AOL (NYSE:AOL) CEO Tim Armstrong bragged in his company’s latest earnings release that it was poised to become “the next great Internet company.” He stands a better chance of fulfilling that promise if AOL was taken private.
Armstrong joined the New York-based media company in 2009 and led the company through its initial public offering, promising to mirror the success of Walt Disney Co. (NYSE:DIS) and CNN. He has tried to back up his grand designs with equally grand deeds.
He acquired Huffington Post earlier this year for $315 million and later added more than 300 journalists to AOL’s payroll. He has tried to capture local audiences through the company’s hyperlocal Patch sites that cover 846 towns. Wall Street, however, has not been impressed with either investment.
Shares of AOL have dropped almost 50% this year thanks to its dismal second-quarter earnings. Sadly, the traffic gains at newer sites have not offset the declines in legacy sites such MapQuest and the AOL.com home page. Patch alone costs $160 million annually to keep afloat, according to a Wall Street analyst.
Armstrong should follow the lead of Michael Bloomberg, who built a phenomenally successful media empire without the prying eyes of shareholders. Bloomberg L.P. is able to spend what it wants when it wants to without worrying about quarterly earnings fluctuations. That type of attitude is needed at AOL, which may not be fixed until 2013, Armstrong told the New York Times.
Otherwise, its outlook seems pretty grim.
AOL lost $11.8 million in the latest quarter, which sadly is the best performance the company has given in recent memory. The company has a wide array of problems, ranging from internal management issues at Huffington Post to its dependence on its declining dial-up Internet access business. AOL’s subscription business generated $201.3 million, or 37% of AOL’s $542.2 million in quarterly revenue. It fell 23% while advertising revenue gained 5% to $319 million.
Though AOL is dirt-cheap — Bloomberg News points out that it’s trading at 57 cents on a dollar — the company might not be an easy sell to a private equity player. For one thing, free cash flow — a key metric for these investors — fell 43% to $77.2 million in the latest quarter. It also has lost about $800 million in the two years that it’s been a standalone company.
Then there’s the Arianna Huffington factor. It isn’t clear whether the larger-than-life editor would stay at her perch on the top of the blogging world if AOL changed hands. Any new owner would replace Armstrong, who has indulged her whims, which reportedly included setting up three nap rooms.
Nonetheless, AOL is far too cheap for a potential buyer interested in gaining access to one of the largest audiences on the Web. Of the 43 U.S. Internet companies with market caps greater than $500 million, AOL has the lowest price-to-earnings ratio, and its valuation of 0.57 times book value also is the cheapest.
Armstrong’s tenure has had some modest successes. Display advertising revenue rose in the first quarter for the first time in four years. Global advertising revenue grew in the second quarter grew for the first time in three years. Those figures, though, might be less impressive than many people realize.
For one thing, most media companies have noted that increased advertising sales helped their bottom lines. Whether these increases are sustainable is another issue. Advertising is corporate America’s answer to a canary in a coalmine. It’s among the first things that get cut when executives expect business to slow down.
Armstrong recently decided to spend $250 million of AOL’s $459 million in cash to buy back shares. That gesture will do nothing to address the serious long-term concerns that many investors have about AOL.
According to the New York Times, AOL hit a “hard bump on its road to becoming a digital media company.” That’s wrong. It’s more like an obstacle the size of Mount Everest.
Jonathan Berr is a former AOL freelancer. He also worked for Bloomberg News for seven years and owns no shares of the companies listed here.
