INSIGHT OR ENVY?
Tim Armstrong, CEO of AOL, Inc (AOL) thinks the internet company is 'severely undervalued' in light of the recent market valuations assigned to hot US internet IPOs. Armstrong had a successful career at Google (GOOG) before taking the head role at AOL. He is generally well regarded, but his comments may reveal corporate envy rather than managerial insight. Armstrong is clearly reaching when he aspires for the same stratosphere of valuations used for the hottest internet technology IPOs. Not only are the valuations on these new companies likely unsustainable, the prospects for these IPOs are bright and revenues are growing. This is a sharp contrast to AOL's seemingly unbroken decline since their merger with Time Warner marked the unofficial peak of the last internet boom.
SOME REASON FOR OPTIMISM, BUT DON'T GET CARRIED AWAY
AOL bulls may argue that there is room for new optimism. While their revenue declines may concern investors, they have produced strong cash flow over the last few years. This is a reason to like the company. In addition, AOL's $315 million purchase of Huffington Post, an internet news aggregation and original content provider, will significantly boost aggregate web traffic at AOL, but AOL paid a steep price that investors were not willing to reward them for. As a matter of fact, the company's market capitalization dropped around $300 million on the day they announced the deal. To make matters worse, investors are still leery of AOL's eye for acquisitions following their ill fated Bebo purchase. Around two years after paying $850 million for the internet company, AOL turned around and sold it for $10 million.
At $20.31, the company is valued at a market capitalization of around $2.3 billion. In the most recent twelve months, AOL generated $2.30 billion in revenues. This was a drop off from the $2.41 billion they generated in 2010 and the $3.24 billion generated in 2009. This puts their trailing price/sales ratio at around 0.92 and price/book of 0.90.
Of course, when you compare your company to stocks with some of the market's highest valuations, your stock will likely look cheap. Any company, from Wal-Mart (WMT) to Apple (AAPL) to Google could argue the same point. Still, let's test Armstrong's point. Here is how AOL stock compares to related companies with exposure to either news, original content or internet.
NY Times Company (NYT) - The company operates one of the world's preeminent newspapers, but like the rest of the industry, they have suffered under the weight of reduced circulation and margin pressures related to cheap online content. Despite their circulation revenues, like AOL, NY Times is also heavily dependent on advertising income. In 2010, 54% of the company's total revenues were derived from advertising. Because of this and their similar revenue trends, NY Times could be one of the better comparisons for the post-Huffington Post AOL. As such, the two companies appear to be priced roughly in line with each other once you average out the differences between price/sales and price/book ratios.
Sales growth: -1.92%
LinkedIn Corp (LNKD) - The online professional network and job search website is one of the hottest internet companies in the current internet boom. LinkedIn may become more closely related to AOL after hiring Fortune editor, Daniel Roth, to head the company's content division. LinkedIn clearly trades at a sharp premium to AOL, but considering the disparity in sales growth, it is hard to say that they are really comparable.
Sales growth: 102.29%
Google Inc (GOOG) - The world's top internet search engine makes money from targeted search advertisements. While AOL uses original content to drive web traffic to their sites, Google relies on the technology underlying their search engine. While this is a meaningful difference, they are both reliant on advertising revenues dependent on web traffic. But in addition to the fact that Google is still growing, it is hard to ignore the fact that Google's technological dominance in a vital area demands a premium over AOL's more generic market position. As such, Google appears to be a poor comparison for AOL.
Sales growth: 23.97%
Sirius XM Radio (SIRI) - The satellite radio company has come a long way since Liberty Media's (LCAPA) capital injection saved it from bankruptcy during the financial crisis. Since then, the company has rebounded both financially and operationally. Subscribers have continued to grow and the company is on the verge of gaining the freedom to flex its pricing power. Between 2008 and 2010, the company's subscriber base grew from 19 million to 20.19 million. SIRI is by no means a perfect peer comparison for AOL, but as a media company with original content and some dependence on advertising revenues, they deserve a mention in this context.
Sales growth: 13.93%
It is hard to blame AOL's CEO Tim Armstrong for looking around enviously at the valuations being thrown around for other technology and media companies, but it is a stretch for him to draw the conclusion that AOL is undervalued. Many of the companies Armstrong focuses on are probably poor comparisons because AOL's revenues are not growing.
Most of the stocks with enviable (though likely unsustainable) valuations have rapidly growing revenues. Amongst our list of possible peers, NY Times is probably the most similar stock and its valuations are roughly in line with those of AOL. And if there is a difference, it probably suggests that NYT is slightly undervalued relative to AOL based on price/sales and sales growth. As such, investors should not expect the stock market to agree with Tim Armstrong's opinion any time in the near future.