AOL Results Show Its Business Is On The Mend

AOL (NYSE: AOL) announced encouraging second quarter earnings, reporting its lowest revenue decline in seven years along with growth in OIBDA for the first time in four years. ^[1] Most encouraging was the 6% year-over-year growth of its global advertising revenue, a division which represents close to 80% of the company’s value if net cash is excluded.

Our price estimate for AOL has been increased from $18.35 to $28.70 per share because of an increase in net cash reported during the quarter. This occurred due to a patent deal between AOL and Microsoft in which AOL netted approximately $1.1 billion for 800 patents. AOL’s net cash now represents approximately 50% of its total value, and the company, during its earnings call, stated that it expects to payback approximately $1 billion to investors during 2012. ^[2]

We believe that, despite this large infusion of cash, the focus should remain on the financial performance of the company’s main operating segments. The return of the majority of its cash signals that AOL will likely not make any new big acquisitions or investments in the near term, and its future financial performance will be driven by the performance of its existing segments. AOL‘s (NYSE: AOL) advertising and content businesses primarily compete with other internet companies such as Yahoo! (NASDAQ:YHOO), Google (NASDAQ: GOOG) and Facebook (NASDAQ: FB).

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The primary driver of AOL’s revenue growth was a 19% year-over-year increase in third-party network revenue. The Advertising.com platform has now posted five straight quarters of revenue growth, reporting an 11% year-over-year growth during the quarter. The business saw an increase in the number of consumers it reaches with ads and also the number of customers that use its platform to deploy their ad campaigns. The company is planning on additional investments in this business in hopes that its technology can help keep expand the number of impressions that AOL ads generate.

Additionally, revenues for the display ads business also increased year-over-year driven by a 21% increase in international revenues. These increases were partially offset by a 1% decline in search and contextual advertising, but this was the smallest decline in three years, and signals a possible stabilization in the segment.

To drive traffic to its properties, AOL’s strategy of increasing content offerings primarily through acquisitions, such as Huffington Post and Patch, is starting to pay dividends. U.S. unique visitors has steadily increased to 112 million this quarter, from 108 million in Q1.

We believe that the renewed focus on new quality content can help increase the number of page views on AOL properties, and consequently the value of AOL’s display ads business. For example, Huffington Post posted double digit traffic growth year-over-year, and new product offerings, such as video news, are expected to increase traffic and user engagement.

Patch, after its initial struggles, grew traffic by double digits in the quarter and also reported a year-over-year increase in revenues of over 100%.  Additionally, AOL’s efforts in the video space are also showing encouraging signs with video ad impressions growing over 100% year-over-year. All of these trends are encouraging signs for a company that has been struggling for years to attract users to its websites. If it is able to drive the number of page views to approximately 180 million by the end of our forecast period, we could see a 5% upside to the stock price. You can assess the impact that an increase in user engagement, as measured by total page views, would have on AOL’s stock price by using our tool below:

It is extremely important for the value of AOL that these trends continue. If it struggles to provide quality content going forward, it would lead to a decrease in user engagement which will consequently create downside pressures to the company’s value. We currently have a $28.69 price estimate for AOL’s stock, which is approximately 3% below the current market price.

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

1. AOL 8-K, SEC [↩]
2. AOL Earnings Transcript, Seeking Alpha [↩]