Time Warner (TWX) AOL: Estimating Q3/Q4 EBITDA Drop

Time Warner CEO Dick Parsons mentioned yesterday that AOL’s subscription business accounted for “the majority” of the company’s profit.  This allows us to take a more informed look at the likely impact of AOL’s ongoing subscriber declines on the company’s EBITDA.  It also allows us to more precisely estimate the value of AOL’s portal business: $20 billion.

Conclusion: As previously discussed, AOL’s EBITDA will likely decline significantly in Q3 and Q4 (from $485 million-range to $400 million-ish).  If AOL wants to maintain Q2’s EBITDA, it will likely have to cut about $75 million of cost (e.g., fire people).  Detailed analysis after jump.  Please see posts below for our maths on AOL’s hypothetical mass firings.

High-level Analysis:  If AOL’s subscription business accounts for the “majority” of AOL’s EBITDA, that means that the advertising business generates less than $240 million of quarterly EBITDA.  Parsons said AOL plans to sell the subscription business in 12-18 months, and under this scenario, we can draw a simple conclusion  AOL will soon consist of a portal business with $2 billion of revenue and about $1 billion of EBITDA.  At, say, a 20X EBITDA multiple, that business would be worth about $20 billion.

Q3 and Q4 Analysis
: As AOL has not yet sold he subscription business, we ran numbers using the following assumptions to estimate future EBITDA:

  • AOL ends Q3 with 9 million subs (per Ron Grant) and Q4 with 8 million
  • Revenue per sub drops to $20, then $18
  • Subscription business was 50% of EBITDA in Q2
  • Advertising grows 10% Y/Y in Q3 and Q4
  • AOL has already captured most cost savings from “going free”
  • 50% of change in advertising and subscription revenue flows through to EBITDA.

Under these assumptions, we conclude that AOL’s EBITDA will likely drop about $75 million in Q3 (to about $400 million) and stay largely flat in Q4 (because of the big gain in Q4 advertising).  If AOL management wishes to maintain current levels of profitability, therefore, it will have to cut about $75 million of cost.  Please see this spreadsheet for details.

AOL Opens Kimono: Yuck
AOL To Fire Thousands to Save Profit?
How Many People Does AOL Need to Fire: A Productivity Analysis
AOL Mass Firings: The Bottom Line