May 28 (Bloomberg) -- Time Warner Inc. plans to spin off AOL this year, unraveling the biggest takeover in corporate history after the $124 billion combination triggered record losses and sank the company’s stock price.

AOL’s online advertising and Internet-access businesses will be separated into an independent, publicly traded company, New York-based Time Warner said today in a statement.

The 2001 acquisition of Time Warner by Web pioneer AOL led to shareholder lawsuits and a regulatory probe. AOL’s subscriber numbers have since shrunk and its ad sales dropped as competitors such as Google Inc. expanded, leaving the Internet unit worth a fraction of its original value.

“It’s kind of a long overdue move that people wished would happen a long time ago when it was clear that these companies were not helping each other,” Andrew Frank, an analyst at industry researcher Gartner Inc. in New York, said in an interview. The merger was “conceived in a closet of unreality.”

Time Warner rose 55 cents, or 2.4 percent, to $23.55 at 4:01 p.m. in New York Stock Exchange composite trading. The stock has gained 5.6 percent this year.

Time Warner Chief Executive Officer Jeffrey Bewkes, who took over last year, is getting rid of AOL to focus Time Warner on the Warner Bros. film studio and cable-television businesses such as CNN, HBO and TNT.

Time Warner wasn’t able to sell or find a partner for AOL after talks with Google, Yahoo! Inc. and Microsoft Corp.

‘Last Resort’

“The obvious implication of spinning out all of AOL in one entity is that Time Warner’s efforts to sell AOL failed,” Fred Moran, a Boca Raton, Florida-based analyst at Benchmark Co., said in an interview. “Now, as a last resort, Time Warner is looking towards spinning the whole company out.”

Time Warner prepared AOL for a separation in the past three months, hiring a new CEO for the division and amending debt agreements. The board’s approval, announced today, sealed the deal a month after the company said a spinoff was likely.

The move gives AOL CEO Tim Armstrong a public company to run after he joined from Google two months ago.

AOL Brand Name

The future of AOL will hinge on improving the consumer experience and being more transparent with advertisers and employees, Armstrong said in an interview today at Time Warner’s annual shareholder meeting in New York. The unit will keep its AOL brand name because it’s recognized internationally, he said, declining to provide specifics about his strategy.

When Google bought a 5 percent stake in AOL for $1 billion in 2005, it valued the unit at about $20 billion. Time Warner said last month it was in talks to buy back the stake. Google wrote down $726 million of the investment last year.

Time Warner’s 95 percent stake in AOL is worth about $6.3 billion, including about $3.4 billion for the ad business and $2.8 billion for the access division, David Joyce, an analyst with Miller Tabak & Co., estimated in a report yesterday.

Michael Morris, an analyst with UBS AG, pegs AOL’s total value at $5.5 billion, based on Google carrying its stake at $274 million.

100-Day Review

Armstrong, in the middle of a 100-day review of the unit, said that he’s trying to reverse what has been a “top-down” management style. He said he’s been meeting with employees and has solicited their feedback. He received more than 1,000 written proposals or answers, he said.

AOL’s access business finished 2008 with 6.9 million paying access subscribers in the U.S., a quarter of the subscribers it had when the 2001 combination closed. It may lose another 550,000 customers this quarter, estimates Joyce, who recommends buying Time Warner shares.

The unit’s ad sales dropped 20 percent in the first quarter, after falling 18 percent in the fourth. Operating income declined to $150 million last quarter from $284 million a year earlier.

“AOL is not a toxic asset,” Bewkes said at the annual meeting. “It is profitable, solvent and will be growing.”

The transaction will be tax-free for Time Warner shareholders, and needs regulatory approval and the board’s final consent to the terms. It will allow Time Warner to resume share buybacks, Bewkes said on the company’s April 29 conference call. Time Warner finished the first quarter with $7.1 billion in cash after shedding its cable-systems unit.

Name Change

In 2006, former CEO Richard Parsons fought off an effort by investor Carl Icahn to split off AOL as part of a larger plan to break up Time Warner. Parsons said at the time that AOL could be worth as much as $26 billion in the following few years.

America Online Inc. bought Time Warner in January 2001, leading to a record loss the following year.

AOL Time Warner, as the company was named after the combination, left a series of executive departures and investigations in its wake. Former CEO Gerald Levin, an architect of the purchase with Steve Case, announced his retirement less than a year after the deal closed as growth slowed. The company dropped AOL from its name in 2003.

Case, the co-founder of AOL, resigned as chairman in 2003 amid shareholder lawsuits and a Securities and Exchange Commission probe into whether AOL improperly booked ad revenue to help close the deal. The company paid $510 million to settle the government probes and $2.4 billion to end the lawsuit.

To contact the reporter on this story: Sarah Rabil in New York at srabil@bloomberg.net

Last Updated: May 28, 2009 16:12 EDT