AOL Gives Up Local News Service Patch As It Fails To Generate Profits

AOL (NYSE:AOL) had invested heavily in its hyperlocal news project Patch.com, but despite all its efforts the portal has failed to turn profitable or meet its revenue goals. As a result, the company has decided to sell off Patch to Hale Global, an investment firm. Under the terms of the agreement, AOL will contribute Patch into a new limited liability company (LLC), which will be operated and majority owned by Hale. While AOL has not disclosed the amount in the transaction, it will retain a minority stake in the newly formed joint venture. In this note, we will examine how this sale will benefit AOL.

See our complete analysis of AOL here

Profits To Improve

According to Bloomberg, AOL invested more than $300 million in developing Patch, which serves local news to communities and neighborhoods across the U.S. ^[1] Although Patch had grown to about 900 sites with over 1,200 employees during the past three years, it continued to erode AOL’s profits. According to Tim Armstrong, CEO of AOL and Patch’s biggest proponent at the company, the website generated nearly $70 million in revenues in 2013, which translates into $78,000 per site. However, the average cost of operating each site is $140,000 to $180,000. This implies that AOL  lost anywhere between $56 million to $92 million in 2013.  Considering AOL’s GAAP net income from continued operations was $90 million in 2012, and $55 million for the first nine months of 2013, Patch was weighing on AOL’s profitability. Absent the full burden of these losses, we expect AOL’s profits to improve in 2014 post the sale of Patch.

Focus On AOL’s Core Business

With the sale of Patch, AOL can now focus on its core ads business. According to our estimates, AOL currently derives 80% of its value from advertising. To increase its revenues, the company is looking to increase its online content and expand its services to newer geographies. Furthermore, AOL is building its real time bidding platform (RTB) for serving ads on third party websites. We believe that the company can now plough back some of the cash from the Patch sale into these expansion efforts.

As AOL’s content and reach improves, we expect user engagement and the unique visitor count 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. Furthermore, we also expect that AOL’s RPM will increase due to better management for unused ad inventory and better sales to advertisers through RTB. Currently, we project the number of unique visitors to increase to 130 million and RPM to grow to $3.5 by the end of our forecast period. However, if these figures were to increase to 150 million and $5 respectively, our stock price estimate could go up by 10%.

We currently have a $33.88 price estimate for AOL, which is approximately 30% below the current market price.

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1. AOL Surges After Ceding Control of Money-Losing Patch Unit, January 17 2014, www.bloomberg.com [↩]