Recommendation: Short AOL, but wait until the stock loses momentum and crosses back below a potential support level at $36 per share.
Options Alternative: Buy to open the AOL July 36 puts for $3.00 per share or less.
AOL (NYSE:AOL) reported that its revenue grew for the first time in eight years in the fourth quarter of 2012. While that is impressive, we remain concerned about the financial pressures the company will continue to endure due to its still unprofitable venture called Patch.
Patch is a network of over 1000 hyperlocal news sites in cities and towns throughout the country. It is the brainchild of CEO Tim Armstrong and was launched in 2009. But despite record Q4 site traffic, Armstrong admitted that Patch had not turned a profit. Reportedly, AOL sank more than $40 million into the venture.
Last year, the company said that the sites would generate between $40 million and $50 million. That failed to happen. Armstrong said part of the reason the goal was not reached was due to Super Storm Sandy. He said about 300 of the first Patch sites established served communities directly hit by the storm. Since these pioneer sites tended to have the most revenues, Patch’s financial bottom line suffered.
It’s troubling that the other two-thirds weren’t generating enough revenue for AOL to hit the $40 million to $50 million goal. During the conference call, the amount of the miss was not disclosed.
Activist Investor Dumps AOL
Even before last year’s devastating storm, shareholders had concerns about Patch. Last summer, Jeffrey Smith, founder of Starboard Value, which had carved out a 5.3% stake in AOL, noted that roughly $150 million of AOL’s loss was due to the poor performance of Patch. (Note: since losing a proxy fight over board seats with AOL, Starboard has eliminated its stake in the company)
During last week’s conference call, Armstrong was steadfast in saying that revenue from Patch would hit the $50 million mark by the fourth quarter of this year. We remain unconvinced.
Click to Enlarge From a technical perspective, AOL is just above a potential resistance level (around $36 per share, which is normally considered bullish). We wouldn’t recommend entering a short position or buying puts until that same support level is broken or even retested on the way down. We are looking at the fundamentals to create that break, but once it happens, a larger decline is likely.
Small Fish, Big Pond
Another concern we have about Patch is that it is attempting to pull off success in a space that even large conglomerates have deemed not worthy of the investment. Take NBC for example. The company, owned by Comcast (NASDAQ:CMCSA), last week shuttered its hyperlocal news service called EveryBlock. In abandoning the business, NBC officials told the Poynter Institute that the business was not only failing to become a strategic fit with its growth strategy, but it was also struggling with the business model.
Then there is Yahoo (NASDAQ:YHOO), which has also taken a stab at a semi-hyperlocal news platform. Called the Contributors Network, the system encourages writers of any background to write about events in their communities. Writers for the open platform can tackle national and international stories too.
Last year, AOL revamped some of the Patch sites for user engagement. It seems to veer away from Patch’s intended purpose to be a local/niche news source. Also, as noted by Trefis, AOL may consider investing in a platform that “engages users on a much deeper level, otherwise it risks losing users to competing sites.” Those include Yahoo, Facebook (NASDAQ:FB) and Google.
Armstrong seems undeterred by the mounting criticism of Patch. He will keep funding it to keep it afloat – at least for this year.
Throwing Good Money Away
AOL’s investors clearly liked the most recent earnings report. Fourth quarter revenue increased almost 4% to roughly $600 million, which beat estimates of about $576 million. That growth stemmed partly from an increase in the company’s advertising revenue. Search ad revenue was a considerable contributor, which rose 17% to about $104 million. The all important display ad revenue was about $169.8 million, which was relatively unchanged compared to the fourth quarter of 2011, when they were $170.6 million.
It would be a shame to let that all go to waste because of throwing good money after bad, but recent history has shown that AOL tends to do exactly that.
Recommendation: Short AOL, but wait until the stock loses momentum and crosses back below a potential support level at $36 per share. A move like that could happen very quickly so a limit order may be appropriate.
Options Alternative: Buy to open the AOL July 36 puts for $3.00 per share or less. AOL options have some odd-lot contracts currently listed, so look out for those or call your broker if you need help identifying the right strike price.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.