AOL is all too familiar with lousy deals. Almost 11 years after AOL (AOL) merged with Time Warner (TWX), the company created some buzz with its announcement to acquire The Huffington Post for $315 million. AOL agreed to pay $300 million in cash and the rest in stock for the mostly liberal news site. The former “You’ve got mail!” giant is going through an extremely aggressive strategy shift and this is by far the the largest of its recent acquisitions. Business Insider got a hold of a leaked AOL document last week in which the company outlined some of the critical focuses, which have shifted almost entirely on content.
The New AOL
In addition to Huffington Post – AOL lists 92 other content type sites which are included in its portfolio. While the majority of these are websites most of us would never use, they also include popular content sites like PopEater, Patch, Techcrunch, Engadget, Mapquest, Moviefone, Games.com, and others. As subscription revenues (5M subscribers still use dial up!) continue to deteriorate, AOL’s goal is to become the leading content provider and to bank that on advertising. The company is cleaning up its balance sheet at the expense of current revenues and profits and using the freed up cash to buy solid content providers, like Huff Post, in hopes of becoming a content superstar.
The Revenue Model
The AOL revenue model is fairly simple – advertising and subscriptions. Ad revenue comes from display, search, and third parties. Analysts expect subscriptions (those dial up users!) to continue decelerating and ad revenues to increase with marginal growth – but an overall deteriorating total revenue. As the company is able to create economies of scale on its content, it will likely create more attractive operating margins, thus translating into a slowly rising net income.
Risks are High
Though display advertising will likely continue its growth, two of AOL’s units will most likely not. As Microsoft's (MSFT) Bing continues to roll into the search space, where Google (GOOG) is by far the dominant player, less users will be inclined to use AOL’s search. I am honestly not sure why anyone still does – since AOL uses Google (contract through 2015) as a search vendor.
AOL overpaid for HuffPost. This is a horrible way to use up cash! I simply don’t believe that paying $315 million for HuffPost was anywhere close to what the site is worth. It is difficult to predict the true value, but it’s clear that AOL paid a premium to get Arianna Huffington onboard. Plus, AOL has a history of messing up mergers.
Management culture clashes are always a risk with any merger, but this one is slightly higher. Arianna Huffington is a talented superstar and she has created a giant at Huffington Post. I also believe though, that the culture at AOL is extremely different. None of AOL’s current content is known for partisan views and its precisely these views that have made Huffington Post what it is today. Placing Arianna Huffington as the Editor-in-Chief of an entire AOL empire (will be known as Huffington Post Media Group) is therefore a huge mistake.
The content space is becoming more crowded and there is a huge risk of “readers” switching up (it’s FREE to switch after all) thus causing a decline in display ads. Placing such an enormous emphasis on its content to create revenue is placing AOL's eggs in one tiny basket.
Forward price earnings (the amount investors are willing to pay for the stock relative to the future earnings) is relatively high also in my opinion at analyst projected targets (~16).
I agree that although the merger carries with it lots of risks, it is an extremely interesting one. I enjoy observing companies, which are going through a restructuring period; I just don’t believe AOL’s strategy is a good one. I would certainly expect it to continue its decline. On the other hand, please join me in wishing a congratulations to Arianna! She obviously got the better end of the deal.