AOL’s (NASDAQ: AOL) Internet subscription business has been in a secular downtrend for the past few years due to the advent of broadband Internet. While the subscription business accounts for over 35% of the company’s revenues, it makes up nearly 95% of its adjusted operating income before depreciation and amortization (OIBDA).  The company’s subscription base has shrunk from over 25 million in 2002 to below 2.5 million in Q3 2013. However, our analysis indicates that the current subscriber base is of high quality based on the the customer lifetime value (CLV) metrics. In this article we will review AOL’s subscription business and how it can aid revenue growth in the future.
Improvement in Quality Of AOL’s Subscriber Base
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AOL introduced a simplified pricing structure for its subscription services in 2011. As a result, subscription ARPU improved to $20.15 in Q3 2013 from $17.88 in Q1 2012. Furthermore, the churn rate, which measures the proportion of contractual customers or subscribers who leave AOL during a given time period, has declined from 2.0% to 1.4%.
Source: Company 10-Q
To value the existing subscriber base, we calculated the customer lifetime value (CLV) metrics, which is a function of ARPU, Churn rate and profit margins. A standard industry metric for over two decades, CLV is defined as the present value of the future cash flows attributed to the customer during his/her entire relationship with the company. We estimate that due to the improvements in ARPU and decline in churn rate, AOL’s CLV has improved from $245 to $365 over the last two years. We have used the following methodology for calculating CLV:
CLV for Q1 2012 = [$17.88 (ARPU) x 27% (GM)]/ 2% (CR)
The rising trend in CLV indicates that AOL now has a high value subscriber base.
ARPU in $
|Churn Rate (CR) in %||
|Gross Margin (GM) in %||
|CLV = (ARPUxGM)/CR in $||
Cash From Subscription Business To Fuel growth In Other Businesses
The dial-up Internet subscription business currently contributes nearly 12% to AOL’s estimated value. We believe that this business will continue to churn out cash, albeit at a declining rate. While we expect the number of subscribers to decline from 2.5 million in Q3 2013 to 800,000 by the end of our forecast period, the CLV will improve to $416 as margins and ARPU improve.
The increase in CLV indicates that the company will continue to generate more cash per subscriber in the future. We believe that this cash can be used to finance other business segments such as online advertising that offer better revenue growth.
According to our estimates, AOL currently derives 30% of its value from display advertising. While AOL is ranked third among video content properties in the U.S., it took the top spot for the number of video ads viewed in September.  To improve its content standing, the company is looking to increase its online video content and expand its services to new geographies. The company can plough back some of the cash from its struggling subscription services into these expansion efforts. As AOL’s video content library improves, we expect user engagement to perk up. User engagement is important for AOL’s overall financial health, as it not only increases the unique visitor count and page views but also drives revenue per page view (RPM) across its properties. We believe that improved video content will drive the monthly unique visitor count and RPM for AOL. Currently, we project unique visitor count to increase to 130 million and RPM to grow to $3.4 by the end of our forecast period. However, if these figures were to increase to 150 million and $4 respectively, our stock price estimate can go up by 10%.
We currently have a $33.88 price estimate for AOL, which is approximately 25% below the current market price.Notes:
- 10-Q [↩]
- comScore Says AOL Is The Biggest Video Ad Property In The US, October 17 2013, www.techcrunch.com [↩]