AOL will spin off from Time Warner next week and trade as a separate company. This week, some Wall Street banks have started coverage of the stock with initial remarks and recommendations.
The latest is RBC, whose Ross Sandler started AOL off today with a “sector perform” rating, “above average” risk, and a $27 price target.
Like most analyses, he focuses on AOL’s obvious challenges: A declining dialup business that makes up most of the company’s profits; its reliance on that shrinking subscriber base to bring viewers to its media business; its poor performance in growth areas like in social media; its declining search and display ad businesses; and its dependence on Google’s search revenue — a deal that expires (at least at its current rates) in a year.
But he also highlights room for upside: If AOL isn’t as dependent on its dialup subscribers for traffic as everyone thinks — see details below; if cost-cutting and asset sales create increased cash flow; or if someone eventually tries to buy AOL.
One short-term risk for the stock: As big, institutional Time Warner shareholders pull out, AOL stock could drop into the low $20s, creating a “more compelling” valuation, Sandler says.
But given that “when issued” trading of AOL stock is already happening — trading around $25 — that discount shouldn’t last long.
Meanwhile, Sandler thinks AOL is worth $2.8 billion, or $27 per share. How does he get there?
- $1.41 billion valuation for access business at 2.7x EBITDA multiple
- $1.38 billion valuation for content/display/search/other at 3x 2010E EBITDA
Key for upside: If AOL is not as dependent on its dialup traffic as everyone thinks, he thinks AOL could trade “at a multiple closer to Yahoo’s 5x EBITDA,” making the overall company worth about $4.1 billion. (Which means shares would get closer to $40.)