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Is This the Best Internet Turnaround Play?

Dan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

AOL (NYSE: AOL) has rewarded its shareholders handsomely over the past several years, and it seems as though quality leadership might lead to stock appreciation in the future. While there are definitely some bright spots, some concerning factors are being overlooked by investors.  

The good news

CEO Tim Armstrong has done a good job turning around the company. He understands industry trends and plans accordingly. He also believes that the Internet will go from being primarily a search and find vehicle to a programming vehicle. If he’s accurate, then AOL will be well positioned for future trends.

AOL has also made some key acquisitions over the past several years, including the Huffington Post. Other AOL online properties include StyleList, TechCrunch, Patch, MapQuest, Moviefone, and Games.com.

In addition to investing in future industry trends, AOL continues to buy back shares. The board recently approved a $150 million buyback, which will be implemented over the next 12 months based on market conditions. AOL does have a strong history of buying back shares at the right times.

Another potential positive is that Citigroup recently initiated a Buy rating on the stock.

The bad news

While there has been much excitement surrounding AOL as of late, revenue has still declined over the past four years. This hasn’t affected the stock price because earnings have significantly improved. However, long-term stock appreciation isn’t possible without top-line growth.

You might think AOL is likely to see top-line growth based on being ahead of the curve for online trends, and there’s a good chance that you’re correct. However, it should be noted that one trend is concerning, which is an aging user base.

As mentioned above, AOL owns several internet properties. Unfortunately, in most cases, the leading age demographic that visits these sites is over 55 years old. For example, according to Alexa.com, the most over-represented age groups for the following sites are as follows:

  • AOL.com: 65+
  • HuffingtonPost.com: 55-64
  • StyleList.com: 55-64
  • TechCrunch.com: 25-34
  • MapQuest.com: 55-64
  • Moviefone.com: 55-64
  • Games.com: 18-24 and 65+ (tie)

This presents a problem. Unless AOL executes some highly effective marketing, its user base will age and it will lose visitors. Of course, AOL is making moves that will cater to the younger age demographic, but to this point in time, AOL’s approach hasn’t been effective in that regard.

Another concern is a decline in global market share for digital ad revenue. Below are some important numbers (courtesy of emarketer.com):

 

2012 Market Share

2013 Market Share

Google

31.46%

33.24%

Facebook

4.11%

5.04%

Yahoo

3.37%

3.10%

Microsoft

1.63%

1.78%

IAC

1.39%

1.47%

AOL

1.02%

0.95%

AOL versus peers

Despite revenue declines, AOL is a highly efficient company with strong margins, which is often a sign of quality management. Another sign of quality management is the company’s debt-to-equity ratio of just 0.05. Therefore, debt won’t impede growth potential.

Google (NASDAQ: GOOG) is a much larger company, and revenue and earnings have consistently improved annually. Google is the most visited website in the United States (second-most visited website in the world), and its product diversification goes beyond the internet. 

Just like AOL, its efficiency and debt management are excellent. In short, it’s one of the best-run companies in existence. While short-term stock price fluctuations are possible, Google should continue to reward shareholders over the long haul -- barring a complete market collapse.

Google seems to have a goal of entering industries where it knows it can steal a significant amount of market share. Its Android operating system is a huge player in the mobile device business, its search dominates competitors, its maps are widely known as the best option available, and Google Fiber has the potential to change the way we watch television and use the Internet.

And those are only a few examples. You should also expect more innovation from Google moving forward, as that's what the company loves to do with its enormous cash pile. 

Yahoo! (NASDAQ: YHOO), like AOL, is a turnaround story. After three years of revenue declines, revenue rebounded slightly in 2012. And despite a slight setback in 2011, earnings have trended higher over the past several years. Unlike AOL, Yahoo! has made successful acquisitions to target a younger audience. The most recent example is Tumblr.com, which has an over-represented age demographic of 18-24.

However, over the past three months, pageviews-per-user declined 12.34%, time-on-site dropped 12%, and searches plummeted 25%. It’s possible that Tumblr lost its cool image after a big public company like Yahoo! acquired it, but it’s too early to tell. Like AOL and Google, Yahoo!’s management has also done a superb job with efficiency and debt management.

Conclusion

Google should be the safest play going forward, and Yahoo! is in the midst of a successful turnaround, making it a quality investment option. AOL is bit more of a gamble. The company seems to be making wise decisions, but execution is still questionable. If AOL is correct about future internet trends, then it could benefit in a big way in the future, but it still needs to attract a younger user base in order to see sustainable top-line growth.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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