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Murky financials may haunt AOL, Netscape, Sun deal

The complex arrangements seem to have a lot to do with what you'd call tax mitigation strategies

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We expressed some scepticism about the commercial viability of the AOL-Netscape (plus Sun) deal when it was announced, and it now seems that our concern was indeed justified. Part of the rationale for the deal centres on some accounting practices connected with pooling rules that are in the process of being scrapped by the Financial Accounting Standards Board. It's a labyrinthine deal centred on AOL trying to avoid having to pay tax on the goodwill. Last November, the deal was announced as having a value of $4.3 billion, but with the rise on AOL's shares, it became $10.2 billion. Netscape's book value was $475 million just before the deal (the fair asset value is not declared at the moment), so there is a potential tax liability of some $9.725 billion for goodwill (defined as the cost minus a fair valuation of the assets), which can be written off over 40 years. So much for dog years. By pooling interests, a company can, at the moment, avoid paying a great deal of tax. Sun is vital to the deal, but it is critically important that Sun is not judged to have acquired Netscape's enterprise software business. Under present rules, two years must elapse before any significant disposal of assets can take place, so assuming the SEC does not challenge the deal, it may reasonably be expected that Sun will formally acquire some of Netscape's assets from AOL around December 2000, although AOL could try to make a case that it did not intend to dispose of the Netscape assets at the time the pooling was established. This is where Microsoft's extra-special interest in the transaction comes in. Microsoft would love to find just a teeny bit of email evidence that contradicts the way the deal has been officially declared to be structured. It could then use this to cause as much damage as possible to AOL and Sun, who look set to make the growth of MSN very difficult on the consumer and corporate fronts. It is known from the disclosure of documents to the SEC that Sun has made a major financial commitment of $275 million in licensing fees, $10 million/year in collaborative marketing, and a minimum of $975 million over three years. There was also a significant backhander: AOL agreed to purchase $500 million of Sun boxes and services, and pay Sun $32 million/year for licensing and support. AOL turned to Sun in the first place because it knew it did not have the technical capability to exploit Netscape's enterprise software, so what better maxim to follow than "the enemy of my enemy is my friend", as Scott McNealy remarked to The Register at CeBIT, in a different context (Linux actually). When some preliminary announcements about the relationship were made yesterday, the situation was further confused. Sun's press release, and the backdrop at the New York announcement, refer to the "Sun-Netscape [sic] Alliance" to "build and market a comprehensive portfolio of e-commerce software". But it was "America Online and Sun Microsystems" making the announcement. You can bet there is a good legal/fiscal reason for this. AOL is developing Netscape Communicator enhancements. The substance of the announcement was pretty thin, although Mark Tolliver, who is the President of the Alliance, said there will be a series of announcements in the next few months, since only a couple of weeks had passed since the completion of the merger. A new product line was being developed, with the first products in Q1 2000. Netscape's directory product would be used by Sun. There will be about 2000 people in the Alliance, with Sun and Netscape contributing roughly equal numbers. The sales force will number 500. It therefore looks as though the real partners are going to keep the corpse of Netscape propped up in the corner during a two-year wake, before deciding about the most economical burial plans. It is unlikely that we have heard the last of this. ®

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