Monday, May 09, 2011

Does AOL Have Turnaround?

It's been about a year and a half since AOL (NYSE: AOL) was spun off from Time Warner (NYSE: TWX) and put under the leadership of former Google (NASDAQ: GOOG) executive Tim Armstrong. AOL reported another plunge in revenues and profits in the first quarter of 2011, but Armstrong continues to wax optimistic. Should you invest in AOL?

AOL's first quarter results do not contain much reason for optimism. Its first-quarter profit of $4.7 million, or 4 cents a share, was down 87% from $34.7 million, or 32 cents a share the year before. And its revenues fell 17% to $551.4 million. But the good news was that AOL's display advertising was up 4% on a 24% decline in subscription revenue.

And AOL has lost considerable market value since it merged with Time Warner in a record $166 billion deal back in early 2001. The New York Times reports that the number of AOL subscribers has dropped 86% from 22 million back then to 3.6 million today. And it is continuing to lose subscribers at the rate of 19,000 a day. AOL's market capitalization is now 98.7% below its peak, at $2.15 billion.

The origins of this market share loss are a strategy launched in 2006 to try to acknowledge that few people needed to pay for dial-in access to the Internet given the wide access to broadband services and to try to make up the difference by selling advertising through proprietary content. As I wrote back in July 2006, the new strategy would require AOL to makeup about $2 billion in lost revenue through advertising

That content strategy has not been  a rousing success. Since 2006, AOL has lost 69% of its revenues from $7.8 billion in 2006 to $2.4 billion in 2010 while net income fell from $718 million to a $790 million loss during the period.

The reason this content strategy is not working is pretty simple. AOL's content is targeted at a different segment of the population than those who actually subscribe to AOL's Internet access service. More specifically, AOL subscribers lean right while the content leans left. This gap makes it hard to sell more advertising since the left-leaning content is not attracting enough new viewers to make up for the loss in AOL's subscriber base.

The strategy to reverse AOL's decline rests on Arianna Huffington who started the Huffington Post (HP) and now runs AOL's content. AOL paid $315 million for HP -- that generated $30 million in 2010 revenues and had 25 million unique visitors. And the Times estimates that HP will generate $60 million in revenues in 2011 and a modest profit.

Is Tim Armstrong right that AOL stock is poised to pop? To make that decision, you might consider using the price-to-earnings-to-growth (PEG) ratio that compares a stock’s market valuation to its forecasted earnings growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is reasonably priced. Higher than that, and it looks overvalued.

But it's hard to calculate a PEG for AOL because it lost $827 million on last 12-months' revenues of $2.3 billion so it has no earnings on which to calculate a P/E. Moreover, its earnings are forecast to decline 3% from $1.11 in 2011 to $1.08 in 2012.

With all the other bad news, a 4% increase in display advertising seems like a pretty thin reed on which to base a turnaround bet.


Post a Comment

<< Home