The Time Warner AOL spinoff values AOL at about $3.2 billion (pre-spin). This valuation is a reasonable 1X multiple of revenue. More importantly, it sets a very low bar for the stock going forward.
AOL has all sorts of problems, which we have described in detail here. But the spinoff valuation is low enough that the company should be able to generate enough cash to justify it even if the turnaround fails and AOL eventually dwindles away to nothing.
Thanks to AOL’s dying subscription business, revenue and operating income will likely decline for the next several years. But major cost cuts will keep cash flow strong, and Tim Armstrong will likely be able to at least stabilise advertising revenue next year. Given that most people have written AOL off for dead, this sets the table for a modest positive surprise.
In short, even if AOL keeps crumbling, it will likely throw off $3 billion of cash before it dies. One way of looking at the stock, therefore, is that you get an option on the turnaround for free.
Below, we estimate how much cash AOL will generate over the next few years. We also introduce the world’s first AOL EPS estimates. To wit:
2010E EPS: $3.20
2011E EPS: $2.80
2012E EPS: $2.45
We’ll adjust those estimates when we see the magnitude of AOL’s cost cuts, which should take place just after the spinoff.