Microsoft (MSFT) rises Thursday evening on Q4 earnings beat >>> READ MORE

Why AOL Is a Better Bet Than IAC/Interactive

In 2011, Tim Armstrong's company sank while Barry Diller's jumped. Here's why this year will be different


Barry Diller’s IAC/InterActive (NASDAQ:IACI) had a great 2011, up 48.9%. Another media-related company, AOL (NYSE:AOL), was just the opposite, down 36.3%. These two companies’ stocks are headed in different directions — and that makes this situation the perfect contrarian investment. Even though at least one big AOL shareholder is tired of waiting for a turnaround, I’ll explain why investors should sell IAC/InterActive and buy AOL.

Too Much Barry Diller

In 2011, IAC/InterActive Chairman Diller has made one purchase on the open market, buying 286,777 of his company’s shares at $31.16 each. That was last February. Diller’s second transaction came in early June, when he exercised stock options to acquire 1.2 million shares at an exercise price of $31.06 per share. As part of Diller’s agreement with the company, he then exchanged 1.5 million common shares into Class B shares on a one-for-one basis.

Since the common stock comes with one vote per share and the Class B gets 10 votes per share, Diller was able to increase his total votes from 36.4% in April to 41% after the option exercise. Normally, when there’s a dual-class structure, it’s common for shareholders to convert Class B shares into common, but I can’t remember ever seeing the reverse.

What’s good for shareholders obviously isn’t good for Diller. His special deal to consolidate his control seems heavy-handed and should be a concern to any investor interested in good corporate governance. After all, Diller received $3.7 million in total compensation in 2010 including $645,000 for the personal and business use of a corporate jet. That’s in addition to his stock holdings in IAC/InterActive that are worth close to $300 million.

Given the stock’s 2011 performance, I’m sure plenty of investors are willing to look the other way. That’s fine, but don’t say you weren’t warned.

Obscure Tax Accounting

Have fun trying to figure out IAC/Interactive’s taxes. While its third-quarter 2011 revenues increased 25% to $517 million, its earnings from continuing operations before income taxes declined by 5.2% to $36 million. But instead of paying the standard tax rate of 25% to 35% or thereabouts, it received a $32 million tax benefit and as a result, its diluted earnings per share were 69 cents instead of 35 cents. According to IACI’s 10-Q, it intended to permanently reinvest outside the U.S. the gains generated from selling’s European business in 2009, thereby generating a tax benefit against taxes paid previously on those gains.

Is it any wonder the U.S. government has a revenue problem? Companies are playing fast and loose with the IRS (and being allowed to) while individuals have the screws put to them. I’m sure IACI’s CFO could do a wonderful job explaining how its taxes work, but I can’t and for this reason alone, I’d be wary about investing.

AOL Is an Easy Target

Down as much as AOL was in 2011, it’s easy to see why the one-time Internet pioneer has so many detractors. But let’s try to look at the facts. CEO Tim Armstrong is building a business around quality content, which explains the $315 million acquisition of The Huffington Post last March. Since arriving at AOL, Arianna Huffington has turned its business upside down, completely revamping its senior editorial team and providing readers with far more in-depth coverage of news that matters.

While it’s true that top executives like Brad Garlinghouse, who was brought in by Armstrong in 2009, are leaving. But whenever  difficult changes are made to a business, some are happy and some aren’t. As far as I’m concerned, the most important sign business is getting better is that advertising revenues in the third quarter rose 8% year-over-year to $318 million, with the all-important domestic display segment increasing 14% to $125 million.

Armstrong’s hard work transforming AOL’s business is working, albeit at a pace slower than most would like, but it’s working nonetheless. While operating income was just $8.6 million in the quarter, given all the changes, shareholders should be pleased this number was actually positive.

Bottom Line

At the end of the day, AOL is trading at just three times cash and 6.5 times free cash flow. In other words, it’s cheap. With the exception of late summer, AOL’s stock hasn’t traded this low since its spin-off from Time Warner (NYSE:TWX) in December 2009. Perhaps that’s why it’s been repurchasing its shares by the boatload, buying back $130 million of its stock between Aug. 11 and Nov. 2. Say what you will about Arianna Huffington, but she’s definitely got a vision for the future. AOL is much better off with her on board, and Tim Armstrong knows this. 2012 should be a breakout year for its stock.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.

Article printed from InvestorPlace Media,

©2017 InvestorPlace Media, LLC