At AOL’s investor day last week, CEO Tim Armstrong complained that the company’s stock is “severely undervalued,” especially relative to some recent Internet IPOs.And that may actually be true.
But investors can be forgiven for not taking Tim’s word for it.
Because AOL hasn’t released enough information to back up its claims that its future growth businesses–the core media business and local play Patch–will actually ever deliver big, profitable growth.
All AOL’s investors know is that AOL’s overall business continues to shrink, and that AOL’s once-prodigious cash flow has suddenly gone negative.
So if Tim & Co. have numbers that explain why they are so excited and confident about Patch and the core media business, they should release those numbers.
Otherwise, investors will continue to conclude that there are no such numbers–that management’s confidence is based on hopes and dreams, not reality–and the stock will continue to sag.
(And after 11 years of big AOL claims falling flat–a couple of years of which have come during the current regime–investors can be forgiven for taking nothing that AOL tells them on faith.)
THE AOL REALITY
Right now, here’s what everyone knows about AOL, based on the first quarter’s financials: It’s a ~$2 billion business shrinking at 15%-20% a year.
And here’s what everyone knows about how that business breaks down:
Display Ads: $130.5 million of revenue, ~$500 million annualized, growing 4%/yr
Search: $96 million of revenue, ~$400 million annualized, shrinking 21%/yr
Total AOL Media: $226 million of revenue, ~$1 billion annualized, shrinking 8%/yr
Revenue $87 million of revenue, ~$350 million annualized, shrinking 19%/yr.
Revenue: $215 million of revenue, ~$850 million annualized, shrinking 24%/yr.
TOTAL REVENUE: $551 million, ~$2.2 billion annualized, shrinking 17%/yr
But there’s some good news in there!
Display revenue is finally growing.
So maybe management is right to be excited.
Unless that growth is coming at the expense of hundreds of millions of dollars of losses on content production. And that’s what investors think is really going on.
And they have reason to think that.
AOL’s Core Business And Patch–The Company’s Future–Are Losing Hundreds Of Millions A Year
How do we know that AOL’s core business and Patch are losing boatloads of money? Because AOL’s dying businesses, “subscription” and “search,” are extremely profitable, but the overall company is not.
In “subscriptions,” AOL members pay AOL ~$20 month to use the company’s dial-up services once in a while. AOL’s dial-up services don’t cost much. So the $850 million of annualized subscription revenue is likely still wildly profitable. In fact, it probably still has at least a 50% profit margin, if not higher. So AOL’s subscription business is likely still kicking off $400 million or more a year of profit (and possibly a lot more).Search is also extremely profitable. All AOL has to do to earn its search revenue is to place a search window on its content and email pages. Then Google returns the search results and gives AOL 90% of the revenue. So AOL’s “search” business probably has at least a 75% profit margin, if not considerably more (it really should be close to 100% margin). So AOL’s search business probably kicks off $300 million or more of profit each year.
So, when you add up search and subscriptions, AOL is likely earning at least $700 million of operating profit per year.
And how much operating profit is AOL actually reporting?
A paltry ~$42 million in the first quarter, or about $175 million a year (excluding restructuring charges, etc.)
In other words, AOL is getting $700+ million of operating profit from its subscription and search businesses and reporting less than $200 million a year of total operating profit. Worse, AOL’s free cash flow has gone negative.
And that suggests that…
AOL’s core “display” ad business–the one it wants everyone to focus on–is losing a staggering ~$500 million a year.
THE AOL GROWTH STORY
If AOL wants investors to get excited about the company’s future growth story, it needs to show investors that this $500 million is being invested wisely.
It also needs to radically cut this investment rate–and soon.
Otherwise, investors are perfectly reasonable to conclude that AOL is just pissing away its remaining legacy cash flow and will never build a profitable growth business.
So, assuming management’s excitement is based on something other than hope, what numbers should management release?
1) A full income statement for the US media business — revenue and losses. Investors deserve to understand how much money the company’s core business is losing and why management thinks it will soon become a profitable growth business. Management also needs to “right-size” this business quickly (in fact, this should have been done years ago). If most of these losses are coming from Patch, which reportedly loses ~$120+ million a year, management should also release the Patch financials–so investors can accurately assess both it and the US media business.
2) Full financials for “Patch” (see above). Patch is a massive investment for the company. Investors deserve to understand just how massive the Patch investment is–because they may believe, as we do, that this money could be better allocated.
3) Unit-level financials for the handful of “Patch” properties that are about to become profitable. Tim Armstrong continues to say that one reason he’s so excited about Patch is that some of the early Patches are about to be profitable. If this is true, management should share their financials (revenue, employees, costs, traffic, etc.) Most investors and some insiders think that Patch is gigantic pipe dream that will never work and, in the meantime, will incinerate $120+ million a year. If AOL’s management knows something these investors don’t, it should share that information.
THE BOTTOM LINE
If AOL wants investors to agree that its stock is “severely undervalued,” it needs to give investors more information with which to come to that conclusion for themselves.
Because talk alone, unfortunately, is cheap. Numbers speak louder than words.
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