AOL, Inc. (NYSE:AOL) was a prime example of a tech bubble stock. In 2000, the small company was able to merge with Time Warner (NYSE:TWC) for $164 billion and now the company has a market cap of only $1.83 billion. In the aftermath of what is called the worst merger in business history, AOL today is a very different company than it was in the tech bubble days. Its business model has changed dramatically and AOL is now trying to downsize instead of grow. The one thing that hasn't changed is the AOL shares are very overvalued.
Analysts expect AOL earnings per share to be 40 cents in 2012 and 56 cents in 2013, giving the company one year and two year forward P/E ratios of 48.2 and 34.4, respectively. Going forward, analysts expect the stock to grow at 9.9 percent annually over the next 5 years, which is below the market average.
Bulls for the stock justify this overvaluation by the fact that AOL is trying to downsize. Revenue for AOL has decreased every year since the AOL Time Warner split and this is supposed to continue until at least 2013. In addition, AOL announced last week that it hired Evercore Partners (NYSE:EVR) to find a buyer for all of its patents.
AOL currently has $2.825 billion in assets and $652.4 million in liabilities on its most recent balance sheet. Unfortunately, over $1 billion of those assets is Goodwill, which almost certainly is overvalued. The company has $173.6 million in treasury stock on its balance sheet, which it began accumulating in quarter three of 2011. Although AOL's current strategy is to downsize near-term, it's not really a reason to hop on board.
Everything that AOL does is substitutable. What keeps the company alive is cash flow from the other web sites that it bought along with customers who still use AOL e-mail out of old habit. If AOL liquidates too far, it will either begin to lose good sources of cash flow or its brand. This strongly devalues AOL's assets and gives it a much lower price tag than what the market currently puts on it.
A lot of people are on board with AOL being overvalued. The stock has a short ratio of 13.2, and 15.8 percent of the float is shorted. Going forward, expect a bear run soon if the shorts can continue to apply pressure. Expect shares to drop under $15, or 22.2 percent, in the next year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.