Pounce on Fumbling AOL

by Jonathan Berr | May 8, 2013 3:08 pm

Pounce on Fumbling AOL

Shares of AOL (NYSE:AOL[1]) got pummeled Wednesday after the parent company of Huffington Post reported disappointing quarterly earnings — the first time in six quarters it failed to surpass analysts’ expectations.

However, while the company’s struggles are going to continue and while shareholders might be in for a bumpy ride, AOL is just too cheap to ignore.

The company remains fairly profitable, even if not at the levels analysts would like. Net income at the New York-based company rose 23% to $25.9 million, or 32 cents per share, versus $21.1 million, or 22 cents, a year earlier. Revenue rose 2% to $538.3 million, as advertising sales rose. Excluding one-time items, profit was 41 cents — 4 cents below analysts’ forecasts. Sales lagged expectations of $542.1 million.

AOL has been ratcheting up spending on Patch, its money-losing network of hyperlocal news sites. CEO Tim Armstrong has said he expects Patch to be profitable by the end of the year, a goal that will be challenging to meet even under the most ideal of circumstances. Patch was the subject of an unsuccessful proxy challenge waged last year by Starboard Value[2]; the company might have won that battle, but it hasn’t won the war.

AOL’s Brand Group — which includes Patch, Huffington Post and Moviephone — reported a loss of $4.9 million in the quarter. Division revenue rose 14% to $189.6 million, helped by gains in search and display advertising. AOL doesn’t break out the performance of its individual properties, but it’s safe to assume that Patch probably still is losing money, as is Huffington Post given the money that AOL continues to pour into the sites.

As I have said before, Patch sites oftentimes look amateurish and don’t offer readers much different than they could get from reading a local newspaper. Advertisers aren’t going to pay premium rates for content that isn’t particularly original. Weird things happen on Patch, too. An article[3] about New Jersey Gov. Chris Christie’s weight-loss surgery appears next to a plus-sized clothes retailer’s ad on one of the New Jersey sites.

To achieve Armstrong’s goal, AOL is going to need to scale back the towns it serves or cut back on people. There have been sporadic reports of layoffs at the sites. Every few months or so, reports in the press emerge about Patch employees being forced to undertake ungodly amounts of work for little money. If these reports are true — and considering the status quo in the journalism business in general, they probably are — they prove the old adage that you don’t get more with less. You get less.

The sites are supposed to feed Huffington Post local perspectives on big stories such as the election. More often than not, though, Huffington seems to assign its own staff to do this sort of work. These types of media synergies look better on paper than they do in real life. Just ask the shareholders who lived through the disastrous merger of Time Warner (NYSE:TWX[4]) and AOL.

There were other reasons not to be impressed by AOL’s quarter, too.

Sales in the company’s third-party ad network business rose 10%, a slowdown from a 31% gain in the previous quarter. However, the business lost $2.5 million in the quarter. Also, unique visitors to AOL Properties increased only 3% on a year-over-year basis.

And yet, despite its many challenges, shares of AOL still are enticing, at least from a value standpoint.

AOL stock trades at a rock-bottom multiple of 3.74, which is near a five-year-low and a steep discount to its peers. Granted, its revenue growth is forecast to be at or near 2% for the next two quarters, but that also means it wouldn’t take much to beat expectations.

As for Patch, I see it being scaled back or merged into Huffington at some point.

During the next few months, Armstrong will have to decide whether to continue to go it alone or find a merger partner. Given the challenges he faces, it wouldn’t surprise me if he tried tries to join forces with another player — perhaps Yahoo (NASDAQ:YHOO[5]) or Microsoft (NASDAQ:MSFT[6]). Shareholders should buy the stock now because they won’t stay this cheap for long.

As of this writing, Jonathan Berr did not hold a position in any of the aforementioned securities. Follow him on Twitter at @jdberr.

Endnotes:
  1. AOL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AOL
  2. unsuccessful proxy challenge waged last year by Starboard Value: http://investorplace.com/2012/03/aols-never-ending-drama/
  3. An article: http://cherryhill.patch.com/articles/christie-underwent-weight-loss-surgery-in-february-eddbc231
  4. TWX: http://studio-5.financialcontent.com/investplace/quote?Symbol=TWX
  5. YHOO: http://studio-5.financialcontent.com/investplace/quote?Symbol=YHOO
  6. MSFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSFT

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