AOL had another horrible quarter, as expected. The good news is that the quarter wasn’t much MORE horrible than expected. In fact, on a revenue and EBITDA basis, it was basically in line.However…
One metric that might slip under the radar but is nevertheless important is Free Cash Flow. Despite huge cost cuts, AOL’s Free Cash Flow tanked year over year–dropping a sickening 55% ($153 million). This compares a revenue drop of only 23%.
Why did Free Cash Flow drop so much?
In part because much of the revenue that AOL is losing is wildly profitable, while the revenue it’s keeping is low margin. Specifically, the high margin revenue AOL is losing is subscription revenue, which declined 28% ($90 million) year over year, and the search revenue, which fell 27%, or $45 million.
Now, everyone knows AOL’s subscription revenue is collapsing. But what fewer people understand is that the subscription revenue and search revenue are tightly linked, and they are both vastly more profitable than AOL’s media and ad network business.
At first glance, the linkage between search and subscription revenue seems counterintuitive: As AOL focuses on growing its media properties, shouldn’t search revenue increase? In fact, the answer is “no.” Because as AOL explains in its press release, its subscribers search much more frequently than its free media readers.
As the company loses those subscribers, therefore, it also loses big chunks of search revenue. And that search revenue is nearly 100% profit (because Google serves the ads). The subscription revenue, meanwhile, which is still composed largely of dial-up subscribers who rarely use dial-up, is also highly profitable.
That’s one of the hidden realities of AOL’s business. And there’s not much the company can do about it.
As the subscriber business continues to decline, more of the search revenue will disappear. It’s possible that Microsoft Bing will come in later this year and pay a silly amount of money for AOL’s remaining 3% of the search market, but even this won’t likely restore AOL’s search business to growth. So the outlook for cash flow is likely to remain worse than it is for revenue, even if AOL stabilizes its media business.
On a positive note, AOL is finally starting to sell off non-core assets (ICQ). And it should be able to raise a reasonable amount of cash for doing so.
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