AOL’s Dirty Little Secret

by Jonathan Berr | August 30, 2011 7:00 am

When Adweek reported last week[1] that AOL (NYSE:AOL[2]) had hired mergers and acquisitions law firm Wachtell, Lipton, Rosen & Katz and investment bankers Allen & Co., CEO Tim Armstrong argued that “There is no deal on the table, no proposed deal.” That’s a level of semantic parsing that would make former President Bill Clinton proud.

In fact, Armstrong and his advisers probably will leave no stone unturned in their quest to provide some relief to AOL’s long-suffering shareholders because the company as it exists now makes no sense. Its disparate services, such as AIM instant messaging, MapQuest and Moviefone, are a vestige of a time when AOL was a “walled garden” that tried to be all things to all people. That’s a strategy AOL abandoned several years ago.

Changing AOL, however, is difficult because of the company’s dependence on its antiquated business of providing dial-up Internet access. The New York-based media firm sums the situation well in a recent 10Q.

“Although our subscription revenues have declined and are expected to continue to decline, we believe that our subscription access service will continue to provide us with an important source of revenue and cash flow for the foreseeable future,” the filing says[3].

For instance, more than 37% of AOL’s second-quarter revenue of $542.2 million came from its dial-up subscribers. Since the costs of the business are low — thanks in part to massive layoffs — and it provides a steady cash flow of about $2 billion, AOL probably would have no difficulty in selling it to a private equity player. Adweek says the business is worth about $1.5 billion.

AOL probably would be able to reap a decent profit if it unloaded some of its better-known services such as Moviefone, MapQuest and AIM. The ad network, which AOL acquired for $435 million in 2004[4], also would attract interest from outside buyers. That business is worth about $200 million, according to Adweek.

Even if Armstrong sells everything that’s not nailed down, he still needs to develop content that’s interesting enough to attract and retain readers. That is proving to be more difficult than expected, even with AOL’s $315 million acquisition of Huffington Post earlier this year. Traffic to its websites including the Huffington Post was flat year-over-year[5] in the three months ended June 30.

AOL will have to acquire smaller brands such as WebMD (NASDAQ:WBMD[6]) or Martha Stewart Living Omnimedia (NYSE:MSO[7]) to increase readership by a significant-enough margin to raise advertising rates. The other option to grow AOL would be to merge the company with either Yahoo (NASDAQ:YHOO[8]) or Microsoft’s (NASDAQ:MSFT[9]) MSN network. None of those possibilities — remote as they might be — are without huge hassles. As I have argued before[10], AOL would be better off if Armstrong took it private.

Shareholders have been fleeing AOL’s stock in droves, underscoring the little faith Wall Street has in Armstrong’s turnaround plan. A recently announced $250 million stock repurchase plan[11] has failed to wow Wall Street. Shares have slumped more than 37% this year. Wall Street analysts have a target price on the shares of $23, well ahead of the $14.91 level where it recently traded. It’s hard to imagine any catalyst that would drive shares much higher than where they are now.

Jonathan Berr does not own shares of any of the companies listed. He is a former AOL freelancer. Follow him on Twitter at @Jdberr.

  1. reported last week:
  2. AOL:
  3. the filing says:
  4. which AOL acquired for $435 million in 2004:
  5. was flat year-over-year:
  6. WBMD:
  7. MSO:
  8. YHOO:
  9. MSFT:
  10. As I have argued before:
  11. $250 million stock repurchase plan:

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