AOL (NASDAQ:AOL) surged 8% during trading on February 7, after the company announced impressive Q4 2012 results. The firm posted 13% year-over-year advertising revenue growth for the fourth quarter and 8% year-over-year advertising growth for the whole year. Additionally, the company reported a 17% increase in search and contextual advertising revenues for the quarter (4% for the year), which is important since search ad revenues made up approximately 40% of advertising revenues in 2012.
After this quarter’s earnings announcement, our price estimate for AOL has increased from $24 to $25 but still remains substantially below the current market price. Overall, we are encouraged by AOL’s results and think that the business seems to be on the mend but think that the market valuation can only be justified by unreasonable growth rate assumptions. It is important to note that the company’s display ad revenues remained flat year-over-year and that its total revenues fell slightly for the whole year. We would start believing in a substantially higher AOL valuation if the company can sustain a high growth rate in its display advertising segment, which is worth 27% of its total value.
Growth in Unique Visitors Encouraging
AOL’s properties experienced its second straight quarter of year-over-year unique visitor growth, which increased to 113 million in Q4 2012 from 107 million in 2011, an increase of 6%. We think that this is an encouraging sign because it signals that AOL is doing a good job of creating content which attracts users.
One of the key points of innovation for the company in 2012, has been the launch of HuffPost live. This product differentiates itself from competitors by being an Internet based news channel, as it streams news for 12 hours a day and provides a social viewing interface. According to management, the social element of HuffPost Live has been quite successful as users have left over 750,000 comments on its sites, and have engaged in debates while watching video news. We think that this product is a good way to attract new users and to engage existing HuffPost users. Additionally, AOL can drive ad revenues from the product as it is able to sell sponsorships and video advertisements during the live segments..
The company has also been making progress on the mobile front. According to management, AOL ranks fourth in mobile users domestically with around 40 million unique visitors, a figure which grew 10% year-over-year. We think that bets on the mobile front will pay off over the long term as AOL’s efforts on the mobile platform will attract new users to the site. Additionally, a strong mobile platform gives the company an opening in emerging markets. This is important because Asia alone makes up approximately 45% of the world’s Internet users and users in these regions tend to access the Internet through phones before they are able to buy PC’s. 
International Display Revenues Grow
A key point of growth for AOL will be international display advertising growth. During the third quarter, international display ad revenues were only 10% of total ad revenues, but posted year-over-year growth of approximately 32%. While the primary countries in which display ads posted growth were the United Kingdom and Canada, we think that AOL has a good opportunity in emerging markets if it able to successfully leverage its mobile platform.
A market that AOL could, and should, focus on is Asia, which has 45% of the world’s internet users even though penetration is at a measly 28%. As internet penetration grows on the continent, we could see AOL continue to post growth in unique visitors. We will be closely watching international ad revenues in the coming year since it is becoming a larger portion of total ad revenues every quarter.
Domestic Display Ads Fall but Expected to Grow in 2013
The company posted flat global display revenue, with a 3% decline in domestic display revenue offset by continued growth in international display revenue. Management stated that the slower growth was because a greater percentage of AOL’s ad inventory was being sold via AOL Network, which had a negative impact on pricing. We expect management to reverse this trend in the coming quarters by trimming AOL’s content portfolio to fewer, more impactful products. We think that display revenues on AOL properties will increase around 6% next quarter as both unique visitors and revenue per 1000 page views (RPM) rise.
We currently have a $25 price estimate for AOL, which is approximately 35% below the current market price.Notes: