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NEW YORK – Time Warner Inc's AOL will cut about 700 jobs, or 10 percent of its workforce, as it copes with an advertising slump, in a move that could make the slimmed-down company more attractive to possible merger partners like Yahoo Inc.

The Internet unit will also eliminate merit-pay increases this year to help minimize layoffs, AOL Chief Executive Randy Falco said in a memo circulated to employees on Wednesday. A copy of the memo was obtained by Reuters.

Most of the job cuts will be made in the United States and will be finalized by the end of March, he said. The rest will be made abroad over the next several quarters.

Falco said the steps were a result of the deepening recession. "Online marketers have tightened their ad buying across the board, reducing their spend by hundreds of millions of dollars," he said.

Time Warner has been in deal talks with Yahoo and Microsoft Corp to find a way to combine AOL's advertising business with either or both of those companies, aiming to gain greater audience scale.

Earlier this month, Time Warner Chief Executive Jeffrey Bewkes met with Microsoft CEO Steve Ballmer and Yahoo Chairman Roy Bostock at Time Warner's New York headquarters.

The additional cost cuts at AOL could help combination talks with potential partners as all sides seek ways to improve operating efficiencies in an increasingly difficult online advertising market.

But even as Bewkes explores an AOL deal, the Internet pioneer is being revalued downwards because of the tough economic environment. Last week Google Inc recorded a $726 million writedown of its 5 percent stake in AOL.

The stake, which Google bought in 2005, had originally valued AOL at around $20 billion. The writedown implies AOL is now valued at around $5.5 billion.

WEAK ADVERTISING

Time Warner said earlier this month that AOL had weaker-than-expected advertising sales in the fourth quarter, forcing a profit warning by the media conglomerate, which also owns cable news network CNN and Warner Bros movie studio.

UBS analyst Michael Morris said he is forecasting a 12 percent decline in AOL's fourth-quarter advertising sales.

"We expect advertising declines at AOL to continue through all four quarters in 2009," said Morris in a note to clients.

Time Warner has previously said it will separate AOL's dial-up Internet access business, leading to a possible sale of that business.

Falco, who took the helm at AOL two years ago, said his three-year turnaround plan was now focusing on three core businesses: advertising with its Platform A business; publishing with MediaGlow; and social media with People Networks, which holds its Bebo social network and AIM messaging assets.

In its cost-cutting efforts, the company is reviewing international operations and its global shared-services functions and is considering consolidating some domestic facilities as it moves corporate headquarters to New York from its hometown of Dulles, Virginia.