A few readers have said we’re too bullish about AOL. This is refreshing, given that we’ve also been blasted for being too critical of the company in recent years.
But in any event, in the interest of balance, here’s some logic from AmTech analyst Ben Schacter, who thinks AOL’s stock is a dog:
We are initiating coverage of AOL with a Neutral rating and $25 price target. AOL is a company with significant challenges ahead in all of its business segments. The subscription business will continue to decline and eventually be shuttered. We value this business at just $6 per share based on a DCF analysis, which implies an EBITDA multiple of just 1.5x based on our 2010 estimates. The advertising segment has three components: O&O display, O&O search, and a third-party ad network business. We value the ad businesses in aggregate at ~$19 per share, which implies a 5.7x multiple on 2010 EBITDA.
We expect each of the advertising businesses to continue to decline through at least 2011. The search and network businesses will come under the most near-term pressure as AOL seeks to address over-monetization, while the O&O display business should benefit from management’s re-focus on premium ad inventory. The key issue facing the O&O businesses is that they are driven by usage on the AOL properties. This usage has been in decline for years, and perhaps the most concerning issue is the acceleration of the declines over the past nine months (see the chart below). If the new management team cannot fix user engagement, most of the other initiatives will not mean much. To that end, the company has laid out a strategy to focus on “niche-at-scale” content and advertising. We are simply not believers in this strategy, and we do not give the company credit for it working.
Bulls will argue that there is upside if the company continues to harvest access dollars while optimising margins in the advertising businesses. It is true that there is significant upside potential if AOL can just get its advertising margins more in-line with its peers. However, with audience loss headwinds from the continued declines in the access subscribers and accelerated declines overall in its key AOL properties (homepage, mail, AIM), coupled with our scepticism of the “niche-at-scale” strategy, we simply think it may be a long wait before overall margins might improve. The bottom line is that while shares of AOL may look attractive on a comparative multiple basis, we recommend investors wait for a more compelling entry point.
For investors looking for an attractive potential turn-around story, we favour YHOO shares over AOL. YHOO user metrics have remained much stronger than AOL’s, and we believe that YHOO is better positioned for margin improvement. We reiterate the three key reasons why we like YHOO shares: 1) Macro turn-around, 2) Margin transformation, and 3) Asia assets. Additionally, GOOG remains our top pick in the space as it should benefit from significant monetization improvements, share gains, an improvement in the macro environment, as well as upside from display and mobile.
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