AOL INC AOL
August 02, 2011 - 2:10pm EST by
JackBlack
2011 2012
Price: 16.69 EPS $1.21 $1.04
Shares Out. (in M): 107 P/E 13.8x 16.0x
Market Cap (in $M): 1,786 P/FCF 6.3x 7.7x
Net Debt (in $M): -283 EBIT 243 181
TEV ($): 1,503 TEV/EBIT 6.2x 8.3x

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Description

The recent pull back in AOL's shares represents a very attractive entry point... The company is in the final stages of its massive restructuring efforts, which included a ton of restructuring and asset dispositions... Since it's spin, AOL's strategy has remained consistent (help branded advertisers spend more money online) and has not waivered despite may potential new business opportunities (social media, group buying, etc) that could have easily distracted the management team... With the restructuring largely behind them, AOL will begin to face very, very easy comps from this upcoming quarter (salesforce reorg, shut down of international businesses, stopping of bad revenue practices all took place during the past 12 months)... with its strict focus on premium US display advertising, we believe AOL will be a much cleaner story going forward and will begin to show accelerating growth in US display advertising over the next coming quarter, helping them achieve their goal of breakeven in their online division by 4Q11 and putting them on track to acheive their goal of returning to OIBDA growth in 2013... 

 

AOL Inc. is a leading global web services company with an extensive suite of brands and offerings and a substantial worldwide audience.  AOL's business spans online content, products and services that the company offers to consumers, publishers and advertisers.  AOL is focused on attracting and engaging consumers and providing valuable online advertising services on both AOL's owned and operated properties and third-party websites.  In addition, AOL operates one of the largest internet subscription access services in the United States.  AOL generates revenue primarily through 1) Online Advertising; 2) Access Subscriptions; and 3) Other Services.

 

1)       Online Advertising:  Advertising is AOL's largest business segment, contributing 53% of total revenue in FY10.  The segment is comprised of 3 key offerings: 

  • O&O Display Advertising: AOL owns and operates over 90 websites showcasing in-house and licensed content. Examples include AOL, AOL Music, Huffington Post, MapQuest, Stylelist, Engadget, TechCrunch, Moviefone, Games.com, Joystiq, Black Voices, Patch, etc. The company sells display advertising such as banners and rich media ads on the content pages of its owned and operated (O&O) content properties. AOL's strategy is to leverage its direct sales force to sell its premium inventory directly to advertisers and agencies, at premium CPM rates.
  • Paid Search: AOL is one of the largest members of Google's AdSense network. Google provides the algorithmic search results as well as the paid search ads to AOL. Advertisers bid for search ads on a cost per click basis on Google's AdWords platform and pay Google only when someone clicks on the search ads shown on AOL's search pages. Google in turn pays AOL roughly 90% of the incoming revenue in the form of TAC (traffic acquisition cost) payments, most of which flows through to AOL's bottom line.
  • Advertising.com: Advertising.com is AOL's ad network that connects third-party publishers with interested advertisers. The ad inventory is typically non-guaranteed in nature and sells at a much lower rate compared to premium ads. Most publishers in the network have a revenue sharing agreement with AOL where 80% or more of the segment revenue is funneled back to the publisher in the form of TAC payments.

 

2)       Access Subscriptions:  This is AOL's legacy business that made AOL a household name in the first place.  As the largest domestic online Subscription provider, AOL leads a small pack of competitors such as EarthLink and United Online.  AOL currently has approximately 3.6m subscribers as of March 31, 2011 with an average tenure in excess of 10 years.  AOL generates revenue by charging its subscribers a monthly fee for providing dial up access and broadband services, including email, security and storage.  AOL's subscription business accounted for 42% of total revenues in FY10.

 

3)       Other Services:  Other services primarily consist of revenue associated with the licensing of AOL's AdTech platform to large advertisers or ad agencies, to help them manage their online campaigns.  The segment also includes licensing fees for its communication products such as email and IM and some mobile revenue.  Other services accounted for 4.5% of total revenue in FY10.

 

Investment Thesis

Talented new management team / Turnaround noise largely behind them: 

  • After 9 years of low morale and significant mismanagement, in April 2009, Time Warner hired Tim Armstrong to become the new CEO, and since then AOL has been busy re-inventing itself as a leading online media company with a renewed strategy, focus and discipline.
  • Tim Armstrong joined AOL from Google, where he oversaw the company's North American and Latin American advertising sales, marketing and operations teams as President of The Americas Operations. He quickly built a very strong bench by recruiting away top talent from Google, Yahoo and even Silver Lake Partners. Despite the rise of sexy web 2.0 startups, Mr. Armstrong has done a good job of retaining his talent, as top executive turnover has been minimal.
  • During 2009 and 2010, Tim Armstrong has embarked on a significant restructuring effort, which included selling off non-strategic assets, shutting down unprofitable operations and businesses, exiting unprofitable partnership deals, halting bad monetization practices, etc. This has led to an incredibly messy transition period and noisy financial statements, to say the least, however, the clouds should begin to clear in the back half of 2011 as the comps get cleaner.
  • Mr. Armstrong has leveraged his close ties to Google and the advertising community to chart the course of AOL's future strategic direction. As the restructuring noise subsides, the new AOL should be very well positioned to take advantage of the secular growth tailwinds of the online advertising market.

 

AOL's new strategic direction is specifically aimed at addressing two major hurdles that large branded advertisers are currently grappling with, which should lead to above average growth rates in the future:  

  • Advertisers are anxious to spend more money online, particularly on display ads, but have been slow to do so due to two major hurdles: 1) it is difficult for large advertisers to spend money at scale due to the fragmented nature of the Display market; and 2) advertisers are fearful that their brand advertising may end up next to low quality content that cheapens or misrepresents their brand when buying at scale through an ad network.
  • AOL is specifically focused on solving this problem via its Project Devil initiative, its focus on premium content production and video, and hyper-targeted content strategy built around vertical (women, technology, music, etc.) and local (Patch) communities.
  • AOL's strict focus on creating an optimal premium display ad environment for advertisers will differentiate it's O&O sites and ad network from its competitors, which should translate into above average growth rates in display advertising, which is projected to grow at a 15% CAGR for the next few years.
  • The total market opportunity for Display ads should increase meaningfully as these key issues are addressed. Advertisers from major brand-focused verticals such as CPG, Pharma, Entertainment, Travel and Media currently spend less than 10% of their ad budgets on line, creating significant opportunity going forward.

 

Ample downside protection: 

  • While in rapid decline, the Access Subscription business is a cash cow, which we expect to generate over $700m in FCF over the next 4 years, or approximately 40% of AOL's current enterprise value of $1.8b.
  • AOL's Online business is currently cash flow negative and is expected to reach breakeven by 4Q11. However, should this not occur, can we make the argument that AOL's Online business is worth at least $1.1b?
  • Due to the large amount of overlapping resources of large online content producers salesforce, ad network, content production and G&A) , there are significant cost synergies to a potential consolidator of the industry, such as Yahoo, MSN, Google, Valueclick, or private equity back players such as Atomic Online. For example, AOL was able to add $20m to the Huffington Posts bottom line of $10m by shutting down AOL's overlapping news and finance divisions. We currently estimate that AOL Online division's opex, excluding TAC, is running at $1.3 billion. Conservatively assuming an acquirer could eliminate 20% of the opex, the savings alone would be worth in excess of $1.4b, based on an 11% cap rate.
  • AOL is currently absorbing $140m in annual run rate operating expenses as it rolls out its hyper-local initiative called Patch. Should this initiative not work out, we estimate shutting Patch down would be worth over $700m, assuming $80m in severance payments and an 11% cap rate.
  • In a worst case scenario, AOL has several levers to pull, including returning to aggressively monetize its audience of 112m monthly unique visitors and engaging in search word arbitrage, similar to that of IACI, which generates over $150m in EBITDA on much less traffic.
  • AOL also has a tax basis in Netscape of $2.5b which may be valuable to a potential acquirer.

  

Acquisition of Huffington Post and TechCrunch will reinvigorate growth and engagement within the old AOL network and vice versa: 

  • Due to the network effect created by cross linking sites within the AOL family, the addition of two fast growing and influential sites will help invigorate growth and engagement across all of AOL's properties. This network effect will also benefit the growth and engagement of Huffington Post and TechCrunch users. After being plugged into the AOL network, TechCrunch grew new users by over 60%.
  • Huffington Post's political relevance positions it well to benefit from 2012's election year. AOL will also benefit from the free national media exposure generated through Ariana Huffington's many appearances on TV.
  • In addition to the Huffington Post, AOL also picked up a state of the art technology platform, with tight integration into the social media world, and a self-policing commentary platform that drives high levels of relevance and engagement. AOL has the opportunity to rolls this unique platform out to its network of content properties, which should drive higher user engagement and awareness.

  

Key Value Drivers 

  • Increase in monthly unique visitors
  • Project Devil engagement metrics and CPM lift vs. traditional display
  • Display ad growth rate
  • Market share gains in Display
  • Continued shift of ad spending to the online
  • Growth in revenue per search
  • Reduce churn in access subscription business
 

Key Risks 

  • Significant amount of cash is used for acquisitions that do not generate sufficient ROIC
  • Double dip recession results in slower (or even negative) growth in online display ads
  • Loss of key executives, such as Tim Armstrong or Ariana Huffington
  • Inability to reignite growth in core AOL O&O properties, decline in monthly unique visitors, or reduced engagement or time spent on AOL properties
  • Accelerated expansion of Patch initiative beyond the $40m per quarter burn rate w/out seeing improvement in results or performance metrics
  • Accelerated decline in pace of access subscription business
  • Higher than anticipated cash flow margin of access business
 

Warranted Value 

  • BASE CASE = $29 (based on 11% FCF yield on FY14 estimates, assumes no incremental revenue benefit from Patch and full absorption of $140m per year burn rate)
  • DOWNSIDE = $16 (based on SOTP, harvest cash flows from run off of Subscription business by 2016 w/ 30% haircut from base case, and 13% FCF yield on FY14 estimates for Online business assuming 30% haircut to base case).

 

CONOLODATED MODEL
  2007 2008 2009 2010 2011 2012 2013 2014
Display Revenue - DOMESTIC  $        747  $        583  $        514  $        473  $        567  $        666  $        733  $        806
% Growth   -21.9% -11.9% -8.0% 20.0% 17.5% 10.0% 10.0%
                 
Display Revenue - INTERNATIONAL  $        149  $        146  $          90  $          48  $          36  $          39  $          41  $          45
% Growth   -2.1% -38.1% -47.0% -25.0% 7.5% 7.5% 7.5%
                 
Search  $        657  $        721  $        610  $        428  $        364  $        346  $        337  $        337
% Growth   9.8% -15.4% -29.8% -15.0% -5.0% -2.5% 0.0%
                 
Third Party Network  $        678  $        633  $        523  $        336  $        336  $        361  $        388  $        417
% Growth   -6.6% -17.4% -35.8% 0.0% 7.5% 7.5% 7.5%
                 
Subscription  $     2,788  $     1,929  $     1,389  $     1,024  $        717  $        502  $        364  $        264
% Growth   -30.8% -28.0% -26.3% -30.0% -30.0% -27.5% -27.5%
                 
Other  $        162  $        140  $        120  $        109  $          87  $          78  $          75  $          75
% Growth   -13.6% -14.1% -9.4% -20.0% -10.0% -5.0% 0.0%
                 
Total Revenues  $    5,181  $    4,153  $    3,246  $    2,417  $    2,106  $    1,991  $    1,937  $    1,943
% Growth   -19.8% -21.8% -25.5% -12.8% -5.4% -2.7% 0.3%
                 
Traffic Acquisition Cost (TAC)  $        604  $        686  $        567  $        298  $        283  $        268  $        253  $        238
                 
Cost of Revenues  $     2,049  $     1,587  $     1,326  $     1,123  $     1,053  $     1,006  $        978  $        962
% of Revenue 39.5% 38.2% 40.9% 46.5% 50.0% 50.5% 50.5% 49.5%
                 
Gross Profit  $    3,132  $    1,880  $    1,353  $       996  $       770  $       718  $       706  $       744
Gross Margin 60.5% 45.3% 41.7% 41.2% 36.6% 36.1% 36.5% 38.3%
                 
SG&A  $        964  $        640  $        535  $        491  $        527  $        528  $        537  $        544
% of Revenue 18.6% 15.4% 16.5% 20.3% 25.0% 26.5% 27.7% 28.0%
                 
Amortization of Intangibles  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
                 
Operating Income  $    2,072  $    1,081  $       680  $       360  $       172  $       186  $       170  $       199
Operating Margin 40.0% 26.0% 20.9% 14.9% 8.2% 9.3% 8.8% 10.3%
                 
Less: Cash Taxes  $      (787)  $      (411)  $      (258)  $      (137)  $        (66)  $        (71)  $        (64)  $        (76)
Tax Rate 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0%
                 
Plus: Depreciation  $        403  $        311  $        262  $        196  $        177  $        182  $        187  $        192
Plus: Amortization  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
Plus: Stock Based Comp  $          20  $          20  $          13  $          36  $          30  $          30  $          30  $          30
Less: CapEx  $      (175)  $      (172)  $      (136)  $        (96)  $      (100)  $      (100)  $      (100)  $    (100)
                 
Unlevered FCF  $   1,628  $      987  $      698  $      505  $      285  $      232  $      222  $      246
Unlevered FCF Yield         18.1% 14.7% 14.1% 15.6%
                 
EBITDA  $   2,571  $   1,551  $    1,079  $      701  $      421  $      372  $      357  $      391
EBITDA Margin 49.6% 37.3% 33.2% 29.0% 20.0% 18.7% 18.4% 20.1%
EV / EBITDA         3.7x 4.2x 4.4x 4.0x
                 
FY14 FCF  $      246              
Cap Rate Assumption 11.0%              
                 
Firm Value  $   2,233              
Less: Debt (99)              
Plus: Cash 382              
Plus: Excess FCF (FY11 - FY13) 739              
Equity Value  $   3,256              
                 
Shares Outstanding 111.5 plus 4.5m for SBC dilution        
                 
Warranted Price - Base Case  $   29.20              

ACCESS BUSINESS MODEL (estimated based on margin assumptions)
  2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Subscription Revenue  $    2,788  $    1,929  $    1,389  $    1,024  $       717  $       502  $       364  $       264  $       132  $         66
% Growth   -30.8% -28.0% -26.3% -30.0% -30.0% -27.5% -27.5% -50.0% -50.0%
                     
Cost of Revenues  $        474  $        357  $        278  $        220  $        165  $        125  $          98  $          76  $          66  $          53
% of Revenue 17.0% 18.5% 20.0% 21.5% 23.0% 25.0% 27.0% 29.0% 50.0% 80.0%
                     
Gross Profit  $    2,314  $    1,572  $    1,111  $       804  $       552  $       376  $       265  $       187  $         66  $         13
Gross Margin 83.0% 81.5% 80.0% 78.5% 77.0% 75.0% 73.0% 71.0% 50.0% 20.0%
                     
SG&A  $        167  $        135  $        111  $          97  $          86  $          75  $          65  $          58  $          33  $          20
% of Revenue 6.0% 7.0% 8.0% 9.5% 12.0% 15.0% 18.0% 22.0% 25.0% 30.0%
                     
Amortization of Intangibles  $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -  
                     
Operating Income  $    2,147  $    1,437  $    1,000  $       706  $       466  $       301  $       200  $       129  $         33  $          (7)
Operating Margin 77.0% 74.5% 72.0% 69.0% 65.0% 60.0% 55.0% 49.0% 25.0% -10.0%
                     
Less: Cash Taxes  $      (816)  $      (546)  $      (380)  $      (268)  $      (177)  $      (114)  $        (76)  $        (49)  $        (13)  $            3
Tax Rate 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0%
                     
Plus: Depreciation  $        139  $          96  $          69  $          51  $          36  $          25  $          18  $          13  $            7  $            3
Plus: Amortization  $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -  
Plus: Stock Based Comp  $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -  
Less: CapEx  $        (70)  $        (48)  $        (35)  $        (26)  $        (18)  $        (13)  $          (9)  $          (7)  $          (3)  $          (2)
                     
Unlevered FCF  $   1,401  $      939  $      655  $      463  $      307  $      199  $      133  $        87  $        24  $         (2)
                     
EBITDA  $    2,286  $    1,534  $    1,069  $      757  $      502  $      326  $      218  $      142  $        40  $         (3)
EBITDA Margin 82.0% 79.5% 77.0% 74.0% 70.0% 65.0% 60.0% 54.0% 30.0% -5.0%
IMPLIED ONLINE BUSINESS MODEL (backed into based on Access Business Model above)
  2007 2008 2009 2010 2011 2012 2013 2014
On Line Revenue  $    2,393  $    2,223  $    1,857  $    1,393  $    1,390  $    1,490  $    1,574  $    1,679
% Growth   -7.1% -16.5% -25.0% -0.2% 7.2% 5.6% 6.7%
                 
TAC  $        604  $        686  $        567  $        298  $        283  $        268  $        253  $        238
                 
Cost of Revenues  $     1,575  $     1,230  $     1,049  $        903  $        888  $        880  $        880  $        885
% of Revenue 65.8% 55.3% 56.5% 64.8% 63.9% 59.1% 55.9% 52.7%
                 
Gross Profit  $       214  $       307  $       242  $       193  $       219  $       342  $       441  $       556
Gross Margin 8.9% 13.8% 13.0% 13.8% 15.7% 22.9% 28.0% 33.1%
Gross Margin (Net RevenueBasis)   20.0% 18.7% 17.6% 19.8% 28.0% 33.4% 38.6%
                 
SG&A  $        797  $        505  $        424  $        394  $        441  $        452  $        471  $        486
% of Revenue 33.3% 22.7% 22.8% 28.3% 31.7% 30.4% 29.9% 28.9%
                 
Amortization of Intangibles  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
                 
Operating Income  $     (679)  $     (357)  $     (320)  $     (347)  $     (293)  $     (115)  $        (30)  $         70
Operating Margin -28.4% -16.0% -17.2% -24.9% -21.1% -7.7% -1.9% 4.2%
                 
Less: Cash Taxes  $       258  $       136  $        122  $        132  $        111  $          44  $          12  $        (27)
Tax Rate 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0%
                 
Plus: Depreciation  $        263  $        215  $        192  $        145  $        141  $        157  $        169  $        179
Plus: Amortization  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
Plus: Stock Based Comp  $          20  $          20  $          13  $          36  $          30  $          30  $          30  $          30
Less: CapEx  $      (105)  $      (124)  $      (101)  $        (70)  $        (82)  $        (87)  $        (91)  $        (93)
                 
Unlevered FCF  $    (147)  $        48  $        43  $         41  $       (21)  $        33  $        89  $      159
Unlevered FCF Yield         -2.6% 3.9% 10.7% 19.1%
                 
EBITDA  $    (319)  $        17  $        10  $       (56)  $       (81)  $        46  $      138  $      249
EBITDA Margin -13.4% 0.8% 0.5% -4.0% -5.8% 3.1% 8.8% 14.8%

 

WATERFALL ANALYSIS

Sum of the Parts Analysis - DOWNSIDE  
                   
    2014 FCF   Cap Rate   Value   Value Per Share  
                   
Online    $       111   13.0%    $         856    $                 8.00 assumes base case is off by 30%
                   
Subscription Wind Down FCF            $         523    $                 4.89 assumes base case is off by 30%
                   
3 Year Cash Build (Online only)          $           70    $                 0.66 assumes base case is off by 30%
                   
Net Cash            $         283    $                 2.65  
                   
TOTAL            $      1,732    $               16.19  
                   
        Upside/Downside   (3%)  
                   
                   
                   
Sum of the Parts Analysis - BASE CASE  
                   
    2014 FCF   Cap Rate   Value   Value Per Share  
                   
AOL    $       246   11.0%    $      2,233    $               20.03  
                   
3 Year Cash Build            $         739    $                 6.63  
                   
Net Cash            $         283    $                 2.54  
                   
TOTAL    $       246        $      3,256    $               29.20  
                   
Shares Outstanding   111.5   Upside/Downside   75%  
                   
                   
                   
UPSIDE OPPORTUNITY  
                   
                Value Per Share  
                   
Patch Breakeven scenario                $                 6.07  
                   
Patch Profitable (15% Op. Margin)            $                 2.01  
                   
+5% to Display Ad CAGR (market growth vs. base case)        $                 4.37 assumes 60% incremental margin... market forecast for display ad growth is 15%-20%
                   
Use of $2.5b Netscape NOL Asset            $                    -    
                   
TOTAL                $               12.45  
                   
        Incremental Upside   75%  

 

Catalyst

Upcoming earnings release shows accelerating display revenue growth
Patch monitization and increase in unique viewers
Growth in Huffington Post unique viewers
    sort by    

    Description

    The recent pull back in AOL's shares represents a very attractive entry point... The company is in the final stages of its massive restructuring efforts, which included a ton of restructuring and asset dispositions... Since it's spin, AOL's strategy has remained consistent (help branded advertisers spend more money online) and has not waivered despite may potential new business opportunities (social media, group buying, etc) that could have easily distracted the management team... With the restructuring largely behind them, AOL will begin to face very, very easy comps from this upcoming quarter (salesforce reorg, shut down of international businesses, stopping of bad revenue practices all took place during the past 12 months)... with its strict focus on premium US display advertising, we believe AOL will be a much cleaner story going forward and will begin to show accelerating growth in US display advertising over the next coming quarter, helping them achieve their goal of breakeven in their online division by 4Q11 and putting them on track to acheive their goal of returning to OIBDA growth in 2013... 

     

    AOL Inc. is a leading global web services company with an extensive suite of brands and offerings and a substantial worldwide audience.  AOL's business spans online content, products and services that the company offers to consumers, publishers and advertisers.  AOL is focused on attracting and engaging consumers and providing valuable online advertising services on both AOL's owned and operated properties and third-party websites.  In addition, AOL operates one of the largest internet subscription access services in the United States.  AOL generates revenue primarily through 1) Online Advertising; 2) Access Subscriptions; and 3) Other Services.

     

    1)       Online Advertising:  Advertising is AOL's largest business segment, contributing 53% of total revenue in FY10.  The segment is comprised of 3 key offerings: 

     

    2)       Access Subscriptions:  This is AOL's legacy business that made AOL a household name in the first place.  As the largest domestic online Subscription provider, AOL leads a small pack of competitors such as EarthLink and United Online.  AOL currently has approximately 3.6m subscribers as of March 31, 2011 with an average tenure in excess of 10 years.  AOL generates revenue by charging its subscribers a monthly fee for providing dial up access and broadband services, including email, security and storage.  AOL's subscription business accounted for 42% of total revenues in FY10.

     

    3)       Other Services:  Other services primarily consist of revenue associated with the licensing of AOL's AdTech platform to large advertisers or ad agencies, to help them manage their online campaigns.  The segment also includes licensing fees for its communication products such as email and IM and some mobile revenue.  Other services accounted for 4.5% of total revenue in FY10.

     

    Investment Thesis

    Talented new management team / Turnaround noise largely behind them: 

     

    AOL's new strategic direction is specifically aimed at addressing two major hurdles that large branded advertisers are currently grappling with, which should lead to above average growth rates in the future:  

     

    Ample downside protection: 

      

    Acquisition of Huffington Post and TechCrunch will reinvigorate growth and engagement within the old AOL network and vice versa: 

      

    Key Value Drivers 

     

    Key Risks 

    • Significant amount of cash is used for acquisitions that do not generate sufficient ROIC
    • Double dip recession results in slower (or even negative) growth in online display ads
    • Loss of key executives, such as Tim Armstrong or Ariana Huffington
    • Inability to reignite growth in core AOL O&O properties, decline in monthly unique visitors, or reduced engagement or time spent on AOL properties
    • Accelerated expansion of Patch initiative beyond the $40m per quarter burn rate w/out seeing improvement in results or performance metrics
    • Accelerated decline in pace of access subscription business
    • Higher than anticipated cash flow margin of access business
     

    Warranted Value 

     

    CONOLODATED MODEL
      2007 2008 2009 2010 2011 2012 2013 2014
    Display Revenue - DOMESTIC  $        747  $        583  $        514  $        473  $        567  $        666  $        733  $        806
    % Growth   -21.9% -11.9% -8.0% 20.0% 17.5% 10.0% 10.0%
                     
    Display Revenue - INTERNATIONAL  $        149  $        146  $          90  $          48  $          36  $          39  $          41  $          45
    % Growth   -2.1% -38.1% -47.0% -25.0% 7.5% 7.5% 7.5%
                     
    Search  $        657  $        721  $        610  $        428  $        364  $        346  $        337  $        337
    % Growth   9.8% -15.4% -29.8% -15.0% -5.0% -2.5% 0.0%
                     
    Third Party Network  $        678  $        633  $        523  $        336  $        336  $        361  $        388  $        417
    % Growth   -6.6% -17.4% -35.8% 0.0% 7.5% 7.5% 7.5%
                     
    Subscription  $     2,788  $     1,929  $     1,389  $     1,024  $        717  $        502  $        364  $        264
    % Growth   -30.8% -28.0% -26.3% -30.0% -30.0% -27.5% -27.5%
                     
    Other  $        162  $        140  $        120  $        109  $          87  $          78  $          75  $          75
    % Growth   -13.6% -14.1% -9.4% -20.0% -10.0% -5.0% 0.0%
                     
    Total Revenues  $    5,181  $    4,153  $    3,246  $    2,417  $    2,106  $    1,991  $    1,937  $    1,943
    % Growth   -19.8% -21.8% -25.5% -12.8% -5.4% -2.7% 0.3%
                     
    Traffic Acquisition Cost (TAC)  $        604  $        686  $        567  $        298  $        283  $        268  $        253  $        238
                     
    Cost of Revenues  $     2,049  $     1,587  $     1,326  $     1,123  $     1,053  $     1,006  $        978  $        962
    % of Revenue 39.5% 38.2% 40.9% 46.5% 50.0% 50.5% 50.5% 49.5%
                     
    Gross Profit  $    3,132  $    1,880  $    1,353  $       996  $       770  $       718  $       706  $       744
    Gross Margin 60.5% 45.3% 41.7% 41.2% 36.6% 36.1% 36.5% 38.3%
                     
    SG&A  $        964  $        640  $        535  $        491  $        527  $        528  $        537  $        544
    % of Revenue 18.6% 15.4% 16.5% 20.3% 25.0% 26.5% 27.7% 28.0%
                     
    Amortization of Intangibles  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
                     
    Operating Income  $    2,072  $    1,081  $       680  $       360  $       172  $       186  $       170  $       199
    Operating Margin 40.0% 26.0% 20.9% 14.9% 8.2% 9.3% 8.8% 10.3%
                     
    Less: Cash Taxes  $      (787)  $      (411)  $      (258)  $      (137)  $        (66)  $        (71)  $        (64)  $        (76)
    Tax Rate 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0%
                     
    Plus: Depreciation  $        403  $        311  $        262  $        196  $        177  $        182  $        187  $        192
    Plus: Amortization  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
    Plus: Stock Based Comp  $          20  $          20  $          13  $          36  $          30  $          30  $          30  $          30
    Less: CapEx  $      (175)  $      (172)  $      (136)  $        (96)  $      (100)  $      (100)  $      (100)  $    (100)
                     
    Unlevered FCF  $   1,628  $      987  $      698  $      505  $      285  $      232  $      222  $      246
    Unlevered FCF Yield         18.1% 14.7% 14.1% 15.6%
                     
    EBITDA  $   2,571  $   1,551  $    1,079  $      701  $      421  $      372  $      357  $      391
    EBITDA Margin 49.6% 37.3% 33.2% 29.0% 20.0% 18.7% 18.4% 20.1%
    EV / EBITDA         3.7x 4.2x 4.4x 4.0x
                     
    FY14 FCF  $      246              
    Cap Rate Assumption 11.0%              
                     
    Firm Value  $   2,233              
    Less: Debt (99)              
    Plus: Cash 382              
    Plus: Excess FCF (FY11 - FY13) 739              
    Equity Value  $   3,256              
                     
    Shares Outstanding 111.5 plus 4.5m for SBC dilution        
                     
    Warranted Price - Base Case  $   29.20              

    ACCESS BUSINESS MODEL (estimated based on margin assumptions)
      2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
    Subscription Revenue  $    2,788  $    1,929  $    1,389  $    1,024  $       717  $       502  $       364  $       264  $       132  $         66
    % Growth   -30.8% -28.0% -26.3% -30.0% -30.0% -27.5% -27.5% -50.0% -50.0%
                         
    Cost of Revenues  $        474  $        357  $        278  $        220  $        165  $        125  $          98  $          76  $          66  $          53
    % of Revenue 17.0% 18.5% 20.0% 21.5% 23.0% 25.0% 27.0% 29.0% 50.0% 80.0%
                         
    Gross Profit  $    2,314  $    1,572  $    1,111  $       804  $       552  $       376  $       265  $       187  $         66  $         13
    Gross Margin 83.0% 81.5% 80.0% 78.5% 77.0% 75.0% 73.0% 71.0% 50.0% 20.0%
                         
    SG&A  $        167  $        135  $        111  $          97  $          86  $          75  $          65  $          58  $          33  $          20
    % of Revenue 6.0% 7.0% 8.0% 9.5% 12.0% 15.0% 18.0% 22.0% 25.0% 30.0%
                         
    Amortization of Intangibles  $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -  
                         
    Operating Income  $    2,147  $    1,437  $    1,000  $       706  $       466  $       301  $       200  $       129  $         33  $          (7)
    Operating Margin 77.0% 74.5% 72.0% 69.0% 65.0% 60.0% 55.0% 49.0% 25.0% -10.0%
                         
    Less: Cash Taxes  $      (816)  $      (546)  $      (380)  $      (268)  $      (177)  $      (114)  $        (76)  $        (49)  $        (13)  $            3
    Tax Rate 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0%
                         
    Plus: Depreciation  $        139  $          96  $          69  $          51  $          36  $          25  $          18  $          13  $            7  $            3
    Plus: Amortization  $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -  
    Plus: Stock Based Comp  $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -    $           -  
    Less: CapEx  $        (70)  $        (48)  $        (35)  $        (26)  $        (18)  $        (13)  $          (9)  $          (7)  $          (3)  $          (2)
                         
    Unlevered FCF  $   1,401  $      939  $      655  $      463  $      307  $      199  $      133  $        87  $        24  $         (2)
                         
    EBITDA  $    2,286  $    1,534  $    1,069  $      757  $      502  $      326  $      218  $      142  $        40  $         (3)
    EBITDA Margin 82.0% 79.5% 77.0% 74.0% 70.0% 65.0% 60.0% 54.0% 30.0% -5.0%
    IMPLIED ONLINE BUSINESS MODEL (backed into based on Access Business Model above)
      2007 2008 2009 2010 2011 2012 2013 2014
    On Line Revenue  $    2,393  $    2,223  $    1,857  $    1,393  $    1,390  $    1,490  $    1,574  $    1,679
    % Growth   -7.1% -16.5% -25.0% -0.2% 7.2% 5.6% 6.7%
                     
    TAC  $        604  $        686  $        567  $        298  $        283  $        268  $        253  $        238
                     
    Cost of Revenues  $     1,575  $     1,230  $     1,049  $        903  $        888  $        880  $        880  $        885
    % of Revenue 65.8% 55.3% 56.5% 64.8% 63.9% 59.1% 55.9% 52.7%
                     
    Gross Profit  $       214  $       307  $       242  $       193  $       219  $       342  $       441  $       556
    Gross Margin 8.9% 13.8% 13.0% 13.8% 15.7% 22.9% 28.0% 33.1%
    Gross Margin (Net RevenueBasis)   20.0% 18.7% 17.6% 19.8% 28.0% 33.4% 38.6%
                     
    SG&A  $        797  $        505  $        424  $        394  $        441  $        452  $        471  $        486
    % of Revenue 33.3% 22.7% 22.8% 28.3% 31.7% 30.4% 29.9% 28.9%
                     
    Amortization of Intangibles  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
                     
    Operating Income  $     (679)  $     (357)  $     (320)  $     (347)  $     (293)  $     (115)  $        (30)  $         70
    Operating Margin -28.4% -16.0% -17.2% -24.9% -21.1% -7.7% -1.9% 4.2%
                     
    Less: Cash Taxes  $       258  $       136  $        122  $        132  $        111  $          44  $          12  $        (27)
    Tax Rate 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0% 38.0%
                     
    Plus: Depreciation  $        263  $        215  $        192  $        145  $        141  $        157  $        169  $        179
    Plus: Amortization  $          96  $        159  $        138  $        145  $          71  $            5  $           -    $           -  
    Plus: Stock Based Comp  $          20  $          20  $          13  $          36  $          30  $          30  $          30  $          30
    Less: CapEx  $      (105)  $      (124)  $      (101)  $        (70)  $        (82)  $        (87)  $        (91)  $        (93)
                     
    Unlevered FCF  $    (147)  $        48  $        43  $         41  $       (21)  $        33  $        89  $      159
    Unlevered FCF Yield         -2.6% 3.9% 10.7% 19.1%
                     
    EBITDA  $    (319)  $        17  $        10  $       (56)  $       (81)  $        46  $      138  $      249
    EBITDA Margin -13.4% 0.8% 0.5% -4.0% -5.8% 3.1% 8.8% 14.8%

     

    WATERFALL ANALYSIS

    Sum of the Parts Analysis - DOWNSIDE  
                       
        2014 FCF   Cap Rate   Value   Value Per Share  
                       
    Online    $       111   13.0%    $         856    $                 8.00 assumes base case is off by 30%
                       
    Subscription Wind Down FCF            $         523    $                 4.89 assumes base case is off by 30%
                       
    3 Year Cash Build (Online only)          $           70    $                 0.66 assumes base case is off by 30%
                       
    Net Cash            $         283    $                 2.65  
                       
    TOTAL            $      1,732    $               16.19  
                       
            Upside/Downside   (3%)  
                       
                       
                       
    Sum of the Parts Analysis - BASE CASE  
                       
        2014 FCF   Cap Rate   Value   Value Per Share  
                       
    AOL    $       246   11.0%    $      2,233    $               20.03  
                       
    3 Year Cash Build            $         739    $                 6.63  
                       
    Net Cash            $         283    $                 2.54  
                       
    TOTAL    $       246        $      3,256    $               29.20  
                       
    Shares Outstanding   111.5   Upside/Downside   75%  
                       
                       
                       
    UPSIDE OPPORTUNITY  
                       
                    Value Per Share  
                       
    Patch Breakeven scenario                $                 6.07  
                       
    Patch Profitable (15% Op. Margin)            $                 2.01  
                       
    +5% to Display Ad CAGR (market growth vs. base case)        $                 4.37 assumes 60% incremental margin... market forecast for display ad growth is 15%-20%
                       
    Use of $2.5b Netscape NOL Asset            $                    -    
                       
    TOTAL                $               12.45  
                       
            Incremental Upside   75%  

     

    Catalyst

    Upcoming earnings release shows accelerating display revenue growth
    Patch monitization and increase in unique viewers
    Growth in Huffington Post unique viewers

    Messages


    SubjectThe Fanhouse Paradox
    Entry08/08/2011 05:16 PM
    Memberalgonquin222
    I looked at this at the spin-off and passed for the following reason and I'd like your take on it since I don't think you addressed it in your write up.
    There was a page in the spin-off document that listed where AOL owned sites ranked among all web properties in terms of page views for various categories. I was amazed that they had one in the top five in like every single category.
    I follow sports pretty closely and was really surprised to see Fanhouse listed in the top five for the sports category. I said to myself, in all the years I have been surfing the web, I don't think I have ever been to this site. Not once. How is it possibly a top five property on the web?
    The answer, it seems to me, is that AOL dial-up and broadband subscribers are funneled to the various AOL properties when they login. I spoke with a former employee of theirs over the weekend and he confirmed to me that this was the case. So what I think you are missing is that as dial-up/broadband subscribers decline so will page views and advertising revenue. In my opinion the market expects subscription revenue to go down but they don't expect the ad revenues to go down with it.
    You can't really separate the two businesses and assume one will grow while the other slowly shrinks. Of course AOL doesn't break out how much ad revenue is derived from their subscribers but I bet it is huge.

    SubjectRE: The Fanhouse Paradox
    Entry08/09/2011 06:32 AM
    MemberJackBlack
    You are right in that heavy users of AOL tend to be dial up subscribers... You can see this in the relavitely flat unique visitor numbers that the company reports (steady 112m uniques)... what you have is declines in AOL and some of the other legacy portals offset by growth in others (Huffpo, Engadget, TechCrunch, StyleList, etc)... I do account for this headwind in my base case model... I assume well below market growth for Search (negative growth vs mid-high single digit market growth) and Display (10% vs. market growth of 15%) advertising to account for this headwind... There should also be some positive network effect (increased traffic) from the fast growth properties on the legacy AOL properties... downloading the Alexa toolbar gives you a decent sense of the traffic trends at each site...

    SubjectRE: beyond parody
    Entry11/17/2011 05:51 PM
    Memberzzz007
    That's an insult to both Cooper Union and the entire LSD subculture.

    SubjectRE: RE: RE: beyond parody
    Entry04/09/2012 11:18 PM
    MemberJackBlack
    Good stuff ithan... no real change to my thesis though... as you can see in my write up, I did not ascribe any value to the patent portfolio in my price targets... so I've just added $10 to my price target and am going to let this rip... this data point is just another example of management continuing to execute on what they have said they would execute on... a few more of this and I think we should see the media reverse course from their negative portraial to something more positive... Tim has executed on just about everything he's said he'd do over the past 18 months...

    SubjectRE: YHOO/AOL
    Entry09/26/2014 03:35 PM
    Memberspecialk992
    I've followed AOL for a while and owned it off and on, and my current take is that it is cheap but appropriately priced as over 100% of the profitability comes from their membership group, i.e. dialup subscribers or people who are just keeping their email accounts. That kind of business deserves a very low multiple, obviously. They are growing EBITDA, basically because they are growing EBITDA at their other divisions and cutting corproate overhead faster than they are losing EBITDA at the membership group but obviously having a shrinking division responsible for over 100% of your profitabilty is a problem.
     
    A deal with Yahoo could potentially change all of that, but I don't know how to handicap that possibility. Yahoo has publicly said they don't want to buy AOL and I am not sure Starboard will be able to force anything given how huge Yahoo is.
     
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