Why Adding AOL To Your Portfolio Can Prove A Great Decision

| About: AOL Inc. (AOL)

AOL (NYSE: AOL) has been struggling to find its footing since the breakup of its famously troubled merger with Time Warner in December 2009. The company has been reducing staff, selling off unprofitable assets while acquiring new ones as it tries to reinvent itself as an ad-supported content creator. With the release of its first-quarter 2013 earnings report, AOL seems to be showing the first signs of achieving its goal. Should you start considering AOL stock as part of your portfolio?

AOL Reports Revenue Increase

AOL declared a loss in 2010, the year following its breakup from Time Warner, before reporting a slight profit of $13 million in 2011 and a larger one of $1.05 billion in 2012. Meanwhile, revenues continually declined from $3.24 million in 2009 to $2.2 million in 2012. Diluted net income per common share hit $11.21 in 2011.

For the first quarter of 2013, however, total revenues grew slightly to $538 million from $529 million in the same quarter last year, the first time since 2004 it had done so, while net income increased to nearly $26 billion from $21 billion in the previous year. This increased diluted earnings per quarter to $0.32 from $0.21. The company's profitability was further buttressed by an increase in cash provided by operations to $40.6 million from nearly $20 million last year, which brought free cash flow to $9.8 million.

More significantly for the company's goal of attracting more advertisers to its digital holdings, the profits were driven by an increase in revenues from domestic display advertising. The hike was attributed to the higher prices the company charged for premium advertising such as sponsorships and video ads. AOL has been moving to reposition its ad strategy around its key strengths, firstly by creating AOL Networks to consolidate its assets in online advertising sales and technology, and also by emphasizing premium content that it can provide ads for. This strategy has been buttressed by AOL's acquisition of technology reviews site gdgt, as well as a deal with Mediaocean and Freewheel that would allow AOL's video inventory to be bundled along with TV ad buys.

Meanwhile, the company continued to shed unprofitable assets, selling some of its music sites and a comic book site to Townsquare Media Group for undisclosed terms in May. It had earlier sold off its youth-oriented social media network Bebo to Criterion Capital Partners for the bargain price of $10 million, substantially less than the $850 million it had originally paid out for the site. However, the deal would allow AOL to completely write off Bebo as a loss for tax purposes. In an attempt to strengthen the profitability of its troubled news site Patch, AOL announced that it would undertake a new round of layoffs, dismissing 40 employees, as well as streamlining the number of the site's regional offices from 20 to nine. It also wants to increase the amount of 'user-generated' content on Patch from its current 20% to 40% in order to reduce the costs of content production.

Meanwhile, the company still enjoys profits from its subscription service, a legacy part of its business. In the first quarter, the membership group, which includes the subscription service as well as AOL mail, fell to $211 million from $235 million in the same quarter last year. However, this still accounted for nearly 40% of total revenues, more than any other segment. Subscription revenues alone reached $165.8 million during the quarter; although this was 9% less than in the same quarter a year ago, and includes revenues from customers paying for dial-up service. But the Brand Group, which includes the company's own branded content, recorded the highest increase in revenues during the period of 14%, to $189.6 million in the first quarter to $166.5 million in the previous year. The company recently announced that it would be releasing 15 original unscripted video programs, expanding further the content portfolio against which it can place online ads.

However, investors were clearly unhappy with the earnings results, which fell short of - or just met - analysts' expectations. Following the release of the report on May 8, share prices closed at $37.74, 10% lower than the closing price of $41.42 the previous trading day. And stock prices have continued to fall, with the share price as of June 3 at $34.87, an 8% decline.

The Bottom Line

Despite the spate of mixed news on AOL, hedge funds and money managers continued to be bullish on the stock. Some 22 hedge funds held positions in AOL stock, a 5% increase from the previous quarter. Of these, Iridian Asset Management held the biggest stake of $133 million or around 2% of its total 13F portfolio, followed by D E Shaw, which had $88.6 million worth of AOL stock or 0.2% of its portfolio. Among the money managers, Columbus Circle Investors had the highest stake at $88.4 million, followed by Kingdon Capital with $14 million.

What this means is that despite the mixed news coming out of AOL, experienced investors clearly still see something in the stock that is worth holding on to. The stock could still return to the $40 - $41 level it was trading at before the first-quarter earnings report was released. All it would take is for the company to start becoming consistently profitable. Keep in mind that despite the many challenges the company faced, it was still able to increase revenues during the first quarter, the first time this has happened in eight years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.