Few companies have transformed over the past two decades as much as AOL, Inc. (NYSE:AOL). Once the largest dial-up online service in the United States, the company nearly crumbled after its horrible marriage to Time Warner Inc (NYSE:TWX), only to be reborn as the one of the largest content farms on the Internet. Now, as AOL enters a new age, it is experimenting with hyperlocal news and partnering with Facebook Inc (NASDAQ:FB) for increased exposure to social media.
My dear investors, it’s time to visit the past, present and future of AOL to see if this resourceful icon of the Internet can keep growing in this decade of rapidly shifting advertising trends.
The Past: Welcome to the walled garden!
For those of us who remember getting online in the 1990s, America Online’s “walled garden” was synonymous with the Internet. Its “Welcome” and “You’ve got mail” greetings became so well known that they became the basis of a movie starring Tom Hanks and Meg Ryan in 1998.
By the dawn of the millennium, AOL, Inc. (NYSE:AOL) had over 20 million subscribers in the United States, and media giant Time Warner, eager to become one of the largest media conglomerates in the world, merged with the company in 2000. Right after that ill-fated merger, AOL’s total subscribers plunged from over 25 million to approximately six million between 2001 and 2009.
Infuriated by AOL’s continuous loss of subscribers, Time Warner gave up and spun off AOL in 2009, calling it “the biggest mistake in corporate history.” At that point, many people believed that AOL, Inc. (NYSE:AOL) was finished, destined to fade away and cataloged in the annals of Internet history somewhere between ARPANET and Facebook.
The Present: Welcome to the farm!
But AOL wouldn’t die. As an independent company, it evolved into a family of content-providing media websites, including TechCrunch and the Huffington Post, among others. By the end of 2012, AOL had invested $600 million in ‘content farms’ to drive traffic to its sites, which translated then into ad revenue. It invested heavily in legions of low-paid bloggers to churn out content recycled (or ‘aggregated’) from other news sites, with the goal of creating as many articles as possible.
In other words, it borrowed a play from Demand Media Inc (NYSE:DMD)’s content farm business model. However, it didn’t devolve completely into a sprawling content farm like Demand Media. AOL, Inc. (NYSE:AOL) still retained its portal website, which still has search, chat and e-mail capabilities, much like its fellow dot-com survivor Yahoo! Inc. (NASDAQ:YHOO). This has kept AOL set on a different growth trajectory than Demand Media, which does not have a portal website. Although Demand Media’s revenue growth looks impressive, it is far smaller than either AOL or Yahoo!, and is currently unprofitable.
During the fourth quarter, AOL earned $0.41 per share, or $35.7 million – in line with analyst estimates, and a significant improvement from the $0.23 per share, or $22.8 million, it reported in the prior year quarter. Revenue rose 4% to $599.5 million, topping analysts estimates of $573.7 million.
AOL, Inc. (NYSE:AOL)’s global advertising revenue rose 13% to $410.6 million, comprised of 17% growth in its search business and a 31% gain in its third party ad business, AOL Networks. However, its domestic display ad sales slid 3%.
It’s also important to note that AOL’s dial-up subscription business – once its bread and butter – hasn’t died out yet. The business posted a 10% year-over-year decline to $174.2 million, but still accounts for 29% of AOL’s top line.
The Future: Hyperlocal News and the Facebook Exchange
Last year, AOL spent approximately $300 million to develop Patch, a site that specializes in local news. Although Patch initially posted promising growth last year, Hurricane Sandy affected over a third of the towns in Patch’s network last October. In addition, Patch emphasized cost reductions over ad sales, since expenses for the segment at one point exceeded $40 million per quarter. For the full year, Patch’s approximately 900 sites generated $34 million in revenue, falling short of the $40 million to $50 million that CEO Tim Armstrong had forecast six months ago.
Despite those losses, Armstrong has remained adamant that the network will achieve profitability by the fourth quarter of 2013. Armstrong has noted that Patch can recoup its losses by working with metropolitan newspapers, television stations and regional advertisers – which were previously neglected in favor of larger networks and companies. Armstrong also stated that AOL, Inc. (NYSE:AOL) is planning to roll out a simpler version of Patch that “focuses on three or four things” rather than a wide variety of news items.
However, I have doubts regarding the growth of Patch, which is only available in limited areas of 23 states. Last month, Comcast Corporation (NASDAQ:CMCSA)’s NBC division shut down Everyblock, its ‘hyperlocal’ answer to Patch, which bodes ill for AOL.
While Patch’s future is still up in the air, AOL’s recent partnership with Facebook Exchange looks promising. AOL, Inc. (NYSE:AOL) has integrated Advertising.com (part of AOL Networks) into Facebook’s new advertising exchange, which allows it to use the exchange to purchase ads for its clients. Facebook currently has a two-tiered advertising system – the first, its internal one, uses user profiles to generate targeted advertising within the social site. The second, Facebook Exchange, allows outsiders to purchase advertisements to be displayed in the social network, which do not use specific user-targeted data.
In other words, AOL Network clients will be able to buy ad space on Facebook’s advertising platform, which reportedly generates over a billion page impressions daily. This is a win-win solution for both parties, as it expands AOL, Inc. (NYSE:AOL)’s advertising presence into social networking, while allowing Facebook to reach out to a larger group of advertisers. The main loser here is Google Inc (NASDAQ:GOOG) – which has been intentionally locked out of Facebook Exchange.
The Bottom Line
AOL’s fundamentals look robust in comparison to its industry peers, showing off some beefy margins, strong past performance and excellent bottom line growth.
| Forward P/E | Price to Sales (ttm) | Return to Equity (ttm) | Debt to Equity | Profit Margin | Qty. EPS Growth (Y-O-Y) | Qty. Revenue Growth (Y-O-Y) | |
| AOL | 22.58 | 1.27 | 48.46% | 4.92 | 47.84% | 56.60% | 3.90% |
| Yahoo! | 19.54 | 5.21 | 29.06% | 0.25 | 79.12% | -7.90% | 1.60% |
| Demand Media | 17.90 | 1.93 | 1.35% | 0.31 | 1.62% | N/A | 22.20% |
| Advantage | Demand Media | AOL | AOL | Yahoo! | Yahoo! | AOL | Demand Media |
Source: Yahoo! Finance, 3/28/2013
Although AOL looks like a decent choice for growth investors, there are a few speed bumps ahead to look out for. First is AOL’s aging dial-up business, which accounts for nearly a third of its revenue. This business is steadily shrinking and could cause losses if gains from its advertising segment aren’t strong enough. Second is Armstrong’s insistence on pushing Patch to be a winner, despite some clear warning signs that his plans might not pan out. Lastly, AOL, Inc. (NYSE:AOL)’s entire network could be threatened by Google’s ongoing war against content farms, which has penalized low quality sites filled with recycled material by excluding them from search results.
Those three concerns aside, I believe that while the past was bleak for AOL, the present and the future could be brighter for the company that defined many of our earliest personal experiences on the world wide web.
The article The Past, Present and Future of AOL originally appeared on Fool.com and is written by Leo Sun.
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