AOL (NASDAQ:AOL) reported its Q4 2014 results on February 11th. The company posted 8% year-over-year growth in revenues to $562.2 million, while the net income grew by 66% year over year to $59.6 million. In our pre-earnings note, we had stated that we will be closely following AOL’s programmatic advertising platform for revenue growth and that it will be a key growth driver for AOL going ahead. As expected, much of the revenue growth for AOL came from the growth of programmatic platform across the third-party network. Its third-party ads division grew by 16% year over year to $259.6 million. Furthermore, AOL reported 6% growth in search and contextual advertising as its marketing efforts bore fruit and revenue per search improved. However, it’s display ads revenues declined by 6% primarily due to the absence of approximately $12 million in revenue from disposed or shuttered brands in 2013, including Patch. Excluding these impacts, display revenue grew 1% in Q4 2014 driven by improved pricing partially offset by lower desktop impressions. AOL’s core subscription revenues continued to decline as revenue fell by 5% to $148.1 million. While the company announced that it continues to realign its business, particularly its sales force, to conform to the needs of programmatic buying, markets reacted negatively to the expected decline in topline from lower display ads revenues (from shuttered and unprofitable sites). However, we are not dissuaded as AOL’s focus continues to be both on running profitable properties that improve the bottom-line, and on investing money into ventures that support its programmatic platforms. In this note, we will analyze AOL’s quarterly results.
Programmatic Platform Boosts Third-Party Display Ads Revenues
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According to our estimates, the third-party display ads division constitutes over 41.3% of AOL’s value. In the fourth quarter, revenues from third-party display ads continued to generate strong growth. Revenues from this division grew by 16% to $259.9 million, albeit at a slower rate, driven by growth in the sale of ads across AOL’s programmatic platform and by the inclusion of revenue from Adap.tv. Third-party property advertising revenue growth slowed during the quarter, primarily for two reasons. First, there is a shift in the mix of revenues and a rapid growth in tech, platform fees, licensing and other service fees for Adap.tv, which is reported in the other revenues in company’s income statement. Secondly, AOL is merging its backend systems to more a robust and scalable platform. The process of transitioning and testing resulted in system disruption and impacted Q4 revenues growth. It is expected to affect growth in Q1 2015 as well. However, post this structuring, AOL is confident that revenue growth from third party revenue will resume.
AOL’s platform is focusing on delivering ads not only across different platforms (such as tablets, mobiles and desktops) but also across different formats (i.e., videos, contextual search, etc). As a result, the cross–screen campaigns allowed the company to report substantial growth in programmatic revenue from nil in 2012 to approximately 40% of non-search advertising in Q4 2014. Furthermore, AOL’s mobile ad revenue was up 50% year over year and it witnessed a 227% increase in mobile programmatic campaigns. 56% of its customers are now running across screen or omni-channel campaign.
We believe that a strong programmatic platform will be a key driver in boosting AOL’s revenues by closely matching an advertiser’s ads with relevant content inventory. RTB (real-time bidding) aggregates the impression slots offered across multiple ad networks and matches them (based on the advertisers’ targets, budget and placement requirements) with the most appropriate ads. Furthermore, with the cross screen platforms, ads served through programmatic platforms are shown over mobile devices, desktops and tablets. With relevant ads displayed across content, AOL can continue to charge higher revenue per page view (RPM) to advertisers. Currently, we expect revenue per page view to grow from $5.00 to $7.05 by the end of our forecast period.
Multiplatform Offering To Offset Decline In Display Ads
According to our estimates, the display ad division constitutes approximately 28% of AOL’s value. The key drivers for this division are unique visitor count, revenue per page view (RPM) and page view per unique visitor. Display ad revenues declined by 6% to $171.5 million, primarily due to the absence of approximately $12 million in revenue from disposed or shuttered brands in 2013, including Patch. This overhang is expected to remain in the first half of 2015 as the company restructures its business by realigning its sales force. Excluding these impacts, display revenue grew 1% in Q4 2014 driven by improved pricing partially offset by lower desktop impressions.
The company was able to withstand the price competition in Display ads industry primarily due to the increase in the number of video ads sold on AOL’s brand properties such as Huffington Post, etc. Furthermore, unique user count and revenue per ad impression related to videos also increased as company delivered both content and ads to mobile platforms.  The company was among the top 3 players in content videos and video viewers category in Q4. The improvement in video offerings translated into overall growth in the number of unique visitors across AOL properties, which grew to 197 million with almost 50% of traffic being mobile. This indicates that AOL was able to serve more display ads to its users through mobile devices during the quarter. This also indicates that AOL was able to engage users across both desktop and mobile devices. User engagement is important for AOL’s overall financial health as it not only increases the unique visitor count but also drives page views and RPM across properties. We currently forecast that the RPM on AOL properties will increase from $3.00 to $3.40 by the end our forecast period.
Marketing Efforts Bolster Search Ad Revenues
According to our estimates, the search ads division constitutes ~17.3% of AOL’s value. Search across AOL is powered by Google. In line with our expectation, revenues from this division grew by 6% to $108.2 million during the quarter. The growth was primarily due to an increase in queries from AOL clients as AOL was able to engage them successfully. Furthermore, AOL stated that its search marketing efforts helped in boosting the queries across its properties. As a result of these efforts, AOL’s revenue per search improved. As the company plans to build sustainable search products in partnership with Google, we expect that its search revenues will be stable in 2015.
We are in the process of updating our AOL model. At present, we have a $41.97 price estimate for AOL, which is inline with the current market price.Notes: