AOL CEO Armstrong on data breach: 'Yahoo did the best job they could'

Just last week, Yahoo (YHOO) disclosed —ttwo years after the fact —that it had suffered a massive data breach that exposed the information of at least 500 million users.

Coming as it did the heels of Verizon (VZ) 's agreement to purchase the company in a nearly $5 billion deal, AOL CEO Tim Armstrong found himself put on the spot as Yahoo faces growing questions about how it handled the affair.

Last week, Armstrong appeared on CNBC's " Squawk Box ", but sidestepped questions about Yahoo's handling of its data security problems. He discussed other issues affecting the Internet marketplace.

CNBC's Andrew Ross Sorkin: It is advertising week, the event bringing together leaders from the marketing and entertainment industry to talk about the latest innovations in ad technology.

Joining us right now is Tim Armstrong, CEO of AOL, who will be speaking at the event, also, CNBC's Julia Boorstin is also here. It's great to have both of you here. We can talk advertising...but I do need to just talk about the security breach with Yahoo for a second, given that you're in the middle of this transaction. There are lots of questions about the breach but also perhaps the implications for this particular deal closing. Will it close?

Armstrong: So, let's start with what the situation is, and maybe answer some more questions. The situation right now is we have the integration work going on, which is the deal that we signed with Yahoo. The data issue we found out about last week, so I would separate the two areas into: We are working with Yahoo right now to really get into the data situation, to figure out what it is; and we are at a very early stage on that right now, so I'm not going to have a lot of answers for you.

Quick: The New York Post says this morning that Verizon is ticked off that they just found out about it so late. Are you guys upset?

Armstrong: Yeah, I think what we are doing right now is just calmly and methodically going through the situation and looking at it, and since we just found out last week, I think it's very, very early stage. So I think we will basically work with Yahoo on it and see what the implications are. And then secondly, we have very close working relationships with the whole Yahoo team, in terms of the overall deal, and the integration work that's happening so that's going very well. I think the data thing was something new that got introduced and we will work through that together with them. Really Verizon shareholders, on our end of things, we really want to be protective of..the consumers [and] the consumer trust. That's what we are focused on.

Sorkin: But do you anticipate potentially seeking to renegotiate the transaction, depending on how deep the security breach is?

Armstrong: I wouldn't comment on that right now, because it's so early on overall, so I think that if we were further on in this process and we had something to say about it, or had more information, we might be able to comment. But we are early in this, so I think it's probably too early to speculate or comment.

CNBC's Julia Boorstin: Earlier today we were reporting on the news that Facebook (FB) overstated the amount of time people were watching videos on the platform. What does this mean for AOL? Is this an opportunity?

Armstrong: First of all, I think it points out how important video is. If you look at all the announcements coming out for Advertising Week, video is incredibly important. For us, our strategy, we're making an announcement this week that we are partnering with American Family Insurance to do 360 videos on HuffPost that are deep engagement videos that will basically highlight the stories of individual consumers using 360 video, and I think when you look at basically what Facebook is doing with video, which is, they are using a platform for what it is, they're getting video in front of as many consumers as possible, and that's a super important strategy for them.

We've taken a slightly different strategy, which is do highly, highly engaging and super brand-deep videos overall, and around our brands, around third-party brands, so I'd say that they're scale and we're engagement, and I think that's really our strategic differences.

Sorkin: Do you think that the numbers that Facebook put out — and you have your own numbers so you can have probably a better sense than anybody — directionally or accurate meaning — a lot of content creators, ad agencies and others directed a lot of money in the last two years towards video in a profound way. Some of them say, in part, because of the numbers that firms like Facebook put out, and so the question is, the switch in business model, if you will, was that the right decision?

Armstrong: Well, we made that same decision as a business. You go back two years ago, almost 0 percent of our traffic was off-line and these other platforms — Snapchat, Facebook — now about 40, 50 percent of our traffic comes from them, so we – like everyone else — made a move. We probably made the most serious move in the media space, into it and I think it was successful for us to do that.

I look at the Facebook numbers as basically a Facebook-specific issue about how they are counting. We have a different strategy around counting, which is we want to move really towards engagement metrics overall, and for our business, we see Facebook as a very successful platform for distributing content. We have our own measurements about how we look at it.

...The Facebook issues with measurement, I'm sure they'll work out with the marketplace. But if you are a content media company and you don't have an off-network strategy with the Facebooks and Snapchat — I think you have to really examine where users are.

Sorkin: You don't think that that announcement's going to change how much money is allocated towards online video over the next year, towards all firms, whether it be Facebook, or yours or others?

Armstrong: I don't think companies can move fast enough into online video investments, and the main reason or two things: One is there's 3.5 billion more people coming online and they're going to be mobile first, and so if you just invest in traditional ways of hitting them with video, you're going to miss that entire market. The second thing is that the engagement rates when you have somebody with video, with a great video piece of media, consumption rates are much higher. You can get 40 percent increases in terms of the engagement on online video versus off-line.

Boorstin: One of the reasons why Verizon is buying Yahoo, is so together AOL and Yahoo could create something that could really rival Google (GOOGL) and Facebook. Those are the two behemoths in this space. Do you think that you could really take them on, and does this mis-measurement issue provide an opportunity for you?

Armstrong: Here's the opportunity, I think if you look at Google's announcements this week around Advertising Week, they are tying video directly into search and other things like that, which is their strength. If you look at Facebook, they're basically now correcting their measurement things, but it's all tied to social. You know, our strategy is: Google is search, Facebook is social, AOL and Yahoo are going to be brand. And what I mean by that is brand is really important. If you see a fleet of videos or a fleet of content as a consumer, you go to the brands you trust and we're trying to build the largest brands in the world that are trusted in media.

Quick: Which gets back to the state of breach, and I hate to bring this up again but as a Yahoo Mail user myself…

Armstrong: I saw your tweets…

Quick: I can't believe they didn't tell me two years ago, or at least when they found out. I don't pay them anything. You're on the hook for billions of dollars. Aren't you mad that they didn't bring this up with you earlier?

Armstrong: I think, Becky, I think that the consumer trust — I've been on the program before and talked to you guys about this — is the core basis of the relationship you have, because it's really easy for consumers to switch internet platforms at this point, so I think the real issue here is 'How do you — first of all, we're in a world — the world has changed. Security and data is going to be something that goes on for hundreds of years probably in the future, so we are at the beginning of that stage. I think Yahoo has tried to do the best job they can. There's nobody at Yahoo who wanted the situation to happen the way it did.

Quick: No, obviously not, but there's two issues. One is from my perspective as the consumer, the other is from your perspective as a buyer. And the idea that they held out and didn't tell you guys till last week when we know they knew about it at least in July, does that make you feel personally betrayed?

Armstrong: I think from the standpoint of being in the deal that we signed and the auction process we went through with them, because we were one party out of multiple parties, you know I think one of the question that has to be answered is, when did they know, and when was the alert set up to let us know overall? And I think that's the stages where we are going through right now. I would say that the process they went through was an unusual process from an auction dynamic standpoint, so all the bidders were in the same situation, you know we are as well. And I think what we're trying to do right now, because I think this is a situation where we do want to separate the data breach from how we work with them.

Quick: Absolutely, and I get that entirely. I guess my question would be, The Wall Street Journal was reporting last week that one of the terms of the contract is that they hadn't had a serious—that there were no data breaches—and I guess contractually are you allowed to go back? What does the contract say?

Armstrong: I think on both sides the contract has very good protections just in terms of going through that type of a process, on a sale process, so I would say, look, there's incredibly smart people on both sides. Our interest level is protecting consumers, protecting Verizon shareholders, and making sure that Yahoo, if the deal goes through, that we have a great relationship with Yahoo on the way through, and we're at such an early stage on this, that I just think if we comment on anything right now, A: It wouldn't be accurate, and B, I think this is one of those cases where it's a cause for methodical walk through, step in the process...

Quick: Calmer heads…I get it. I'm mad for me and, I'm mad for you, too.

Boorstin: But there's speculation now that if this deal doesn't go through, that Verizon might be interested in buying Twitter (TWTR)? Do you think that would make sense?

Armstrong: Well I think that's a separate— I won't comment on that at all, And I'd be careful what you read out there right now because I think there's a lot of conjecture out there. I would say it points to something that's incredibly important, though, overall is that the consolidation factor and the scale factor in these businesses is becoming critically important.

So if you look at all the deals that have happened — or the speculative deals that are happening— and you look at the 3 billion additional consumers coming online, you look at a $90 billion real market opportunity in the next couple of years in these markets— there's a real trend where people are waking up and realizing digital is massive and these platforms are going to get consolidated.

Armstrong: I know you will not talk about Twitter as a Verizon prospective bidder, but let me ask you this, one of the other companies that's out there is Salesforce (CRM), and a lot of people look at that and say, 'What does Salesforce —which has historically been a B2B business—doing thinking about Twitter?' Does that make sense to you?

Armstrong: I think, again, you have to take a giant step back and say, what is the landscape? One of the things we did at AOL recently is we built a map of the universe, and we said 'In this universe, where's all the opportunity, where are all the companies, and you realize there's 10 or 12 or 15 companies that are really going to compete for the 7 billion people that will be online in the next few years. Salesforce is one of the companies that's in data, in CRM, in connectivity and so the reality is business and consumer have kind of mixed together. If Salesforce is interested in that, may not be directly in the strike zone from the outsider looking at it, but you don't know what the long term is.

Quick: I want to see that map.

Sorkin: What about your former employer, Google?

Armstrong: I think, I wouldn't be surprised if anybody on the map is interested in anybody else on the map at this point because the consolidation factor, very few companies are good at digital. It's the most important trend in the media space, consumer space, and I think there's a lot of benefit to getting to scale.

Sorkin: If that CEO thing doesn't work out, politics could be great for you.