May 29 (Bloomberg) -- AOL, the Internet unit being spun off by Time Warner Inc., may take on debt because it has a “very healthy” cash flow, Time Warner Chief Executive Officer Jeffrey Bewkes said.

“Theoretically it could support some debt,” Bewkes said today at an investor conference in New York. AOL’s capital structure won’t be decided until terms of the separation, announced yesterday, are completed, he said.

AOL may assume at most $1.5 billion in debt because its leverage shouldn’t exceed Time Warner’s when cash flow from subscribers is declining and the recession limits advertising visibility, Michael Morris, a New York-based analyst with UBS AG, wrote in a report yesterday. Time Warner ended the first quarter with $10.4 billion in net debt.

Time Warner decided to spin off AOL intact with both of its businesses -- Internet access for subscribers and the online advertising unit -- to make it easier for the new management team, Bewkes said. The U.S. Securities and Exchange Commission may take a few months to approve the separation, he said.

Time Warner, the New York-based owner of the Warner Bros. film studio, fell 13 cents to $23.42 at 4 p.m. in New York Stock Exchange composite trading. The stock has gained 5 percent this year.

AOL CEO Tim Armstrong, 38, who’s in the middle of a 100-day review of the business, said yesterday he’s keeping all options open for a strategy to revive sales. Since AOL’s $124 billion acquisition of Time Warner in 2001, successive AOL leaders have failed to jump-start growth with free e-mail accounts, about $2 billion in acquisitions and a move of the headquarters to New York to be closer to advertisers.

No Easy Solution

“I won’t say they’ve tried everything under the sun but most of the ideas that could be found have been tried,” Jeffrey Logsdon, an analyst at BMO Capital Markets, said in an interview. “It’s not readily apparent that there’s a simple or easy solution to the challenges AOL faces.”

Logsdon, based in Los Angeles, recommends buying Time Warner shares.

Armstrong joined from Google Inc. two months ago. He will probably place AOL’s recently acquired businesses, including social-networking Web site Bebo and its Truveo video search engine, into a separate ventures unit that can attract outside investment, according to a person familiar with his plans.

Keith Cocozza, a spokesman for Time Warner, declined to comment on AOL’s strategy.

Web Pioneer

AOL, a Web pioneer co-founded by Steve Case in 1985, has seen the number of U.S. subscribers to its access service shrink in the past eight years. Its online advertising business also declined as competitors such as Mountain View, California-based Google expanded and advertisers hit by the recession started cutting online spending last year.

Armstrong, who has already brought in new managers, said that he’s trying to reverse what has been a “top-down” management style. He said he’s been meeting with employees to get their feedback and received more than 1,000 written recommendations.

The unit will keep its name because it’s recognized internationally, Armstrong said, declining to provide specifics about his strategy.

AOL Name

“We will be standing very strongly behind the AOL brand name,” Armstrong said.

When Case and former Time Warner CEO Gerald Levin combined Time Warner and AOL, subscribers had already started to drop AOL’s dial-up Internet service and sites such as Sunnyvale, California-based Yahoo! Inc. were gaining users and share in the online advertising market.

Jonathan Miller, hired to run AOL in 2002, offered e-mail and software for free to broadband users four years later, three months before leaving, to lure more viewers to AOL’s sites.

Randy Falco, who succeeded Miller in November 2006, focused on increasing online advertising. That strategy backfired when advertisers started to cut spending last year. Armstrong replaced Falco in March.

“I still don’t think there’s any kind of silver bullet for what AOL can do to turn around their business tomorrow,” Andrew Frank, an analyst at industry researcher Gartner Inc. in New York, said in an interview.

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.

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

Last Updated: May 29, 2009 16:12 EDT