In response to the “AOL infomercial” posted by an SAI reader this morning, another SAI reader, Steve Baldwin, shreds AOL’s latest 10Q (TWX) and asks a lot of smart questions. Steve’s comments and analysis are in red below. SAI’s annotations/responses in blue:
My God, it’s an AOL infomercial, right here on Silicon Alley Insider. Still, I’m glad someone here has faith in the AOL future. And because I still do have some love left in my heart for AOL, here’s what TWX says about AOL in its most recent SEC quarterly finding, plus a few comments and questions:
—- FROM AOL 10Q Q1 2008 —-
During 2007 and the first quarter of 2008, Advertising revenues on the AOL Network were negatively impacted by certain factors and trends, including declines in the price of advertising inventory, shifts in the mix of sold inventory to lower-priced inventory and the increasing usage by online advertisers of third-party advertising networks.
— Uh oh – looks like that awful Ads-as-Pork-Bellies Trend is hurting the premium placement business.
— Yes…these trends are the justification for AOL’s emphasis on third-party networks (that and the fact that Ad.com has been the company’s strongest business for the past few years).
Additionally, during the first quarter of 2008, AOL’s Advertising revenues were negatively impacted by the challenges of integrating recently acquired businesses under Platform-A, including certain sales execution issues.
— Sales Execution losses? Is this code-speak for terminating sales people?
— Don’t think the sales people were actually canned until Q2. Think this is code-speak for “Why we fired the AOL salespeople instead of the Advertising.com salespeople when we combined the salesforces.”
The increasing usage of third-party advertising networks has had a positive impact on AOL’s Third Party Network Advertising revenues. However, such revenues have historically had higher traffic acquisition costs (“TAC”).
— Again, the oh-so-corrosive efffect of ad networks is in play here.
— Crucial point, Steve: AOL always talks as though a dollar of Advertising.com revenue is worth the same as a dollar of owned and operated revenue. It isn’t. In fact, it’s only worth about 1/5th-1/10th as much.
Due to the differing cost structures associated with the AOL Network and Third Party Network components of the Global Web Services business, a period over period increase or decrease in aggregate Advertising revenues will not necessarily translate into a similar increase or decrease in Operating Income before Depreciation and Amortization attributable to AOL’s advertising activities.
— I’m not sure what this means but it sounds ominous.
— Same point as above. Margin for Ad.com (network) off of gross ad sales is much lower than for owned-and-operated properties.
The Company anticipates a significant decline in revenues from a major customer of Advertising.com during 2008 as a result of the customer’s acquisition of a business believed to perform online advertising services that are similar to those provided by Advertising.com. For the three months ended March 31, 2008, revenues from this relationship decreased to $17 million from $56 million for the three months ended March 31, 2007. For the full year 2007, AOL earned Advertising revenues from this relationship of $215 million.
— Hmm. Dependency on a few large advertisers isn’t a good thing. Who is this unhappy customer?
— Think it’s Apollo.
AOL’s Publishing business group, a component of the Global Web Services business, develops and operates the products and programming functions associated with the AOL Network. The AOL Network consists of a variety of websites, related applications and services, including those accessed via the AOL and low-cost Internet access services. Specifically, the AOL Network includes owned and operated websites, applications and services such as AOL.com , international versions of the AOL portal, e-mail, AIM, MapQuest, Moviefone, ICQ and Truveo (a video search engine). The AOL Network also includes TMZ.com , a joint venture with Telepictures Productions, Inc. (a subsidiary of Warner Bros. Entertainment Inc.), as well as other co-branded websites owned by third parties for which certain criteria have been met, including that the Internet traffic has been assigned to AOL.
— I agree that AOL has some content muscle here. The question is how much is it worth in a world where good content is a commodity?
— $5 billion? Note that last clause, though (which we’ve highlighted). If AOL wants to persuade us that its user numbers are real, we need to know exactly how much is coming from “other co-branded web sites owned by third parties”, as well as what “co-branded” means.
Paid-search advertising activities on the AOL Network are conducted primarily through AOL’s strategic relationship with Google Inc. (“Google”). In connection with the expansion of this strategic relationship in April 2006, Google acquired a 5% interest in AOL, and, as a result, 95% of the equity interests in AOL are indirectly held by the Company and 5% are indirectly held by Google. As part of the April 2006 transaction, Google received certain registration rights relating to its equity interest in AOL. Beginning on July 1, 2008, Google will have the right to require AOL to register Google’s 5% equity interest for sale in an initial public offering. If Google exercises this right, Time Warner will have the right to purchase Google’s equity interest for cash or shares of Time Warner common stock based on the appraised fair market value of the equity interest in lieu of conducting an initial public offering. The Company cannot predict whether Google will request the Company to register its 5% equity interest in AOL or, if requested, whether the Company would exercise its option to purchase Google’s interest at its then appraised value.
— The GoogleFox is in the hen-house, and will continue to exercise influence over AOL’s destiny.
— Yes, although hard to imagine that Google will force TWX to take AOL public. IPO would be a disaster.
Historically, AOL’s primary product offering has been an online subscription service that includes dial-up Internet access. AOL continued to experience significant declines in the first quarter of 2008 in the number of its U.S. subscribers and related revenues, due primarily to AOL’s decisions to focus on its advertising business and offer most of its services (other than Internet access) for free to support the advertising business, AOL’s significant reduction of subscriber acquisition and retention efforts, and the industry-wide decline of the dial-up ISP business and growth in the broadband Internet access business.
— You really have to look hard these days to find people who haven’t found a better way to access the net than through AOL. Is there anybody who believes that these people are a choice advertising demographic?
— Great point.
The decline in subscribers has had an adverse impact on AOL’s Subscription revenues. However, dial-up network costs have also decreased and are anticipated to continue to decrease as subscribers decline.
— Great. You’re going to save money by having fewer paying customers. Now that’s a business plan.
— Unbelievably, this business is still contributing a significant percentage of AOL’s overall profits. We’ll know how much when they split the businesses.
AOL’s Advertising revenues associated with the AOL Network, in large part, are generated from the activity of current and former AOL subscribers.
— So your main target for advertising is AOL subscriber Luddites? Any plans to fix this?
— Just as important…what are you going to do when you sell this business? Long-term traffic distribution deal? You can’t just let those users disappear.
Therefore, the decline in subscribers also could have an adverse impact on AOL’s Advertising revenues generated on the AOL Network to the extent that subscribers cancelling their subscriptions do not maintain their relationship with and usage of the AOL Network.
— Sounds like a hull collapse to me.
— Yes…so question is what’s left. Our estimate is still $10 billion of value, but that could be on the high side.