AOL (NYSE:AOL) is set to report its 2013 first quarter earnings Wednesday, May 18. While it continues to have a substantial share in the dying dial-up Internet space, it is transitioning into a company that relies on content and ads to drive its revenues. We have previously argued that the company’s content offering is inferior compared to some of its competitors. (See AOL’s Weaker Content Weighs On Display Ads Business And Valuation)
AOL has taken prudent steps to improve its content such as a slew of new original video content spanning across autos, entertainment, tech, style, business, sports and food sectors. During the earnings call, we will watch for improvements in AOL’s display ads business, which makes up around 50% of its total value. We will specifically look at metrics like unique visitors and page views per unique visitor across AOL and third party properties. Additionally, we will look at the results of search ads division as it has shown good growth in the past few quarters.
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AOL’s stock has surged 20% since the fourth quarter earnings announcement. The firm posted relatively encouraging results which included year-over-year advertising revenue growth of 13%. It reported 17% increase in search and contextual advertising revenues, which signified the growing importance of search ads, as this now constitutes ~40% of advertising revenues.
While a bullish sentiment surrounded the stock after the earnings release, it is important to note that the company saw no growth in total revenues year-over-year for 2012. We remain cautious about its overall business and will start believing in a turnaround if the company continues to post growth in key segments over the next couple of quarters.
Video Content To Drive Display Ads
According to our estimates, display ads division constitutes approximately 50% of AOL’s value. Revenues from this division were around $1.05 billion in 2012, and we think that they will continue to increase and reach around $1.36 billion by the end of our forecast period. The key drivers for this division are unique visitor count and page view per unique visitor.
During 2012, AOL implemented re-designs to its email platform and its social network Patch. Continuing its effort to increase user engagement, AOL has started developing video content for different domains such as tech, style, business and sports etc. We expect that AOL will continue to focus on expanding its video business because online video advertising is set to become one of the biggest parts of the display advertising mix, reaching approximately $9 billion in total spending by 2017, from $3 billion in 2012.  User engagement is important for AOL’s overall financial health as it not only increases the unique visitor count but also drives page views across its properties.
We will closely watch the impact of the new video content on AOL’s display ads revenues. AOL has been pushing for video content over the past few quarters, and we are keen to know if AOL was successful in attracting new users. We currently forecast that the page views per unique visitor on AOL properties will stay flat over our forecast period. However, due to better content if the metric rises from around 145 in 2013 to 200 by the end of our forecast period, we could see 10% upside to our price estimate.
Search Ads Revenue In Focus
According to our estimates, the search ads division constitutes ~11% of AOL’s value. Revenues from this division were around $372 million in 2012. During Q1 CY12, AOL launched a new global search app which conducts search in 46 languages simultaneously. This was one of the key reasons, together with aggressive marketing and tie up with Google, for the 17% increase in search ads revenue.
In this earnings announcement, we will be closely looking for more traction in the search ads revenue. We are also interested in the trend in click-through rates that determine the revenue per search (RPS) for AOL. In Q4 CY12, AOL was able to garner higher click-through rates and, therefore, higher RPS. Since revenue per search is one of the key driver for this division, we would like to know the additional steps that AOL has taken to increase its RPS. We currently forecast revenue per search to decline from $39.7 per 1000 searches in 2012 to $34 by the end of our forecast period.
We currently have a $25 price estimate for AOL, which is approximately 20% below the current market price.Notes: