money” from the patent transaction totals over $1 billion, this concern would not seem to apply in the AOL scenario.  Of course, both Armstrong and Minson discuss this repurchase as a first step, so the situation bears further watching in the months to come.

While liquidity to pull off this stock repurchase does not seem to be problematic given the proceeds of the patent sale to Microsoft, AOL’s attorneys do have their eye on another issue of potential concern, which will make them move more slowly than they might otherwise like to return the sale proceeds to shareholders.  More specifically, due to the size of the stock repurchase and AOL’s present market capitalization, the company explained they will proceed carefully and make sure they “preserve large tax attributes” which could be in jeopardy if the repurchase triggers a “change of control” as defined by the Internal Revenue Code.

AOL will return of the patent proceeds to shareholders in multiple steps and potentially through several methods. These methods may include a tender offer, share repurchases in the open market, privately-negotiated transactions and the payment of dividends. AOL says they remain confident that through employing different alternatives 100% patent proceeds will be returned to shareholders by the end of 2012 without causing any negative tax consequences.

The offer to purchase, the related letter of transmittal and the other tender offer materials will be mailed to AOL shareholders in the coming days. Shareholders who have questions may call Allen & Company, LLC, the dealer manager for the tender offer. Shareholders who have questions or would like additional copies of the tender offer documents, when available, may call the information agent at (877) 278-8941. Banks and brokers may call (212) 440-9800.