As Time Warner's AOL Spin-Off Is Set, Price Looks Meager

Time Warner (TWX) is getting ready to spin off AOL on Thursday December 10^th. Investors will get one share of AOL for every eleven Time Warner shares they hold. The media will likely be focused on how this event marks the end of the colossal mistake that was the AOL-Time Warner merger, but my interest lies in the fact that AOL is going to be valued at next to nothing and former Google (GOOG) sales star Tim Armstrong is the company’s new CEO.

Through SEC filings, Time Warner has estimated AOL’s value on a standalone basis to be about $3.2 billion, or $30 per share (108 million shares outstanding). Current forecasts put 2010 EBITDA for AOL at around $1 billion, so Time Warner is only valuing AOL at a little more than 3 times cash flow, mainly because the company’s business is in decline. Wall Street in general is not impressed with AOL’s future prospects but Armstrong is a very strong executive and many in the industry would not bet against him, especially when the bar has been set so low.

What is interesting is that AOL has already started trading on a when-issued basis and right now is only fetching about $24, 20 percent less than Time Warner’s own conservative valuation. At that price, AOL is valued at only $2.6 billion or 2.6 times 2010 cash flow projections. The reason of course is that AOL’s cash flow is expected to drop going forward (the company still gets a lot of its cash from dial-up subscribers, and that business will continue to shrink). I have seen estimates that cash flow could drop to $750 million from $1 billion between 2010 and 2014.

Can new CEO Tim Armstrong figure out a way to start growing the company’s non-dialup businesses again? No doubt it will be a tough task, but a change in leadership and direction could very well help AOL become a relevant content company. It certainly would not take much progress in that direction to warrant a $2.5 billion or $3 billion valuation, so I would not be surprised to see some value players consider taking a risk on Armstrong and the dirt cheap stock of standalone AOL. In fact, I am likely going to be one who at the very least takes a very hard look at the stock if it stays in the low to mid 20’s once shares are distributed next week.

Disclosure: No position in AOL at the time of writing.