As a strategic advisor to clients, I am constantly evaluating the Internet landscape and one conclusion I’ve reached recently is that next week’s AOL analyst day puts AOL in play…period. The analyst day that is coming up next week is the defining event in the company’s recent history in my opinion: either the company can convince investors that it sees a path to profitable growth or it can’t. With the former, investors could get behind the stock, driving it higher; while with the later, the Bears likely press shorts, making AOL’s market value too cheap to core asset value for Strategic / Financial players to pass up. Either way, I think investors win by owning the stock before analyst day.
Below I’ve listed my Top 10 items that I think CEO Tim Armstrong and AOL must address in their first analyst day since being spun out from Time Warner. At <$20, the stock is languishing almost 20% below is spin price (~$23) and time is running out. I think AOL needs to address the below concerns to give investors confidence that Tim has the company headed in the right direction – and just as importantly, that he also has the recognition and willingness to sell or break up the company if it appears his strategy isn’t proceeding as hoped. Tim Armstrong in only 40 years old, and I would have to believe that a stand alone $2b market cap company CEO isn’t his swan song. Making investors money by building his vision or seeing a high value strategic alternative will be critical to the future careers of him and his top management. I think its likely that one of Eric Schmidt’s dubbed “Gang of 4” ultimately acquires AOL to leverage what they want; given current prices, any of these acquirers can take the assets they want for free, while selling off what they don’t need (explained more below).
So having said all of that, here is my view on what AOL needs to address next week at their analyst day:
1) Emphatic Clarity on the Leadership – There has been some concern that AOL is no longer solely Tim’s company, and that Arianna may be better positioned long term to run the company. I think it must be clear that this is Tim’s company – investors invested in him and his vision. Arianna is a strong and powerful ally to Tim, but it should be made clear who’s the boss. Further, Tim should clearly articulate to investors what he thinks AOL is today, where he’s steering the company, and what’s the correct strategy to get there. Ultimately he should re-assure investors that they are investing in him, and that he is trying to maximize the value of the assets he was given (which could entail selling the company or breaking off pieces). In the end, whether AOL succeeds in its plans or fails, Tim should ultimately be the one judged. My view is that Tim is intelligent, aggressive, and focused on either building the premier online asset, or maximizing shareholder wealth through asset sales if his growth plans look untenable – he must underscore that he will be a good steward of shareholders capital and avoid “hail Mary acquisitions”.
2) Show Path of Core Display Growth and Profitability – The core display business is the key to what Tim is trying to turn around. Not only is AOL trying to grow core domestic display, but the unit hemorrhages a ton of cash each year (>$300m this yr including Search). The company needs to provide a roadmap for investors on how AOL can achieve market double digit topline growth rates, and how it can do so profitably. How long should it be before AOL can reach healthy growth at industry margins? And if it can’t grow profitably, is it best to break up the company now and sell off the pieces to maximize value and avoid wasting cash. What are the metrics that investors should be looking for to indicate progress?
3) Monetize Access and use the cash to build the Vision – In my opinion, its time for the company to sell the access business, and given the financial firms I’ve spoke to, there’s interest. I also hear that there’s nothing technological that would prevent the split; in fact, as part of this, AOL could structure the deal to the likely buyers with agreements to still point the traffic to AOL.com for a certain period of time – this would help alleviate any traffic ramifications. Also, AOL should retain co- rights to the customer data, which can be used to sell ancillary services, or even provide a payments platform. As for what to do with the proceeds, Tim could use the cash to purchase more premium content prudently (maybe something in his 80/80/80 “local, women, influencer” mandate) – this should accelerate the turnaround, as well as alleviate the continuous negative comps that the declining access business causes. Lastly, it would shine a spot light on the core businesses and force them to be more profitable.
4) Patch Revenue Potential and path to Profitability Should be sketched out. One of the biggest overhangs on the stock is the Bearish view that the company is spending ~$160m per year on Patch, which is generating negligible revenue and is extremely unprofitable. While most investors are willing to concede that Patch is in an investment mode, many question remain as to whether it can ever be profitable. I think management needs to show a more clear path on how the revenues can build and the potential profitability of this unit as it scales, instead of merely suggesting “a rolling thunder” of Patches turning profitable by year end.
5) Acknowledge Seed de-emphasis – While the wild success of Seed would have been a great outcome, probably the second best outcome is acknowledging that it’s not working the way management wanted and hence they are prudently scaling back investment. If this is wrong, then the opposite should be done – shine a spot light on the success of the division, as it has been noticeably absent in recent addresses. Acknowledging the de-emphasis of an underperforming business gives extra credibility to management, if they show they wont waste investors capital on low probability / challenged products.
6) Discuss International Growth – The Street is aware that AOL pared back its unprofitable geographies, but now with a stronger / heartier AOL with the addition of Huff Po, AOL should articulate what markets it could reenter and when. How big can these markets be overtime and why should AOL be successful there?
7) Alliances – Jack Ma. Jack Ma, the head of the dominant Alibaba Group in China is powerful, ambitious and looking to shape the future. The disputes between their 40%+ partner (Yahoo) are legendary and Alibaba is ripe for change. Tim should be lining up with Jack in multiple arenas: cross geography trade, advertising, and payments. Bigger picture, I still believe Jack & Tim paired with some Private Equity money could do what many have speculated for years: merge AOL into Yahoo. It’d be win / win for everyone: Jack finally gets control of Yahoo and can enter the US market; Tim gets a larger platform to operate with more scale and the resources to be the dominant online property; Carol (yahoo! Ceo) succeeds in getting her shareholders their returns; and the shareholders finally make money on Yahoo!
8) Alliances – The Gang of Four. As Eric Schmidt identified recently, there is “The Gang of 4” in technology: Google, Apple, Facebook, and Amazon. AOL should be in discussions with all four players (in addition to other players) for significant partnerships and a potential acquisition. The company should be leveraging each player off the other, and given its tiny $2b market cap, is an easy acquisition by any of these players.
A. Google. Don’t forget that Tim (and a bunch of Sr staff) came from Google, but since Google historically has avoided is own content (ex YouTube), one might think that there may not be as much to do here; however, Google has moved more towards content recently (ITA, Places, Music) and there could be room here to partner in several key areas like Mapping (does AOL really need to be a principal in mapping?), Payments (AOL’s deep credit card database could augment Google’s NFC payment efforts), Mobile (AIM could provide the base to compete with Blackberry Messenger for Android) , and local (the ~1000 towns of Patches can provide instant access to local sales forces and Google’s Groupon-like project “Offers”. Important to note that there could also be synergies with Google’s Doubleclick and AOL’s Ad.com / Ad Tech AG. Lastly, AOL has a lot of data on its 4m+ subscribers and we all know how much Google loves data. Also, AOL should pursue any areas where it could leverage Google’s massive infrastructure, where AOL could benefit from scale and pare back some of the losses in display.
B. Apple – Least likely probably is a deal with Apple, as Apple typically like to go it alone. However there are some areas where the companies could work more closely together, including mobile (AIM and key properties built in on iOS – or could Apple move away from Google maps to MapQuest?), using iAds across all AOL apps, marketing Apple products to AOL’s subs, social content for Ping (AIM, .aol addresses). I place a low probability on Apple acquiring AOL, but there is some obvious room to work more closely together.
C. Facebook – This one to me seems like the best fit, let me tell you why. Facebook has an amazing amount of data for people and their social graph, but it is lacking in general type content, which could keep users around longer on Facebook. A content sharing arrangement could therefore be beneficial as Facebook could leverage AOL’s content to become the “Social Portal” – the 1 website with all your personal and general content needs. The size and scale would catapult AOL into the top tier of advertiser meetings (which are currently mostly designated to just Google, Facebook, and Yahoo!). Further, Facebook and AOL could also more tightly integrate their communications platforms leveraging scale and cutting back costs. The treasure trove of credit card information AOL already has could accelerate FB credits utilization. AOL could also leverage Facebook’s international presence, as AOL looks to rebuild globally.
D. Amazon – There is clearly some value in various types of Amazon / AOL deals. Amazon would ideally like to add the ~3.7m subscribers & credit cards that AOL has on file to its base of customers for quicker buying. Further, what if the ~70m AOL Media users were actually able to search for Amazon inventory without having ever left AOL? Additionally, Amazon’s Web Services massive scale could readily reduce some of the technology costs for AOL. Further, Amazon’s Living Social could benefit from Patch’s local sales force. Lastly, content optimized for the Kindle could provide further opportunities.
9. Not one of the “Gang of 4”, but….Microsoft – I have long thought that a spin of MSN from Microsoft with a balance sheet (say ~$10b to handle the ~$3b annual annual operating loss rate of MSN) would make perfect sense to merge into AOL. In this scenario, the company could fund 2 years of losses, buy AOL for ~$3b and still have a $1b left over for cushion to turn the unit around. They would have tremendous online reach, and Tim would have a bigger platform to run (display and search!). Microsoft share holders would be excited to see the money losing unit gone and off their hands, while investors who wanted exposure to search and online advertising would get a larger vehicle to bet on. For whatever reason, the scenario just doesn’t appear to be what Microsoft is focused on.
10. AOL CAN BE BOUGHT FOR “FREE” – AOL’s Value is small and could easily be digested by any of the above partners. AOL is only ~$2b market cap company. Assuming one of the larger players above was intrigued, they could pay a 50% premium to the current $2b market cap ($3b) and force the board to bring it to shareholders. Shareholders would be happy they made a good return; Tim and his management team would be happy to run a larger platform & know they made their shareholders money; and the buyer gets a unbelievable steal – lets see why:
Assuming a ~$3b purchase price of AOL
-$1.25b for selling the Access business
– $700m of cash by year’s end
– $100m for selling Map Quest (don’t need to be principal)
– $200m for Advertising.com (Don’t need to be a principal)
– $200m for AIM (someone like Facebook would just port users over)
– $200m for AdTech AG ad serving technology (don’t need to be principal)
– $100m for remaining real estate assets
– $100m left in tax shields from Bebo
– $100m tax shield value from Netscape (admittedly very conservative)
~$3 of non-core sellable assets
= The Buyer gets ALL of AOL’s core properties + the Google search deal for FREE
Hence, I think there are many positive outcomes for AOL share holders if you believe in management taking the prudent steps and can have a long enough time frame. It is hard to imagine AOL as a stand alone entity and with cheap credit, the time is ripe for someone to buy the company for “Free”.
My only concern is management doesn’t address the top 10 issues, and the stock continues to tread water. However, that can only last for so long….
Disclosure: I am long AOL