Summary:

• Creating value requires growth, not cost reductions
• Yahoo and AOL have no growth, and no new market development plans
• Yahoo and AOL lack the resources to battle existing competitors Google and Apple
• Don’t invest in Yahoo or AOL individually, or if they merge
• Companies that generate high valuation, like Apple, do so by pioneering new markets with new products where they generate growth in revenue, profits and cash flow

Rumors have been swirling about Yahoo! and AOL merging – and Monday’s refresh led to about a 2% gain in the former, and 4% gain in the latter. But unless you’re a day trader, why would you care? Merging two failing companies does not create a more successful progeny.

AOL had a great past.  But since the days of dial-up, the value proposition has been hard to discern.  What innovations has AOL brought to market the last 2 years?  What new technologies is AOL championing?  What White Space projects are being trumpeted that will lead to new capabilities for web users if they purchase AOL products? 

And the same is true for Yahoo!  Although an early pioneer in on-line advertising, and to this day the location of many computer user’s browser home page, what has Yahoo! brought to market the last 2 years?  In the search market, on-line content management, browser technology and internet ad placement the game has fully gone to competitor Google.  Although the new CEO, Ms. Bartz, was brought in to much fanfare, there’s been nothing really new brought forward.  And we don’t hear about any new projects in the company designed to pioneer some new market.

And from this merger, where would the cash be created to fight against the likes of Google and Apple?  Unless one of these companies has a silver bullet, the competitors’ war chests assures “game over” for these two.

Sure, merging the two would likely lead to some capability to cut administrative costs.  But is that how you create value for an internet company?  What creates value is developing new markets – like AOL did when it brought millions of people to the internet for the first time.  And like Yahoo! did with its pioneering products delivering news, and placing ads for companies.  But since both companies have lost the willingness, capability and resources to develop new markets and products they’ve been unable to grow revenues and cash flow.  The road to prosperity most assuredly does not lie in “synergistic cost reductions” across administration, selling and product development for these two market laggards.

The reason Apple is skyrocketing in value is because it has pioneered new markets.  And produced enough cash to buy both these companies – if there was any value in them.  SeekingAlpha.com lays out the case for almost 100million iPad sales, and a lot more iPhones, in “What Could Justify a $500 Apple Stock Price.”  But beyond selling more of what it’s pioneered, Apple has not stopped pioneering new markets.  Another SeekingAlpha article points out the likelihood of Apple making video chat something people will really want to use, now that it can be done on mobile devices like iPads and iPhones, in “Apple’s Future Revenue Driver: FaceTime.”  It’s because Apple has the one-two punch of growing the markets it has pioneered while simultaneously developing new markets that makes it worth so much.

If you’ve been thinking a merged Yahoo/AOL is a value play – well think again.  Both companies are well into the swamp of declining returns.  So focused on fighting off the alligators and mosquitos trying to eat them that they long ago forgot their mission was to create new markets with new products that could carry them out of the low-growth swamp.  Sell both, if you haven’t already, and don’t look back.  Whether you take a loss or gain, at least you’ll leave with some money.  The longer you stay with these companies the less they’ll be worth, because neither has a sail of any kind to catch any growth wind.

Apple at $500 might sound crazy – but it’s a better bet than hoping to make any money in the individual, or merged, old-guard companies.  They don’t have the cash, nor the cash flow, to drive new solutions.  And that’s how value is created.