AOL: You've Got Cash!

Includes: AOL, ELNK, SPOK
by: Dalrymple Finance

I have made several purchases of AOL (NYSE:AOL) stock in the past. I bought the stock early after the spin-off, then bought it again when it took a drubbing (mild language) in the summer. I have since sold the position.

I admit I was fascinated with AOL. The spin-off documents were practically hypnotic. I couldn’t take my eyes off the huge volumes of cash the company printed. I thought to myself: “if only the company would distribute some of the cash hoard”. If only.

The table below shows AOLs cash generation over the last few years. Figures are in millions of dollars.

Using a share-count of 106 million, the company generated over $7 per share in free cash in 2009 and $3.50 thus far in 2010. AOL's 2010 numbers are down a lot. However, assuming a stock price of $25, it is still over a 14% free cash flow yield for the first nine months of the year. It is this FCF yield I find so enticing about the company. Yet, although that cash seems tantalizingly close, it remains out of shareholder reach.

AOL, like most firms, wants to be a growth company. Apparently, there are few that want to manage a low-to-no growth company, let along one experiencing revenue decline. We all know the company’s dial up and subscription business is dying, but as companies like Earthlink (NASDAQ:ELNK) and U.S. Mobility (USMO) show, mature businesses can go on longer than one might think. What makes mature businesses great is the huge amounts of cash they can generate. And guess what, managing businesses for cash generation (and distributing it) makes for a good stock. Check out both ELNK and USMO. Shareholders like it when management return capital. It's surprisingly simple. After all, generating the cash is the hard part; returning it should be easy.

Instead of focusing on maximizing cash flow benefits to shareholders, AOL has excelled in squandering cash. In 2008, the firm bought Bebo for $850 million only to sell it in 2010 for somewhere around $10 million. Ooops! The company has a history of bad acquisitions.

AOL’s CEO, Mr. Armstrong, has not been at the helm long and can't be held responsible for its history. However, company trajectory under his tutelage remains seemingly unchanged. The cash will continue to be used to build a "growth" company through acquisitions. Too bad. If I wanted to own a growth company I would buy one.

Thus far in 2010, the company has spent over $100 million on acquisitions. Hey, I love Tech Crunch (one of the acquired properties), but what makes AOL think that although it has made a lot of bad acquisitions in the past, the company will now start making good ones? The fact is that it probably won’t.

Unfortunately, managing a company to maximize cash flow is harder, a lot less sexy, exciting and ego boosting than dashing around with your favorite investment bankers making acquisitions.

If AOL wants to benefit the shareholders and create a strong stock, all it needs to do is give some cash back. Just 50% of free cash would be great. At current cash generation rates this could create a dividend north of $2. Were this to happen, the stock would not remain at $25 for long.

Unfortunately, I have concluded that unless a deep-pocketed activist investor gets involved, AOL is unlikely to part with its cash. Instead of focusing on what it can do (generate cash), the company will continue to focus on what it wishes it could do – be a savvy, high-growth, acquisition powerhouse. Alas, while this may feed the egos of AOL corporate types and the wallets of advising investment bankers, shareholders are left behind.

Disclosure: No position