by Will Ashworth | February 12, 2013 1:42 pm
AOL’s (NYSE:AOL) on a roll … big time.
Just yesterday it gained 7.4% on more than four times the usual volume. The online content provider’s excellent fourth quarter earnings Feb. 7 have prompted a significant rally. AOL stock is up 22.4% year-to-date through Feb. 11; it looks ready to test its five-year high of just under $40.
What’s going on over at 770 Broadway?
A little over a year ago I made the argument that AOL’s tough 2011 was in the rearview mirror and good times lay ahead. I further predicted that Barry Diller’s baby, IAC/InterActive (NASDAQ:IACI) — which had had a good year in 2011 — was due for a fall in part because of its poor corporate governance. Both predictions came true: AOL’s stock gained 130.2% in 2012 compared to 12.6% for IACI. (Sure, an almost 13% gain can’t be considered a fall but it was less than the S&P 500, so on balance shareholders would probably have liked to have seen more.)
That was then. Where is AOL headed now?
Valuation website Trefis puts a price estimate on AOL of $25, suggesting it thinks the company’s stock is incredibly overbought at the moment. Some analysts, however, are incredibly bullish on AOL’s future. RBC Capital Markets recently raised its rating from “sector perform” to “outperform” on the basis of AOL’s turnaround in revenue. On Monday, Jefferies raised its price target by 14% to $50 on its belief that AOL’s core assets are much more valuable than investors realize.
While not completely out of the woods just yet, CEO Tim Armstrong has AOL on a good trajectory. Here’s why.
The most obvious place to start is revenue. That’s what’s has RBC excited, and why shouldn’t it be — AOL delivered Q4 revenue growth of 4% year-over-year, its first increase since being spun-off from Time Warner (NYSE:TWX) in December 2009. Leading the charge is its Third Party Network with Q4 revenue growth of 31% and full-year growth of 23% to $471.6 million, or almost 22% of overall 2012 revenue. New publishers and advertisers are brought on board daily (10% more advertisers in Q4) attracted by AOL’s breadth of offerings. Interestingly, while the average monthly unique visitors in Q4 to its Third Party Network declined 7.5% year-over-year to 74 million, its revenues increased dramatically. That tells me it was delivering better yields for its advertisers and publishers. At the end of the day, both of these groups want the right eyeballs, not necessarily the most. Thanks to the successful efforts of the Third Party Network, AOL’s global advertising revenue grew by 13% in Q4 and 8% for the entire year to $1.3 billion.
Perhaps even more important than the fourth-quarter increase in revenue is its 1% increase for fiscal 2012 in adjusted operating income before depreciation and amortization (OIBDA). AOL’s $412.6 million in OIBDA posted in 2012 stemmed the precipitous decline that’s seen profitability drop by more than two-thirds from $1.5 billion in 2008 to $409 million in 2011. In its conference call, Tim Armstrong indicated that it hadn’t expected to grow OIBDA year-over-year in 2012; the company is a year ahead of schedule. Much of this success is attributable to AOL’s expense control. For instance, its full-year adjusted OIBDA expenses excluding traffic acquisition costs were $66 million less in 2012. Armstrong believes that it has further potential to reduce its corporate expenses beyond the $500 million it’s cut on an annual basis since becoming a public company.
Anyone who follows AOL knows that it comes with a lopsided income statement — its legacy subscription business delivers 40% of its revenue and a whopping 91% of its OIBDA. Worse still, the legacy business continues to erode (although AOL did manage to generate 4% sequential growth in the fourth quarter in its average revenue per subscriber). At the same time, its other two segments (Brand Group, AOL Networks) are growing revenues but having a difficult time on at the bottom of the income statement. Armstrong believes the company will do a better job in this area, and there’s no reason to think he’s blowing smoke. I look at the situation as a glass half-full, where AOL’s legacy profits give it time to improve profitability in the two segments that are quite rightly its future.
In the past 12 months, AOL repurchased a total of 20.8 million shares at an average cost of $33.59. The $700 million investment reduced shares outstanding by 19% in 2012 to 76.6 million. As a result, Tim Armstrong is now AOL’s biggest shareholder. If ever there were a motivation for someone to keep his foot on the gas, this is it. Armstrong knows the business isn’t perfect. But he also knows that the opportunity to deliver advertisers the audience they’re looking for is tremendous.
Those able to hold for two to three years should do just fine. If you haven’t bought in and want something big in 2013, I’m not sure AOL is for you. Having said that, Jefferies’ $50 target doesn’t seem unreasonable by sometime in 2014.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
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