AOL’s Third Quarter Could Be A Foundation For A Brigther Future

AOL (NASDAQ:AOL) surged 22% during trading on November 6th after the company announced relatively encouraging third quarter results. The firm posted 7% year-over-year advertising revenue growth, the highest growth rate in over 7 years. Additionally, the company reported an 8% increase in search and contextual advertising revenues, which was the first growth quarter in over three years.

While AOL had a huge 22% jump in stock price to $44 during trading on Tuesday, we reiterate our price estimate of $29. We are encouraged by AOL’s results and think that the business could be on the mend, but one decent quarter does not mean a turnaround for a company which has been struggling for almost a decade. It is important to note that the company did not grow total revenues year-over-year during the third quarter, and its revenues for nine months ended are still down during the fiscal year. We would start believing in an AOL turnaround if the company continues to post growth in key segments over the next couple of quarters.

See our complete analysis for AOL here

Growth in Unique Visitors Encouraging

According to management, AOL’s properties experienced unique visitor growth of approximately 4% year-over-year. We think that this is an encouraging sign, because it signals that AOL is doing a good job of creating content which attracts users.

For example, Huffington Post’s HuffPost Live, is a new streaming news channel started by AOL during the third quarter. This product differentiates itself from competitors by being an internet based news channel, as it streams news for 12 hours a day and provides a social viewing interface. With this product, AOL has been able to sell  sponsorships and video advertisements during the live segments, both of which will drive advertising revenues over the longer term.

Additionally, the company has been attracting new users by redesigning some of its mobile platforms, such as AOL On, TechCrunch, Winamp, etc. We think that bets on mobile will pay off over the long term, as AOL will likely attract new users onto its platforms via the mobile front. Additionally, a strong mobile platform gives the company an opening in emerging markets, which will be important especially since Asia alone now makes up approximately 45% of the world’s internet users, and users there tend to access the internet through phones before they are able to buy PC’s. ^[1]

International Display Revenues Grow

In our opinion, a revenue source which will be key in the future is international display advertisements. During the third quarter, international display ad revenues were only 10% of total ad revenues, but posted year-over-year growth of approximately 15%. While the primary countries in which display ads posted growth were the United Kingdom and Canada, we think that AOL has a good opportunity in emerging markets if it able to provide solid mobile content which appeals to users.

A market that AOL could and should focus on is Asia, which has 45% of the world’s internet users even though penetration is at a measly 28%. As internet penetration grows on the continent, we could see AOL continue to post growth in unique visitors. Over the coming quarters, we would like to see AOL’s management lay out strategic initiatives for driving visitor growth in emerging economies.

Domestic Display Ads Still Disappoint

Domestic display advertising revenues, which make up over 50% of  advertising revenues on AOL properties, contracted 3% year-over-year. Management, during the earnings conference call, stated that it plans to reverse these trends in part by trimming AOL’s content portfolio to fewer, more impactful products.

We think that AOL management has the right strategy for improving domestic display ad revenues going forward, but are skeptical as to whether or not the company will be able to pull it off. The internet landscape in the United States is fraught with competition, and AOL’s sites will have a tough road ahead as they seek to drive display ad revenues.

We currently have a $29 price estimate for AOL, which is approximately 35% below the current market price.

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