While AOL’s (NYSE:AOL) display advertising revenues grew at around 12% in 2011, in contrast to a 14% decline from 2009 to 2010, high costs clearly took a toll on the company’s gross margins, which fell from over 41% in 2010 to just around 28%.  However, we do believe that AOL has managed to retain singular focus on advertising, and costs incurred on digital content acquisition in 2010-2011 should pay off in future years as margins improve. AOL operates in an intensely competitive display advertising market, with players like Google (NASDAQ:GOOG) and Facebook.
Expect More Inroads Into Mobile
While AOL recently announced its partnership with mobile advertising platform Mobsmith, further integration of AOL’s content within the tablet/smartphone space will be necessary to improve traffic. However, this may also mean more costs, and given the rapid decline in operating margins in the past few years, it will be interesting to see how CEO Tim Armstrong balances display ad growth versus expenses.
Meanwhile, subscription revenues have shown another year of rapid decline, falling by over 21% from last year. In hindsight, it clearly justifies the merging of the web services and subscriptions division, and we will not be surprised to hear the announcement of a spin-off of this segment sometime soon.
We have a revised price estimate of $16 for AOL stock. Our revision is primarily based on the changed forecasts for AOL’s display ads division, as well as a change to the company’s net cash/debt position.
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