AOL (NYSE: AOL) recently announced that it plans to buy back an additional $550 million worth shares as it seeks to return $1.1 billion that it generated from the sale of patents to Microsoft (MSFT). While this might be a good sign for investors who have seen the AOL stock more than double during the year, we think that this repurchase also signals a lack of growth opportunities for the company. AOL is primarily an Internet content provider and competes with Google (NASDAQ: GOOG) and Yahoo! (NASDAQ: YHOO) for Internet traffic.
Buyback signals fewer opportunities
As AOL is in the process of reinventing itself, a sound strategy is to buy new companies or make strategic investments to try and increase traffic on its websites. We think that returning cash instead of pursuing new opportunities indicates that the company may have run out of ideas for new business growth.
During the past few months, AOL has experienced substantial traffic growth on its acquired sites such as TechCrunch and Huffington Post. Cash from the Microsoft deal provided AOL with the opportunity to acquire more content providers like the above and attract more eyes to its properties. An increase in unique visitors could have provided an upside to the display ads business, which is currently AOL's most valuable operating segment, making up approximately 20% of the company's value. You can assess the impact of the changes in monthly unique visitors on AOL's value by using the chart below.
Nevertheless, the buyback can be construed as positive news for investors because it shows that the management will not make acquisitions just for the sake of it. It should be noted that overpaying for a company and subsequently writing it down can waste cash and destroy value.
We currently have a $29 price estimate for AOL which is approximately 15% below the market price.
Disclosure: No positions