Monday, March 24, 2014

AOL's Generous Valuation Dangerous For The Stock- 03/25/2014


  1. Sources: AOL 10K, 10Q MD&A, seekingalpha
    AOL Inc is a leading global media and technology company with worldwide audience. They offer a series of digital brands, products and services to consumers, advertisers, publishers and subscribers.

    3 reportable segments:(2013 Rev 2.3 billion, total OIBDA 481 million)
    - The brand group, generates revenue from a number of owned and operated sites, such as, The Huffington Post, TechCrunch, MapQuest, and also some co-branded websites.
    - The membership group, This segment serves their registered account holders. Revenue comes from subscription and AD offerings on its properties, including AOL mail and marketing compensation from third parties.
    - AOL networks . Network units is consisted of platforms that advertisers and publishers can use to reach customers across all devices. Revenue results include the performance of,, Adlearn Open Platform, etc.
    Revenue breakdown: AD from AOL properties 43%, AD from third party networks 17%, Subscription 28%, others 2%. AD from third party's share of rev increased 9% in 3 years, and subscription's share of rev decreased 8%. Membership group 125%, Brand group 8%, AOL networks -3%, Corporate and other (cost unit) -29%.
    FCF was 79% of OCF and 11% of Rev. (FCF 253 million)
    Uses of CFS:
    1. Acquisitions 134%, 2. Debt repayment 25%, 3.Shares repurchased 57%, 4. Dividends paid 1.6% 5. CapEx 28%

    In 2013, BI global Internet media competitive peers: average 34.3% sales growth, 13.1% profit margin, median 24.6X forward P/E
    In 2013, AOL: 5.9% sales growth 4.3% profit margin , 15.9X forward P/E. AOL had worse performance and is also valued lower by investors.

    - Though brand group and AOL networks generates the majority of revenue, they earned a much less percent share of OIBDA. The membership group contributed more than 100% of total revenue, despite that segment is declining. Outdated services like AOL mail is still very important to AOL, and the other segments have to offset the continued decline of the membership group.
    - From 2011 to 2013, AOL increased profit margins 4% to 7%. SG&A expenses declined by 27%, and gross margins declined from 28% to 26.5% during the same period. It showed that AOL's apparent performance improvement was made on excessive SG&A cost cutting, and it's unsustainable.
    - Competition: its flagship media outlet Huffington Post is in a vulnerable position, facing digital competitors such as BuzzFeed and Reddit and also traditional media companies Washington Post and NY Times. Moreover, AOL's media outlet relies on traffic from links on portal, which is losing subscribers.
    - 9% revenue growth might seem good, but much less than the 32% industry growth in spending on display ads.

    Conclusion: I am bearish on AOL. Though AOL is trading at a lower multiple, its growth and profitability ratios lags behind its competitors, in addition, it faces intense competition without a moat.

  2. Sources:
    - 2013 10K
    - Seeking alpha
    - Yahoo finance

    Business Overview:
    AOL is a leading global media and technology company with a substantial worldwide audience and a suite of digital brands, products and services offering to consumers, advertisers, publishers and subscribers.

    It has three reportable business segments: (% of total revenue in FY 2013; % of OIBDA in FY 2013)
    - The Membership Group, which consists of offerings that serve registered account holders, both free and paid:36%, 124%
    - The Brand Group, which consists of portfolio of distinct and unique content brands as well as certain service brands: 34%,8%
    - AOL Networks which consists of interconnected programmatic and premium advertising offerings that advertisers and publishers use to reach consumers across all devices:34%,-3%

    Revenue by source: 70% from advertising and 28% from subscription, 2% from other.

    Core Businesses: Membership Group
    - Approximately 2.5 million domestic AOL subscribers
    - AOL is losing subscribers, and Membership Group revenue has declined by 19% over the past two years

    Customers and source of revenue:
    - Advertisers on AOL Properties and third party networks, as well as publishers on third party networks generating advertising revenue
    - Subscribed customers generating subscription revenue
    - Relationship with Google generating search revenue

    Internationally, the primary competitors are global enterprises such as Yahoo, Google, MSN, IAC, facebook and other social networking sites, as well as a large number of local enterprises

    Financial Overview:
    - FCF: dropped 22% from 2012 due to decrease in cash flow from operating, driven mainly by a decrease in operating income.
    • FCF as % of Rev: 11% in 2013, 14% in 2012, 10% in 2011, 21% in 2010
    • FCF as % of OCF: 79% in 2013, 82% in 2012, 72% in 2011, 84% in 2010
    • Use of FCF:
    o Acquisition: more than 100% of FCF was used for acquisition payment of $329.5 million related to most use of cash
    o Shares Repurchase: 53% of FCF
    o Dividends payment: 1% of FCF
    o Debt repayment: 24% of FCF
    o Capital expenditure: 66% of FCF
    - Profitability: operating profit margins although much lower than its competitor Google and Yahoo, increased from 8% in 2012 to 13% because of its cutting in SG&A; gross margins have declined from 28% to 26.5%, lower than industry avg.; ROIC 5%, also lower than industry avg.
    - Financial position: D/E remained at 0.02

    What is going right?
    - Acquisition of augmented the capabilities of AOL’s programmatic platform and increased its display ads sales
    - Company’s demand side platform,, has a visitor reach of 85% and has been consistently ranked second behind Google’s ad network for the past few quarters.

    What can go wrong?
    - Revenue:
    • The industry is fairly competitive with low barriers to entry and rapidly shifting consumer tastes, pressure on market share
    • Key AOL properties like The Huffington Post or look vulnerable to losing readers in the coming year
    • Increasing competition with google may put pressure on relationship with google and negatively affect its search advertising revenues
    - Expenses:
    • The rising tide in digital ad spending - 32% growth in spending on display ads- may wipe off 9% increase in rev in Brand Growth
    - FCF:
    • Acquisitions and strategic investments in other businesses could adversely affect FCF

    Overall speaking, I remain negative on AOL mainly because of its declining subscriptions, lower margins.

  3. 2013 10-K
    Seeking Alpha
    Morning Star

    3 Business Segments (Revenue %, YOY growth %) Fiscal year 2013

    - Brand Group 32.8% 9%
    - Membership Group 34.7% (8%)
    - AOL Networks 32.5% 22%

    CORE BUSINESS - Membership Group
    - Membership Group revenue decreased due to the 10% decline in domestic AOL subscribers
    - This decline was partially offset by an increase in ARPU of 8%. This increase is primarily due to price increases related to value plan strategy that provides additional features and services to subscribers.

    NEW BUSINESS - Brand Group and AOL Networks

    - AOL offers advertisers, agencies and publishers access to AOL’s online advertising tools
    - AOL sells advertising on AOL Properties, which include owned and operated content, products and services included in the Membership Group and Brand Group segments
    - Approximately 2.5 million domestic AOL subscribers.
    - AOL offers a range of integrated products and properties including communication tools, mobile services and subscription packages
    - ARPU was $19.85, $18.39 and $17.71 for the years ended December 31, 2013, 2012 and 2011, respectively.

    - Profitability: gross margin 26.5% decreased in the past five year
    - Net margin 4% higher than industry average 2%
    - ROE: 6% matching industry average
    Free Cash Flow:
    - FCF in FY 2013 - $192 million, 27% decrease (from 2012)
    - FCF/CFO 60% in 2013
    - FCF/Revenue 8% in 2013
    Use of FCF
    - M&A payment of $329.5 million related to in 2013
    - Repurchase of common stock
    - $4.4 million Cash Dividend payment
    - Primary competitors are Yahoo, Google, Facebook, MSN
    - Local competitors are TechCrunch, Engadget, Buzzfeed and Reddit

    PRO (what is going right now)
    - Digital video market trend:
    - Cutting cost:
    - Eliminate non-core business:
    - M&A with
    - Margin ceiling: In its role as a facilitator between publishers and advertisers, AOL Networks is essentially a middleman, and that's not a very high margin business most of the time.
    - Intense Competition: Competition among Internet companies offering online content, products and services is intense both domestically and globally and new competitors can quickly emerge.
    - Declining subscriber base: The subscriber base has declined and is expected to continue to decline, which has negative results in the Membership Group revenue.
    - Limit of cost cutting: Cost cutting does not drive growth in the medium of the long term. Already we can see that AOL is starting to reach the limit of its cost cutting efforts.
    - AOL engage in constant dividend payout every year. The revenue fluctuation may affect FCF and dividend