AOL’s (NYSE:AOL) stock has had a stellar run over the last year as it has more than doubled from its levels in March 2012. This jump was driven by an improved perception surrounding AOL’s business model and sale of patents to Microsoft, which netted the company $1 billion in cash.
While we agree that some of AOL’s businesses look promising going forward, we think that the level of optimism currently surrounding the company is overdone. We have already accounted for display ad growth in our AOL valuation and think the turnaround the market expects will be difficult to execute in the coming years.
Our current price estimate stands at $25, which is approximately 30% below the current market price.
U.S. Tech Environment Competitive
AOL competes in a highly competitive tech landscape where it will have to poach customers from competitors in order to grow market share in the Unites States, a region which generates 90% of its display advertising revenues. While the company has some solid content sites such as TechCrunch and the Huffington Post in its portfolio, these sites are subject to competition from players such as GigaOm, the New York Times (NYSE:NYT) and the Wall Street Journal.
This high level of competition is a reason why we aren’t as enthusiastic as the market about AOL’s prospects. We already forecast an increase in unique visitors on AOL’s properties to 127 million from the present 113 million over our forecast period and think that capturing a materially higher user base will be difficult to achieve. Additionally, we think that there could be some downside to our forecast if the company is not able to innovate its products. If the number of unique visitors stays flat during our forecast period due to lack of innovation, we would see around 5% downside to our price estimates.
Revenue Per Page View Will Not Grow As Fast as The Market Expects
Revenue per 1,000 page view (RPM) is one of the most important drivers in our valuation of AOL’s display ads division. We estimate that RPM declined in 2012 to $2.96, but we estimate that it will grow to around $3.40 by the end of our forecast period.
As with the growth in unique visitors, we think that the market believes that RPM will rise much faster than our forecasts. However, one of the primary reasons that AOL’s RPM will not grow at a faster rate is because of a relatively inferior social offering with Patch.
Even though the AOL has invested heavily in the company since its purchase, we don’t see how it can lucratively monetize what is essentially a local news website. We think that Patch is not close to having the user data or user engagement of competing social networks such as Facebook (NASDQ:FB) and Google’s (NASDAQ:GOOG) Google+, and we expect that advertisers will choose these competitors when spending their limited ad budgets. This is especially relevant in the context that social media ad spending in the United States is expected to more than double to $9.2 billion by 2016, and a lack of a solid social product will cause AOL to mostly miss out on this growth opportunity.
We currently have a $25 price estimate for AOL, which is approximately 30% below the current market price.