AOL’s Damn-the-Torpedoes Strategy on Patch

by Jonathan Berr | June 12, 2012 7:30 am

When it comes to local news service Patch, AOL (NYSE:AOL[1]) CEO Tim Armstrong is taking his cues from naval hero Admiral David Glasgow Farragut. Legend has it that at the height of the Civil War Battle of Mobile Bay, Farragut rallied his sailors with the words “Damn the torpedoes! Full speed ahead.”

Like Farragut, Armstrong is facing an enemy that’s trying to sink him, though in his case it’s with words not explosives. Activist investor Starboard Value Fund is trying to torpedo Patch, AOL’s hastily cobbled together network of more than 800 local news sites, saying its business model doesn’t work. Starboard estimates that Patch lost $147 million in 2011, generating only $13 million in revenue. AOL, which disputes Starboard’s claims, is fighting back as its proxy battle with Starboard comes to ahead at the annual meeting this week.

In a press release issued today[2], AOL argued that Patch is gaining traction and will generate between $40 million and $50 million in revenue this year, helped by gains in advertising revenue and growth in traffic. The New York-based Internet media company does not give profitability information, and a spokeswoman declined to comment beyond the press release.

“They are not going away,” said Gordon Borrell, head of market researcher Borrell Associates, who met with Patch management today in New York City. “Newspapers are a lot about Patch because it’s the closest thing that many have in competition when it comes to news…. [However], I don’t think Patch poses a huge threat to them.”

Starboard has attracted support of Glass Lewis and Institutional Shareholder Services for its plan to shakeup AOL, though the two proxy-adviory firms are[3] split as to what board members backed by the activist investor they support. Their position has to be disheartening to Armstrong, who has seen shares of AOL soar nearly 80% in the wake of a $1 billion patent sale to Microsoft earlier this year. The activists counter — rightly so — that selling assets is substitute for an actual strategy.

AOL launched Patch in 2009 without first figuring out how it would make money, a problem that other hyper-local sites experienced. The Patch sites all have sameness about them, thanks to their minimalist design. Bad layout doesn’t scare users away from successful sites such as craigslist, if the site proves useful. But the case for Patch isn’t a slam-dunk.

To be sure, Patch, which probably will lose money this year and next, is gaining traction. AOL describes the network as the fifth-largest regional/local property on the Web, up from 10th place when it first entered the rankings in December 2010. Total revenue is 14% higher than its previous record set in November 2011. Patch has booked 130% of its total 2011 revenue already this year. The data, while impressive-sounding, don’t answer Starboard’s point about Patch’s viability.

For instance, investors might wonder if the spike in Patch revenue might be attributable to a reduction in advertising rates. Also, I would be curious to learn more about the traffic increase. It would be useful to know how much of it comes from aggregation sites such as Google News and how much comes from users who seek out the particular Patch Web page.

Some of the New Jersey Patch sites I looked at today had celebrity news such as stories about hip-hop singer Lauryn Hill’s tax troubles[4] and the end of NPR’s hit show Car Talk. Advertisers won’t be impressed if those sorts of stories are getting traffic because they can be read on scads of other sites. Advertisers want their ads associated with unique content.

Regardless of the Starboard proxy fight’s outcome, AOL may eventually shutter or merge some Patch sites simply because the economics are unsustainable.

Jonathan Berr is a former AOL contract writer. He does not own shares of any stocks mentioned here. Follow him on Twittter @jdberr.

Endnotes:
  1. AOL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AOL
  2. press release issued today: http://corp.aol.com/2012/06/11/patch-scores-highest-traffic-and-revenue-in-its-history/
  3. the two proxy-adviory firms are: http://blogs.wsj.com/deals/2012/06/05/starboard-aol-fight-has-proxy-advisers-on-the-fence/
  4. Lauryn Hill’s tax troubles: http://investorplace.com/2012/06/singer-lauryn-hill-might-land-behind-bars-for-tax-dodging/

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