Positive Fundamental Trends and Dividend Catalyst Make AOL a Good Buy
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AOL Inc. (NYSE: AOL) has performed well so far this year, with its stock gaining 85%. Management’s efforts to unlock shareholder value and the company’s content focused strategy seem to be working. The company’s recent acquisitions are generating good revenues, and AOL’s Patch is starting to moderate its losses. In the first quarter, AOL posted EBITDA of $94MM, well above Street estimates of $77MM. Global advertising also continued its upward trend, as advertising revenue showed its fourth consecutive quarter of Y/Y growth, rising 5%. With these positive results and new management strategies helping the company return to its sustainable long term growth trajectory, we rate the stock as a buy.
Key Positives for AOL:
$1B in patent sale proceeds to be returned to shareholders: AOL recently sold 800 patents related to internet technologies to Microsoft (NASDAQ: MSFT) for approximately $1.1B in cash. After the sale, AOL retained 300 of its patents. With this move AOL will be able to focus its strategy around building content rather than trying to sue its competitors.
Further, on June 28, AOL management indicated that all the proceeds from the Microsoft patent deal will be distributed to the shareholders by the end of 2012. AOL has structured the move so that the taxes on the cash proceeds will be immaterial. This definitely is a welcome move from the shareholders' point of view.
Patch has started to sustain itself: Patch could be an organic game changer for AOL in the long term. Patch, as a local knowledge platform, is gaining users and has performed well in the month of May, with a 14% increase in unique visitors over April, moderating its losses and expecting to hit profitability by the end of 2013. AOL expects Patch to generate $40-50 million in revenues this year. Patch has generated 115% of 2011 revenue thus far in 2012.
Mergers and acquisitions bringing in revenues: AOL third party revenues (Ad.com and acquisitions) have grown for the seventh straight quarter to $110.2 million, showing 23.3% Y/Y growth. AOL has been working towards the integration of its many acquisitions such as Huffington Post, Techcrunch, Pictela, and Goviral to provide an end-to-end solution for advertisers and publishers. With increasing contributions from these networks, AOL can expect significant revenue growth.
Additional revenue opportunities (Project Devil and AOL Video): Project Devil is a way to have interactive ad content on websites and mobiles. According to AOL, Devil ads have 4x the engagement rate, 3x the engagement time, and increase purchase intent by 263%. Right now Devil ad penetration is less than 1% and, for every 1 percentage point it increases, revenue is expected to increase by approximately $40 million, making it a great prospect for AOL. Apart from that, AOL Video has emerged as the 6th largest video network in the US, selling 1 billion video impressions in 2012 Q1 compared to 500 million in 2011 Q1.
To conclude, AOL’s fundamentals are headed in the right direction. Its content focused strategy seems to be working, with Patch losses dropping and M&A bringing in more revenues. The company also has additional revenue opportunities in the form of project Devil and AOL video. In addition to fundamentals, the company’s shareholder will be rewarded handsomely by year's end, as AOL shares will see benefits from the Microsoft deal in the form of dividends. We find the risk-reward for the stock attractive at current levels.
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