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Have These Tech Icons Found Their Way?

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

Most of the early internet portals have long since disappeared, or they were swallowed up by larger, more diversified companies. Excite, @Home, and go.com were a few of the high-flying names whose long-term business plans didn’t quite match their hype. Two of the biggest portals, AOL (NYSE: AOL) and Yahoo (NASDAQ: YHOO), have survived on the strength of their investment holdings, but the companies have generated little revenue growth lately. So, do these icons deserve a place in investors' portfolios?

Fighting a giant

AOL and Yahoo previously tried to provide an all-encompassing suite of internet services, which included access, search, shopping, and online business marketplaces. Unfortunately for them, Google (NASDAQ: GOOG) came along in the late 1990s to dominate the search market, with a current domestic market share around 70%. Its dominance is so prevalent that AOL and Yahoo currently outsource their text-based search results to Google and Microsoft, respectively.

In FY2012, Google continued to report strong financial results, with a 21.5% organic increase in revenues, excluding the revenue from its recent purchase of Motorola Mobility. While the company generated a 34% increase in total paid clicks, it had to pay more for the customer traffic, as acquisition costs rose 24.3%. In addition, Google’s entry into the low-margin manufacturing space through its Motorola acquisition reduced its overall operating profitability. However, the company’s massive operating cash flow, with $16.6 billion generated in FY2012, allows it to continue investing heavily in non-search growth markets.

Slimming down

Active investors have been fomenting positive change at AOL and Yahoo for a number of years, often in their respective boardrooms. At AOL, the changes have included the outsourcing of its text search business to Google, as well as the sale of some of its patents to Microsoft for roughly $1 billion. AOL now focuses on providing advertising services to its third-party network, which is a segment that grew 31% in 2012. The company has also been building its strength in content through the acquisition channel, with purchases of TechCrunch in 2010 and Huffington Post in 2011.

In FY2012, AOL reported a slight 0.5% decline in revenues, but its adjusted operating income rose 1.0%. While the company’s brand and membership divisions had lower revenues, its third-party network benefited from a 23% increase in search activity. Despite a strong user base for its affiliate network, though, AOL still generates virtually all of its operating profit from the declining internet access business.

Looking ahead, AOL realizes that its future lies in the delivery of compelling content and advertising through both its proprietary properties and its affiliate network. It has wisely returned cash from its 2011 patent sales to shareholders through a special dividend and an ongoing share repurchase program. The new AOL will be a smaller, more focused entity capable of generating long-term shareholder returns, rather than the behemoth that merged with Time Warner.

The revolving corner office

Meanwhile, Yahoo seems to have a new CEO every year, but none of them have been able to create significant sales momentum. In FY2012, the company reported flat revenue growth compared to the prior year, while adjusted operating income rose 2.7%. Yahoo’s outsourcing of its text search capabilities to Microsoft seems to have stemmed its market share losses, but the company looks unable to pick up ground against Google’s search engine.

However, Yahoo is a fairly low-risk investment option while management, including new CEO Marissa Mayers, tries to generate incremental returns from its affiliate network and popular stable of finance, sports, and news portals. The company’s cash and equity stakes in Alibaba and Yahoo Japan were valued at roughly $21 billion as of December 2012, with the rest of the company being valued at around $4 billion. While Yahoo recently released an outlook for FY2013 that is flat with financial results in 2012, any upside should provide a nice boost to the company’s intrinsic value.

The bottom line

Activist investors used old-fashioned, brute force tactics to convince management teams at AOL and Yahoo that they needed a different business approach. The companies’ future results are increasingly tied to their ability to develop and distribute content that is timely, relevant, and entertaining for consumers. While the jury is still out, these two companies are making the right moves and have earned a spot on investors’ watchlists.

Robert Hanley owns shares of AOL and Yahoo. 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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