AOL's Results Slightly Less Horrible!

AOL CEO Tim Armstrong at NYSE

AOL just released its first earnings as a born-again public company.  They were bad, but not awful.  And they contained a few positive signs.

Key points:

* Advertising revenue declined only 8% overall.  This is bad, but much better than the decline in prior quarters, which peaked around 20%.  Importantly, domestic display revenue–AOL’s new core business–grew for the first time in two years.  (The decline mainly came from search and international display).

* U.S. domestic display revenue actually grew (1%).  This is AOL’s core business now, so the turnaround is important.  International display declined 22% (ouch), but AOL has basically exited this business, so it’s irrelevant.  Notably, Yahoo’s domestic revenue didn’t grow, so AOL actually gained a bit of share here.

* The ad network business has stabilised (-1%).  We still think AOL should sell (which might fetch as much as $1 billion), but, regardless, it’s encouraging to see its revenue stabilise.

* Operating income and cash flow dropped precipitously, but this problem has now been dealt with.  Operating income was hammered by traffic acquisition costs from a lousy PC-distribution deal and a bloated cost structure.  Both have now been addressed, so operating income should pick up in Q1 and Q2.

* And now for the bad news….Search revenue dropped 19%.  AOL’s ad revenue is comprised of three businesses: Display, Network, and Search. Search is a third of this–a ~$600 million business with almost 100% profit margins.  The reason it is declining is that the people who use AOL Search are mainly subscribers to the old dial-up service, and as they leave, they take their searching with them.  This trend will continue, and there’s little AOL can do about it.

* Subscription revenue dropped 28%, an acceleration from last quarter.  There are no signs that the loss of subscribers is abating.  As they leave, they often take their searching and other activities with them. 

* Lastly, there is some scant evidence that AOL’s media properties are growing despite the loss of subscribers.  The company has stopped reporting pageviews, but it is now reporting a smorgasbord of measurements of “uniques”.  Some of these say traffic has increased, some say it has declined.  So take your pick.

(OK, more precisely: Uniques to “AOL Properties” decreased 8%, by one measure.  Uniques to “AOL Media,” meanwhile, increased 4%.  So we’ll call it a wash.)

Bottom line, AOL’s opportunity remains the same:

  • Sell off non-core properties for $1+ billion
  • Restore the domestic ad business to solid growth
  • Buy stuff that complements the new core business
  • Figure out some way to retain the remaining paying subscribers by giving them something worth paying for

If AOL can do most of that, the business will be worth considerably more than the ~1X revenue it is trading for now, especially when it is eventually acquired by Microsoft or Yahoo.

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