AOL Is Kicking Ass. So Why Am I Worried?

by Marc Bastow | November 6, 2012 2:59 pm

AOL Is Kicking Ass. So Why Am I Worried?

Back in August, when AOL (NYSE:AOL[1]) announced it would return some of the lucre from its $1 billion in patent sales to Microsoft (NASDAQ:MSFT[2]) via a special dividend, I made a case to buy the stock[3]. The company, which slowly is transforming form Internet service provider to ad-based content provider, seemed to be finding momentum.

That momentum continued today when AOL reported third-quarter earnings that beat the pants off the previous quarter and the year-ago period. AOL earned $20.8 million (22 cents per share), crushing last year’s $2.6 million (2-cent) loss, while revenues of just more than $531 million remained constant — which actually is an upgrade from previous declines. Both figures handily beat Street estimates, helping AOL shares to 15% gains by late afternoon.

By all accounts, AOL and its stock are headed in the right direction. So why am I not totally sold?

For one, while AOL has beaten analyst earnings estimates in four straight quarters, the beats have been slimming, from 18 cents in the last fiscal quarter of 2011 to 11 cents in Q1 2012, 9 cents in Q2 and 5 cents this time around.

For the current quarter, global advertising improved by 7% to $340 million, search advertising increased 7.9% to $91.8 million, and AOL’s advertising network surged 18% to $112.8 million. But, AOL’s domestic display advertising numbers — which include ad revenues for Huffington Post — fell 2.6%. That’s hardly promising, not to mention, you have to wonder whether Huffington traffic will slow after the election — which obviously has spurred interest in politics — is over.

You also have to wonder how much more headway AOL can make on the ad front. According to research firm EMarketer, AOL ranks fifth in ad revenues behind Google (NASDAQ:GOOG[4]), Yahoo! (NASDAQ:YHOO[5]), Facebook (NASDAQ:FB[6]) and Microsoft. Gobbling much more market share of any of the above seems a Herculean task.

AOL’s effort to push the Web publishing model includes its Patch local-news division. However, while CEO Tim Armstrong spent $300 million to develop Patch, he only sees it bringing in $50 million in revenue this year, according to Bloomberg[7]. That might be moving in the right direction, but it’s hardly paying for itself yet.

Also worth mentioning is AOL’s (expected) decline in its dial-up model, where revenue fell 10% in the quarter.

My advice at the time was for a short-term look predicated mostly on getting the dividend in December. Since then, the stock is up more than 25% … and riding 170% gains … and has set a new all-time high.

This is a tricky call: Momentum is only as strong as your last earnings report, and this one was, by most accounts, pretty damn good. I still wouldn’t jump in with both feet, as I’m still skeptical about AOL’s long-term profits, but I might consider sticking in another toe before the stock goes ex-dividend Dec. 3 — even if it’s just to land more of that special payout.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he was long MSFT and AOL.

Endnotes:
  1. AOL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AOL
  2. MSFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSFT
  3. I made a case to buy the stock: http://investorplace.com/2012/08/is-aol-sweet-dividend-tempting-enough-msft-yhoo/
  4. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  5. YHOO: http://studio-5.financialcontent.com/investplace/quote?Symbol=YHOO
  6. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  7. according to Bloomberg: http://www.bloomberg.com/news/2012-11-06/aol-swings-to-profit-in-third-quarter-on-higher-ad-sales.html

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