Reasons for Revising AOL Price To $34

We recently upgraded our price estimate for AOL (NASDAQ:AOL) from $27 to $34, based on the company’s continued strong growth in advertising revenues. We have increased our forecast for the revenue per page view for display ads and the total number of unique visitors. While we have argued our concern about AOL’s market price being too high, there is strong evidence that the company’s advertising revenues will continue to grow in the near term. Additionally, AOL reported improvement in margins as its cost-cutting measures gained traction. We expect the company’s margin to continue to improve in the future. After this upgrade, our stock price estimate is in line with AOL’s current market price. In this article, we will discuss the factors that will drive growth at AOL.

See our complete analysis for AOL here

Factors Driving Display Ads Revenues

According to our estimates, the display ads division together with display ads revenues on third-party websites constitutes over 50% of AOL’s estimated value. The key drivers for this division are unique visitor count, revenue per page view (RPM) and page view per unique visitor.

Focus on Video Content To Boost Unique User Count– AOL is focusing on improving user engagement by offering premium video content for different domains such as tech, style, business and sports. Additionally, the company is bridging the gap between TV and digital video content by signing new premium content providers such as Fortune, CNNMoney, People etc. ^[1] While the company now has 700,000 videos in its library, it continues to develop original video content for its properties. 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 believe that improved video content will drive the monthly unique visitor count at AOL and have increased our projection to 130 million by the end of our forecast period.

Focus on Programmatic Platform– A real-time bidding platform (RTB) or programmatic platform is a method of selling and buying online display advertising in real time. According to eMarketer, advertisers spent $2 billion on RTB in 2012. It projects that this spending will increase to $3.4 billion in 2013. eMarketer also expects that real-time bidding will account for more than $8.49 billion in digital ad spending, or 29% of all digital display spending by 2017. ^[2]

We believe that RTB will be a key growth driver for AOL as it is instrumental in increasing RPM by efficiently matching ads with relevant video content. While the company acquired adapt.tv to bolster its demand side platform (DSP) for video ads, its supply side platform (SSP), Adtech, continues to support publishers by effective management of unused ad inventory.

We think AOL is well positioned to capture a bigger chunk of RTB spending in the future by leveraging its DSP and SSP. While AOL doesn’t disclose the breakup of its revenues from its RTB platform, if AOL were to capture 10% of this spending in the U.S., its display ads revenue can double by 2017. Additionally, we also expect that AOL’s RPM will increase due to effective management of unused ad inventory and better sales to advertisers. Currently, we project that RPM will grow to $3.6 by the end of our forecast period. If RPM were to increase to $5 by the end of our forecast period, our price estimate can increase by additional 15%.

Search Ads Revenues To Grow

According to our estimates, the search ads division constitutes ~19% of AOL’s value. While this division posted four quarters of continuous growth in revenues, we believe AOL still has room for improvement. Although, AOL has managed to improve its click-through rates and RPS through its marketing efforts in the first half of 2013, its market share declined to 1.3% in the U.S. ^[3] However, search across AOL properties is powered by Google, which has recently launched enhanced Google adword campaign. We believe that this newly launched product will increase the number of searches performed across AOL properties from smart mobile devices. Additionally, AOL’s push for content will also drive the search volume at AOL websites. We, therefore, expect that revenues for AOL’s search ads division to increase in the future.

Margins Set To Improve

AOL has undertaken cost-cutting measures to improve its profitability. While it continues to eliminate non-core activities, it also plans to pull back on its Patch local news operations to stem losses. ^[4]  We believe that these efforts will help the company to rein in its expenses and improve its margins in the future. Additionally, its SG&A (selling, general and administrative) expenses stood at 19% of AOL’s total revenues in 2012. The company was able to maintain a tight leash on its SG&A expenses in the first half of 2013. We now project that the SG&A expense will drop to 18% by the end of our forecast period.

Our price estimate for AOL now stands at $34, which is in line with its current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Earnings Transcript, August 7 2013, www.seekingalpha.com [↩]
2. RTB Ad Spend Continues Robust Growth, April 4 2013, www.emarketer.com [↩]
3. comScore Releases August 2013 U.S. Search Engine Rankings, September 11 2013, www.comscore.com [↩]
4. See our take on it here [↩]