When a 15% Dividend Doesn't Matter
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Anyone who has read my writing in the past knows that I'm a big fan of dividend stocks. However, what I'm not necessarily a fan of is one time special dividends. They are exactly what they sound like: one time items that may never be repeated. This is why when AOL (NYSE: AOL) recently announced they would pay a $5.15 one-time dividend, I couldn't help but yawn. For a company with fundamental issues, paying out a one-time dividend, from a one time cash windfall, seems like the height of short-term thinking. There is some good news for investors, however, as the company is using about $600 million of this cash to repurchase shares. I guess the question for investors is now that we know about the share repurchase and dividend, is AOL worth buying after all of this is completed?
AOL is a classic case of a company that got too comfortable with a very successful business and didn't see the forest for the trees. The company's subscription services was such a cash cow that Time Warner chose to merge with AOL. Time Warner I'm sure thought the subscription model would last. Unfortunately, most people know the end of that story, as Time Warner and AOL ended up splitting again, with the latter being just a shell of its former self. AOL today is essentially two different businesses: display advertising and Internet properties, plus their old-school subscription model. I've written in the past that one thing AOL could do to unlock value for shareholders would be to split these two businesses. In a similar move, United Online (NASDAQ: UNTD) recently announced its intention to split the company by spinning off its more capable flowers business and leaving behind its Internet companies. United Online realizes that its NetZero and United Online businesses are cash cows, but they are dragging down the company's more impressive FTD unit. Ironically, I suggested that United Online take this step before it happened too. When it comes to display advertising, the market is certainly crowded with Google (NASDAQ: GOOG) as the argued leader, and Facebook as a growing presence. The challenge for AOL is that both Google and Facebook have millions and millions of users that AOL simply doesn't have. This is the first challenge the company faces: What type of growth can AOL offer after the dividend and share repurchases are completed?
If you are considering investing in AOL, the first question you should ask is what exactly am I getting? The company's last quarter fairly represents what AOL is capable of, and if you subtract the Microsoft deal the numbers are just not impressive. Without the over $1 billion in licensing revenue from Microsoft, the company would've reported a $71 million loss. In addition, the company's Global Advertising is 90% domestic and 10% international. The problem is that domestic display revenue was essentially flat year-over-year, while international display revenue grew 21%. When it comes to search revenue, AOL essentially doesn't even register compared to larger competitors like Google. The company's search revenue declined 1% even though unique visitors increased 5%. What was primarily troubling was that the company's traffic acquisition cost increased 14%. When you consider that Google has seen paid clicks increase by better than 30%, and their traffic acquisition cost has stayed relatively flat, you can see why AOL is not a real threat to the search giant. AOL's subscription business showed revenue down 13% and subscribers decreased 12%. To be blunt, it's just a matter of time before AOL's subscription services is either spun off or disappears completely. This essentially leaves AOL in a weak competitive position. The only other question is: Does AOL have something to offer investors beyond these one-time actions from the Microsoft deal?
The primary benefit to long-term AOL stockholders of the Microsoft deal will be the company's share repurchases. Though the exact number of shares is very much up in the air, a $600 million buyback at current prices would retire about 17.8 million shares. AOL shows outstanding shares of about 94 million, so 17.8 million being retired would be the equivalent of almost 19% of the outstanding share count. While this sounds good for long-term investors, this is already being accounted for in analyst estimates for next year. In fact, next year's estimates have jumped 37% in the last 90 days, indicating that the company will see a lower share count and possibly improved earnings growth. The company is free cash flow positive, generating an average of $35 million in free cash flow over the last few quarters. In addition, CEO Timothy Armstrong owns over 870,000 shares, and even if we subtract the $5.15 from the current share price, the value of his holdings is over $25 million. Considering his annual pay is just over $3 million, and this means the CEO is betting roughly eight years of his income on a turnaround in the company. This is a strong vote of confidence from the top man at AOL, but even with all this said, there just seems to be better opportunities for investors available.
Once the one time dividend is paid to AOL shareholders, the shares will certainly drop by commensurate amount. This leaves the long-term shareholder with a stock that's closer to $29 as opposed to $34, which is where it trades today. Reducing the stock price to $29, the shares sell for over 23 times next years earnings. By comparison, Google sells for just 15 times 2013 earnings.
While Google is growing its advertising and search revenue by significant amount across-the-board, AOL is only seeing growth internationally. In addition, Google generates significantly more free cash flow for each $1 of sales compared to AOL. In the most recent quarter for both companies, Google produced $0.29 of free cash flow per $1 of sales versus just $0.10 of free cash flow at AOL. This is really the main difference between the two companies: While AOL can use their one time cash windfall to help the stock short-term, Google is in the far superior position and can help their shareholders over a much longer time frame. Considering the weakness in AOL's organic business, unless you're in arbitrage speculator willing to make a bet on the one time dividend, the stock just doesn't look like a good long-term investment.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Google and United Online. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.