AOL to make over $1 billion in patent sale to Microsoft

AOL is starting off the week with a bang -- and a billion-dollar jolt to its financials.

The company today announced that it has inked a deal with Microsoft that will see the online firm sell 800 of its patents and their related patent applications. In addition, Microsoft will be granted a non-exclusive license to the patents that AOL retains. The deal will cost Microsoft $1.056 billion in cash.

After the deal is done, AOL will hold 300 patents and patent applications related to advertising, search, and other technologies. It has also agreed to sign a license to use the patents that it's selling to Microsoft.

For Microsoft, the upside to spending $1 billion on patents is clear. The software company has realized that in order to compete with archnemesis Google, it'll need to have more patents to incorporate into its own technologies or to license to competitors.

And even at a cool billion, the deal might actually be a bargain. It's no secret that Microsoft has been eyeing online firms to acquire, Yahoo being chief among them, so it could increase its presence on the Web. By taking AOL's patents -- arguably the most important aspect of its business -- Microsoft has been able to sidestep a full buyout that would have potentially cost it several billion dollars more.

AOL's effort to sell off patents has been in the works for several months. Back in March, Bloomberg reported that AOL had hired investment banking advisory firm Evercore Partners to help it auction off 800 of its patents to the highest bidder. AOL also hired Goldman Sachs and a legal counsel to facilitate the sale.

AOL has been struggling over the last several years as it has tried to move on from its dial-up roots to becoming a Web powerhouse. The company has tried acquisitions, including buying up The Huffington Post, and has laid off employees. Last year, the once-upon-a-time online giant announced that it was reorganizing by combining its dial-up business with its Web services division.

Still, AOL continues to disappoint investors. In 2011, the company generated just $13 million in profit on over $2.2 billion of revenue. In the last year, its shares are down 8 percent, and in the last five years, its stock has dropped by 20 percent. Those issues recently prompted activist investor Starboard Value to launch a proxy war against the company and offered up five people to assume positions on the company's board.

"We strongly believe that AOL is deeply undervalued and that there are opportunities to substantially improve overall operating performance and valuation based on actions within the control of management and the Board," Starboard Managing Member Jeffrey C. Smith wrote to AOL at the time. "AOL's stock price has underperformed over almost any time period and we believe it is time for the Board to take immediate action to address the significant concerns highlighted in this letter."

For its part, AOL said at the time that its patent portfolio was integral to future growth and would eventually help the company achieve Starboard's goals. In a statement today, AOL said that it plans to "return a significant portion of the sale proceeds to shareholders" -- an obvious attempt to quell unrest.

In a memo to employees today, as reported by TechCrunch, AOL hailed the patent sale as a big step on the company's long, long comeback trail:

This process of unlocking the value of our patent portfolio, that we began last fall, is a significant example of focusing our time and energy around strengthening our company's balance sheet and unlocking value for our shareholders. Most importantly, this is another step forward for the comeback of AOL and allows us to remain laser-focused on our strategy and future growth.

Even so, a sale of patents is by no means a fix to AOL's many issues. The company is having trouble competing in the advertising space, its online properties, while popular, can't keep a company of that size afloat for long, and once this deal closes, it'll be left with only 300 more patents. At this point, it's all about what AOL will do with the cash it generates in this sale.

AOL and Microsoft hope to close the patent deal by the end of the year. The deal must clear regulatory hurdles to be completed.

AOL's shares are up 34 percent in pre-market trading, gaining $6.39 to land at $24.81.

This story has been updated throughout the morning.