Here’s a hint: Since Amazon stock is up 42%, Google stock is up 15% and Apple stock is up 58%, you’re going to have to look for a company with returns of more than 115% since January 1.
Give up? Oh wait, it was in the headline all along.
Yes, this red-hot pick is none other than AOL (NYSE:AOL). The seemingly improbably turnaround of AOL in 2012 hasn’t gotten a lot of fanfare, as investors have been caught up in the sexier tech stories of the year, including iPhone vs. Android and Kindle vs. iPad wars. There’s also the implosion of Hewlett-Packard (NYSE:HPQ) and Research In Motion (NASDAQ:RIMM) to scoff at, or the charming Marissa Mayer taking over at a troubled Yahoo! (NASDAQ:YHOO).
But despite the steady drumbeat of criticism for AOL’s CEO Tim Armstrong — most recently from hedge fund Starboard, which has lost faith in the expensive local news boondoggle Patch and debated a proxy fight for seats on the board — it seems that investors finally have something to be pleased about. In fact, several of AOL’s largest shareholders have been sticking up for Armstrong now that the company’s fortunes have started to turn around.
At least on a share price basis, anyhow…
That’s in large part because of a titanic divestiture of tech patents to Microsoft (NASDAQ:MSFT) in exchange for $1 billion in cash. The deal covered technology spanning social networking, advertising and search. And with the proceeds, AOL just announced plans six weeks ago to return $1.1 billion to shareholders via a special dividend and huge buyback plan.
Shares have understandably soared as a result. But the real question is whether this turnaround is just a blip on the radar or a sustainable evolution for the once-mighty Internet company.
What’s the Long-Term Plan?
The patent news was huge for AOL investors. Yet that plan is obviously not sustainable. The challenge going forward is how to restructure the business in a way that provides sustainable revenue and profits, with a serious potential for future growth.
On that front, AOL is still in deep water.
For starters, it’s worth noting that AOL still gets a third of its revenue from the rather quaint category of paying Internet access subscribers — and that stream of cash will assuredly go to zero sometime in the near future. As the rise of high-speed Internet and mobile computing continues, screaming dial-up modems are rather quaint vestiges of the past, akin to VHS tapes and the telegraph.
And speaking of mobile, while AOL traffic remains pretty constant across its properties — in large part due to the acquisitions of TechCrunch in 2010 and Huffington Post in 2011 — it is hard to imagine that the AOL.com portal will keep up. It used to be that email addresses @aol.com were common, and that the traffic to the site’s homepage was all but guaranteed. But as more folks access email on their smartphones or tablets, the idea of accessing webmail at a portal like that is falling out of favor.
And beyond the whole philosophical issue of technological disruption, the bottom line is that display advertising at AOL isn’t keeping pace with rivals like Google or Facebook (NASDAQ:FB).
“While we continue to be optimistic about the model and believe that the company is rich in asset value,” Topeka Capital analyst Victor Anthony writes in an e-mail, “we would like to see double-digit growth in the core display advertising business as evidence that AOL can fully compete with Google and Facebook for the display ad dollar. From where we are today, we are not yet convinced that to be the case.”
Strategically, there’s also the fact that Armstrong continues to stick to his guns on the money-losing Patch news venture, but profitability remains out of reach five years after the idea was rolled out independently by Armstrong and then acquired in 2009 after he became CEO. This is his brainchild … but so far it’s been a rather disappointing little venture that consumes a lot of cash and creative bandwidth at the company.
And nothing coming down the pipeline seems likely to deliver the glitz and glamour needed to change this narrative. The latest channel at AOL is HuffPost Live, an effort to produce 60 hours of video news programming per week. The jury is still out on reception, but I watched the first presidential debate there just to gauge the experience … and frankly, it felt like a Skype chat or a Google hangout with a bunch of opinionated and slightly naïve college students. Perhaps it will stick, but I won’t be tuning in anytime soon.
So Why the Huge Stock Surge?
What gives? How can AOL be flying so high in the face of these challenges?
Well, for one that huge $1 billion payday from the patent sales gives the company ammo to make more changes, and it buys plenty of time. While not glamorous, the company was indeed profitable in fiscal 2011 and was slated to be in the black again for 2012 even before the patent payday. So the company is not in panic mode due to cash burn … at least, not yet.
And while the future growth remains questionable, the current footprint of AOL as a modern media company is hard to argue with. Over 112 million unique visitors trafficked AOL properties in the second quarter of this year, a simply staggering figure.
If you took all of those AOL users last quarter and made them their own country, for instance, it would be the 11th most populous nation on the planet, smack dab between Japan and Mexico.
And then there are the long-view analysts who are convinced that the established reach along with the current content strategy and future potential adds up to a win.
“Despite everything we hear about AOL,” says Ron Josey, an analyst with ThinkEquity, “they are still one of the most trafficked properties on the Web.” He adds: “They still generate a lot of users, they still generate a lot of content for these users to consume, and they’re still generating buzz around newer properties.”
There are also folks who expect Patch to indeed catch on soon. This graphic from the Wall Street Journal shows how users have grown, and reports that the unit could be profitable as early as next year. Patch traffic has grown sharply to over 10 million visitors from less than 7 million a year earlier, according to recent comScore figures.
Another interesting rub is that while AOL’s overall share of online ad revenue has declined, the massive scale of this market — particularly in online video — means that a slightly smaller piece of the marketplace could still mean stable or even growing profits.
Think of AOL toting around a leaky bucket while it’s pouring rain. Even though some is slipping away, there is plenty of water to make up for the loss.
And more broadly, there’s the idea that the “cycle of constant drama” has allowed overly pessimistic investors to dominate the conversation, and that long-term investors may be served by taking a shot on this big-name property while it’s out of favor. After all, the vitriol over Patch is admittedly all-consuming. As one exhausted Patch staffer put it in his departure, “You’d think we were creating toxic waste, instead of, you know, free useful information.” If you’re a glass-half-full investor, this is your moment.
The Verdict on AOL Stock
So should you buy AOL stock? I say hell no — largely because I don’t believe that the Tim Armstrong plan will result in growth. It may result in AOL keeping the lights on, sure … but not growth, as the mobile revolution leaves its portal property in the dust and as its waning dial-up business goes dead. Armstrong just got a big extension through 2016, and frankly if we don’t have anything impressive by now, I am convinced we will see more of this same movie until his tenure is up.
And though AOL stock is at an all-time high, it’s priced at a rich forward P/E ratio of 28.
Worst of all, the top line at AOL is stuck in a steady downward spiral. Despite the acquisition of TechCrunch and HuffPo, AOL has seen total revenue cut almost in half in just four years, from $4.17 billion in 2008 to a prediction of $2.15 billion in fiscal 2012. Layoffs and patent sales can juice profits, but there is no way to hide that revenue shortfall forever.
There is the prospect of a dividend based on this new cash stockpile. But as Hewlett-Packard and Cisco (NASDAQ:CSCO) have shown us, it doesn’t make you a relevant tech stock just because you have a crapload of cash lying around and a decent dividend yield.
After that special dividend is dished out in December, it will be interesting to see if traders cut and run.
Don’t get caught holding the bag. There are much more interesting turnaround stories to waste your money on than AOL.
- Check out Tim Armstrong’s motivational email from earlier this year to all AOL staffers, including the line “‘Beat the Internet’ has been an important theme in the turn-around of AOL” without a hint of irony. (Capital)
- Jonathan Berr, a former AOL employee and current InvestorPlace contributor, weighs in on the shortfalls of Patch. (InvestorPlace)
- Why Armstrong is bullish on online video advertising. (New York Times “Media Decoder” blog)
- Another Armstrong misstep that’s a bit inside baseball but worth rehashing was the rather poorly named (or poorly designed) CrunchFund that caused claims of a conflict of interest between Tech Crunch and the startups it reports on. (Tech Crunch).
- Why Yahoo!’s new darling Marissa Mayer may be making the same mistakes AOL did. (Business Insider)
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he owned a position in Apple but no other stocks named here.