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AOL, Inc. (AOL) Is Down and Out, Buy Microsoft Corporation (MSFT) Instead?

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AOL, Inc. (NYSE:AOL) has been working on a turnaround for some time now, moving away from being an Internet search contender and Internet provider to a full-blown content company. This is currently one of the things Yahoo! Inc. (NASDAQ:YHOO) is struggling with, finding its path; will it continue to try to contend with the Google Inc (NASDAQ:GOOG) search giant or make the full-blown move to the content and display space? It appears that with the recent Tumblr acquisition, Yahoo! is embracing its life in the content market.

AOL, Inc.AOL, Inc. (NYSE:AOL) of late

AOL, Inc. (NYSE:AOL) was once the leader in providing dial-up software, funneling dial-up customers through its web browsers and generating ad revenue. However, Google Inc (NASDAQ:GOOG) soon took over the search game and the Internet began to change, leaving AOL behind.
Since then AOL, Inc. (NYSE:AOL) has struggled, but it has gained traction in generating ad revenue. AOL now operates an extensive suite of brands and offerings, including online content, products and services. Its key properties are now throwing off strong revenue growth, including the Huffington Post, Patch and Games.com. But has AOL’s stock outpaced itself?
AOL, Inc. (NYSE:AOL) posted first-quarter EPS of $0.33, compared to consensus of $0.35; its stock tumbled more than 10% on the news.  But despite missing EPS expectations, the company saw top-line growth in its advertising revenue for the first time in five years.
However, from a valuation perspective, AOL has traded at a five-year average relative P/E of 163%, but currently trades at a 188% premium. AOL has managed to outperform Yahoo! Inc. (NASDAQ:YHOO) lately, and was up almost 100% for 2012, but it’s the future we look to. I think that Yahoo! could be the the turnaround bet of 2013, whereas AOL was the turnaround story in 2012.

The better bet

Yahoo! reported first-quarter EPS that was up 11.6% sequentially and 48.7% year-over-year. Some of the future growth for Yahoo! should be in the display market. Yahoo! has plans to continue improving ad quality, better user experience and add new ad products to help drive click-through rates. The number of paid clicks jumped 16% sequentially last quarter, the fourth straight quarter that growth has accelerated.

The big news of late for Yahoo! is its $1.1 billion purchase of Tumblr, which has more than 100 million users, but little revenue. The deal has been compared to some of the other major tech deals that have allowed large-tech companies a chance to reinvent and re-innovate. Such deals include Google’s purchase of YouTube for $1.6 billion some seven years ago and AOL’s acquisition of Huffington Post for $315 million in 2011.

Yahoo! handed its search duties over to Microsoft Corporation (NASDAQ: MSFT) in 2010, allowing Bing search engine results on its websites. As part of the deal, Yahoo! pays Microsoft Corporation (NASDAQ: MSFT) 12% of the revenue from ads on those pages. Yahoo! is now interested in getting out of the partnership.
The deal would allow either party to opt out in 2015, but one of the big issues is that without Microsoft Corporation (NASDAQ: MSFT) to power its search, the company could be left behind in the search market. Search is still a big part of the Yahoo! business model, accounting for $1.9 billion of Yahoo!’s nearly $5 billion in revenue for 2012.

In 2012, the company generated 38% of revenue from display advertisements on its own sites, and the balance from search and other activities. What’s impressive is that Yahoo! currently gets no material revenue from mobile ads, leaving a huge market for the company to tap into.

Other than its search battle, part of the underlying value at Yahoo! is its Asian assets. Its investment in Chinese Internet company Alibaba had September- quarter revenue growth up 74%. Alibaba owns more than 80% share in China’s eCommerce market and an IPO in the next year or so could unlock a sizable profit for Yahoo!.
Microsoft Corporation (NASDAQ: MSFT) posted recent quarterly results (fiscal 3Q) with EPS that beat the consensus estimate by 7.5% and beat the 5.5% average positive surprise over the last four quarters. Microsoft also ended the quarter with cash of more than $74 billion, up approximately $6.2 billion during the quarter.
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