Wall Street is starting to weigh in on AOL’s stock, which will start trading today.
Here’s Doug Anmuth of Barclays. His conclusion is slightly more optimistic than ours, but the underlying message is the same: You’ve got upside!
AOL when-issued shares begin trading today and will go regular-way on December 10. We do not currently have a rating or price target on AOL shares, but we believe they are fairly valued in a range of $35 – $39, which implies a 2010 market cap of $3.8 billion – $4.2 billion. This range corresponds to roughly 8-9x 2010E PF EPS and 3.0-3.5x 2010E EBITDA based on our assessment of earnings potential.
- We expect AOL’s revenue and profit declines will moderate over the next few years, but we do not project growth in our model in any year through 2014. Our 2009-2012 3-year CAGRs for revenue and EBITDA are -8% and -10% respectively. AOL should be able to expand margins slightly in 2010 as the company removes a significant amount of costs, primarily by reducing its workforce by one-third. But most importantly, we expect the Access business to remain a solid generator of FCF going forward, despite continuing subscriber losses. We project ~$700 million in free cash flow potential in 2010, or nearly $6.50/share.
- We believe AOL’s strategy under new Chairman and CEO Tim Armstrong is more aggressive than recent efforts toward both cost-cutting and content differentiation. With much of the access cost structure already optimised and transferred from fixed to variable, management is now deeply removing costs across other business lines, right-sizing the company to be leaner and more competitive. And on the advertising front AOL is more focused on Owned & Operated (O&O) display and content creation through both AOL verticals and a network of smaller, non-AOL branded sites.
- However, we believe executing a return to growth for AOL will be very challenging going forward. We project the access business will continue to decline ~25% annually over the next few years and access subs are among the most engaged on the AOL platform. AOL’s strategy of differentiating itself through content creation and more vertical sites will be difficult in an increasingly competitive online advertising space and with declines in unique visitors and page views likely to continue.
- Key things to watch for: 1) Time Warner shareholder reaction following the spin; 2) significant cost-cutting to drive free cash flow; 3) a new search deal beginning in late 2010; 4) whether AOL’s display strategy can gain traction; 5) trends in key metrics like Unique Visitors and Page Views.
- Earnings potential 2010: Revenue $2.8B (-13%), EBITDA $1.014 billion (-13%, 36.1% margin), PF EPS $4.38, FCF $692 million (-21%).
- Earnings potential 2011: Revenue $2.6B (-7%), EBITDA $925 million (-9%, 35.3% margin), PF EPS $4.31, FCF $565 million (-18%).
Here are Doug’s estimates: