AOL-Time Warner-Homestore?

November 19, 2002

HOMS execs tried to sell company to AOL – ownership still possible

Inman News Features

Imagine AOL owning Homestore. It may seem an unlikely prospect, but it's not entirely outside the outer edges of the realm of possibility, given the complexities of an existing agreement between the two companies and new hints that Homestore's former executives already may have tried to sell the company to AOL, ostensibly to bury the online real estate company's fraudulent accounting practices in the dustbin of the acquisition.

An amended complaint filed on Friday in Los Angeles District Court by the California State Teachers' Retirement Systems, which is the lead plaintiff in the consolidated class-action shareholder lawsuits against Homestore, reveals the details of some fascinating negotiations behind the scenes between Homestore and AOL.

The complaint stated that the two companies were talking acquisition in March 2001 and that Homestore viewed AOL as a "savior" that would enable Homestore's then-executives to bury certain accounting shenanigans involving third-party vendors and roundtrip transactions that improperly boosted Homestore's revenues.

The potential merger was dubbed "Final Four," because the discussions were going on during the NCAA basketball tournament. Final Four refers to the final four teams in the annual tournament.

At the time in 2001, discussions were so serious that Homestore compensation packages and stock options were reviewed, according to unnamed sources cited in the complaint. Homestore's former CEO Stuart Wolff potentially could have netted $100 million while former COO John Giesecke and former executive Peter Tafeen stood to make $15 to $20 million and former CFO Joseph Shew could have netted $5 million. Giesecke and Shew last month plead guilty to securities fraud.

The complaint stated that the compensation committee of Homestore's board of directors reviewed "triggers on change in control and acceleration of options." Wolff also was working out the details of an employment agreement with AOL, which was struggling with the potential loss of "$50 million revenue recognition from the House & Home deal," according to the CalSTRS complaint.

"Until the talks stalled sometime in May 2001, the senior management at Homestore considered the 'Final Four' acquisition by AOL to be one way out of having done the fraudulent first quarter 2001 revenue deal," the complaint alleged.

The talks supposedly stalled because the acquisition became "too rich" for AOL when Homestore's stock price climbed after it released its first quarter 2001 financial results. The acquisition would have been valued at approximately $4 billion at that time.

But that's not the whole story.

It all started in April 2000, when Homestore and AOL signed a five-year marketing and distribution agreement. Homestore paid AOL $20 million in cash and approximately 3.9 million shares of HOMS stock—then trading in the $20-plus per share range—and guaranteed that certain percentages of the stock—if still owned by AOL—would be worth 30-day average closing price of $65.64 per share with respect to 60 percent of the shares on July 31, 2003 ($153 million), $68.50 per share with respect to 20 percent of the shares on July 31, 2004 ($53 million), and $68.50 per share with respect to the remaining 20 percent of AOL's shares on July 31, 2005 ($53 million). Homestore agreed to cover any shortfall in the value of the shares to AOL in a cash payment not to exceed $90 million, an amount reported as restricted cash on Homestore's balance sheet, and the rest in either cash or stock-plus-a-premium at Homestore's discretion.

AOL reportedly still owned all the shares as recently as Sept. 30, when Homestore recorded a $215.8 million distribution obligation representing the fair market value of those 3.9 million shares on its books, according to the company's third-quarter 2002 report filed with the Securities Exchange Commission.

Homestore 13 months ago filed a demand for arbitration alleging that AOL breached the agreement by not building 18 specific promotions for Homestore and delivering guaranteed Homestore impressions to AOL users. The complaint also alleged that AOL breached its duty of good faith and fair dealing and violated contractual guarantees of exclusivity, premier partnership and prominent partnership for Homestore. An arbitration hearing was held in July and the companies are awaiting the results.

If the arbitration goes against Homestore, it's conceivable that AOL could end up owning a controlling interest in the online real estate company. Consider: Approximately $153 million would be due on July 30, 2003. Ninety million could be paid in cash, leaving about $63 million to be satisfied in cash or more stock. A stock grant plus the agreed-upon 12 percent premium would amount to $70.5 million or around 74 million HOMS shares at this morning's market price of 95 cents per share. Homestore had 118 million shares outstanding on Sept. 30, according to its third-quarter financial statements. Add 74 million shares to the 3.9 million AOL already owns and AOL would hold somewhere in the neighborhood of 66 percent of Homestore.

Homestore of course isn't obligated to buy 74 million shares of its own stock on the open market and hand them over the AOL. In fact, the company may well have a lot of other more or less appealing options, including paying out more cash, issuing more stock with the approval of its shareholders, renegotiating the original agreement with AOL, taking on additional debt to pay off AOL, soliciting bids from third parties to acquire the company and so on.

But set aside all that number-crunching and financial maneuvering and one way or another it is possible that AOL eventually could wind up owning a controlling interest in Homestore.

That prospect may already be causing some angst in Chicago at the National Association of Realtors, which licensed the domain to Homestore for the purpose of operating NAR's official homes-for-sale Web site. The terms of the operating agreement give NAR considerable veto-power over the Web site's design and content and the right to take away use of the domain if ownership of Homestore changes hands. Would NAR pull out of the operating agreement if AOL took over?

Copyright: Inman News Service

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