We recently upgraded our price estimate for AOL (NYSE:AOL) from $34 to $42, based on the company’s continued strong growth in advertising revenues. One of the key drivers for our price revision is the steady improvement in AOL’s Display Ads revenues from third-party websites. Additionally, AOL reported improvement in margins as its cost-cutting measures gained traction. We expect the company’s margins to continue to improve in the future. After this upgrade, our stock price estimate is in line with AOL’s current market price. In this article, we will discuss the factors that will drive growth at AOL.
Programmatic Platform To Boost Revenues
According to our estimates, Display Ads on third-party sites is AOL’s largest division and makes up 34% of its value. A real-time bidding platform (RTB) or programmatic platform is a method of selling and buying online display advertising in real time. RTB aggregates the impression slots offered across multiple ad networks and matches them (based on the advertisers target, budget and placement requirements) with the most appropriate ads.
According to eMarketer, advertisers spent $2 billion on RTB in 2012. It projects that this spending will increase to $3.4 billion in 2013. eMarketer also expects that real-time bidding will account for more than $9 billion in digital ad spending, or 29% of all digital display spending by 2017.
We believe that RTB will be a key growth driver for AOL since it is instrumental in increasing RPM by efficiently matching ads with relevant ad content. Company’s demand side platform, Advertising.com, has a visitor reach of 85% and has been consistently ranked second behind Google’s (NASDAQ:GOOG) ad network for the past few quarters. Furthermore, with the launch of Marketplace in 2013, AOL has access to the complete stack of advertising technology that can offer a full-service solution to premium advertisers and publishers alike. The capabilities of AOL’s programmatic platform have been further augmented by the acquisition of Adapt.tv in the third quarter of 2013. According to comScore, AOL sold nearly 4.3 billion ad impressions in the U.S. in December 2013. By comparing pre-acquisition and post-acquisition ad impression numbers, we estimate that Adapt.tv constitutes for over 50% ad impressions sold in December.
We think AOL is well positioned to capture a bigger chunk of RTB spending in the future by leveraging its DSP and SSP platforms for both, video and static display ads. While AOL doesn’t disclose the breakup of its revenues from its RTB platform, if AOL were to capture 10% of this spending in the U.S., its display ads revenue from third-party could double by 2017.
RTB was also instrumental in improving revenue per thousand impressions (RPM) for AOL, due to the more effective management of unused ad inventory and better sales to advertisers, and this metric improved by 25% to $4.50 in 2013. With relevant ads displayed across content, AOL can continue to charge higher revenue per page view (RPM) to advertisers. We have revised the RPM to grow to $6 by the end of our forecast in 2020. As a result, our stock price estimate has increased by $2.50. However, if RPM were to increase to $7 by the end of our forecast period, our price estimate can increase by additional 10%.
Focus on Video Content To Boost Unique User Count and RPM
According to our estimates, Display Ads division is AOL’s second largest division and makes up 30% of its value. AOL is focusing on improving user engagement by offering premium video content for different domains such as tech, style, business and sports. Additionally, the company is bridging the gap between TV and digital video content by signing new premium content providers such as Fortune, CNNMoney, People etc, and expanding its footprint to emerging countries. While the company now has 700,000 videos in its library, it continues to develop original video content for its properties. User engagement is important for AOL’s overall financial health, as it not only increases the unique visitor count but also drives page views across its properties. We believe that improved video content will drive the monthly unique visitor count at AOL and have increased our projection to 130 million by the end of our forecast period.
As users flung to AOL properties, we expect RPM to improve as advertisers are willing to pay more for premium content. According to emarketer, premium video content ad inventory is worth $3.28, while the average RPM for video inventory is around $2.46. Currently, we project that RPM will grow to $3.46 by the end of our forecast period. However, if AOL’s RPM were to increase to $5 by the end of our forecast period, our price estimate can increase by additional 10%.
Margins Set To Improve
AOL has undertaken cost-cutting measures to improve its profitability. While it continues to eliminate non-core activities, it also sold off its Patch local news operations to stem losses. These efforts helped the company to improve its operating profit margins from 8% in 2012 to 13% in 2013. Additionally, it’s SG&A (selling, general and administrative) expenses stood at 14% of AOL’s total revenues in 2013. We believe that the company will continue to reap benefits from these efforts in the future as well, and project that the company SG&A expense will stabilize at current level by the end of our forecast period.
Our price estimate for AOL now stands at $41.51, which is in line with its current market price.