Monday seemed like a time warp back to the giddy 1990s as AOL’s (NYSE:AOL) stock spiked by 43% to $26.40. The company announced that it sold over 800 patents to Microsoft (NASDAQ:MSFT) for a cool $1.1 billion. Earlier expectations on Wall Street were that the intellectual property would fetch just a few hundred million.
However, investors should be wary of AOL’s current stock price. On Tuesday, the shares were already trading around 4.5% lower at midday. Apparently, at least some of Monday’s spike was from a short squeeze, when short sellers rush to close out their positions, forcing them to buy heavy amounts of stock.
If anything, AOL may now be in an even better position for a short. While the patent sale is a big win — and the company is promising to send a “significant” amount of the cash back to shareholders in some form — it doesn’t address the company’s many underlying problems.
AOL revenue has dropped every year since its breakup with Time Warner (NYSE:TWX) in 2009, and it’s expected to fall again this year. Can a one-time extraordinary event cover for a dwindling business model?
Let’s take a look. First, the good news:
AOL’s dial-up service is still the company’s cash cow, with 105 million users, many of whom lack alternatives or the willpower to change old habits. It’s a business that can last for a fairly long time, and it costs almost nothing to maintain.
Second, the Microsoft patent deal will immediately improve AOL’s balance sheet. Of its $2.8 billion of assets, some $1 billion is in goodwill, a situation now addressed as those assets have been monetized. At the same time, the cash stash helps pad the top line on the assets side of the ledger.
Last but certainly not least, the company does have the Huffington Post Media group, courtesy of a $315 million purchase last year. The HuffPost is doing well on the viewership side, showing a traffic increase of 12% year-over-year, and at one point it outdrew The New York Times website.
Now comes some of the bad news:
The dial-up model is clearly a dinosaur. It won’t grow, and in fact it will continue to erode slowly but steadily.
While a source of growth, Arianna Huffington’s internal empire is an operation with a small amount of highly paid star power among its 300 writers and a dizzying number of bloggers trying to find their own niche while getting paid peanuts.
Sure, Huffington Post Media brings in more viewers to the AOL pages. Overall traffic is up, so the site has lifted AOL’s overall audience. But is it enough to make a big difference in AOL’s long-term growth? Is Huffington Post even running profitably? It’s very hard to tell.
And then there are the dimming stars like AOL’s Instant Messenger (AIM), which is slowly but surely being bled dry through layoffs and corporate apathy. It continues to lose users at a rapid clip. And you can’t possibly overlook Patch, the collection of local news sites that’s also a cash drain, according to a Business Insider report.
Simply put, AOL can’t seem to find any powerful-enough growth drivers, even though the dot-com market is heating up.
The Internet pioneer is facing a tough problem that afflicts many tech companies: the “innovator’s dilemma.” This is when a new innovation disrupts the market and makes it nearly impossible for the incumbents to react. That because they’ve become overly reliant on the revenues of their existing products.
In AOL’s case, that dilemma struck its dial-up business, putting the company in the position of trying to replace it – a spot it’s been stuck in for years.
AOL surely isn’t alone in this kind of jam. Even fast-growing local-coupon operators like Groupon (NASDAQ:GRPN) have had problems getting to profitability.
Yet as AOL struggles to get traction, its younger competitors continue to take market share. Facebook will be public soon, and it’s already getting aggressive with acquisitions, such as its $1 billion deal for Instagram. Google (NASDAQ:GOOG) continues to grow at a healthy pace and is becoming a powerful force in mobile as well.
And yes, plenty of well-funded start-ups are also threats, including Pinterest (already the No. 3 social network), Foursquare and Spotify – just to name a few.
AOL has made some bold moves to turn things around. But there’s little evidence that the efforts are working. Instead, it looks like AOL will continue to languish — making it tough for the stock to see any more sizeable gains going forward. Given Monday’s gigantic run-up, that could make AOL a very tempting short indeed.
InvestorPlace Assistant Editor Marc Bastow contributed to this report.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.