Can AOL Turn Things Around?

Its been about a year and a half since  AOL (NYSE: AOL ) was spun off from
Time Warner (NYSE: TWX ) and put under the leadership of former Google (NASDAQ:
GOOG ) executive Tim Armstrong. AOL reported another plunge in revenues and
profits in the first quarter of 2011, but Armstrong continues to wax optimistic
about the internet stocks future. So should you invest in AOL stock? AOLs first
quarter results do not contain much reason for optimism. Its first-quarter
profit of $4.7 million , or 4 cents a share, was down 87% from the year before.
And its revenues fell 17% to $551.4 million. But the good news was that AOLs
display advertising was up 4% despite a 24% decline in subscription revenue. And
AOL has lost considerable market value since it merged with Time Warner in a
record $166 billion deal back in early 2001. The New York Times reports that the
number of AOL subscribers has dropped 86% from 22 million back then to 3.6
million today. And it is continuing to lose subscribers at the rate of 19,000 a
day not a surprise, considering the move away from dial-up and towards high
speed Internet options. AOLs current market capitalization of $2.1 billion is
about 98.7% below its peak of $222 billion at the end of 1999. A lot of AOLs
troubles are not its fault. The companys current strategy,  launched in 2006 to
try to acknowledge that dial-in Internet access was fading as wide access to
broadband services was on the rise, focuses on selling advertising through
proprietary content. But that content strategy has not been  a rousing success.
Since 2006, AOL has seen revenue decline almost 70%, while net income fell from
$718 million in profits  to a $790 million loss during the same period. The
reason this content strategy is not working is pretty simple. AOLs content is
targeted at a different segment of the population than those who actually
subscribe to AOLs Internet access service. More specifically, AOL subscribers
lean right while the content leans left . This gap makes it hard to sell more
advertising since the left-leaning content is not attracting enough new viewers
to make up for the loss in AOLs subscriber base. The strategy to reverse AOLs
decline rests on Arianna Huffington who started the Huffington Post and now runs
AOLs content. AOL paid $315 million for HuffPo a media property that generated
$30 million in 2010 revenues and had 25 million unique visitors. And the Times
estimates that Huffington Post will generate $60 million in revenues in 2011 and
a modest profit. Is Tim Armstrong right that AOL stock is poised to pop? To make
that decision, you might consider using the price-to-earnings-to-growth (PEG)
ratio that compares a stock's market valuation to its forecasted earnings
growth. By that measure, if a stock trades at a PEG of 1.0 or lower, it is
reasonably priced. Higher than that, and it looks overvalued. But its hard to
calculate a PEG for AOL because it lost $827 million on last 12-months revenues
of $2.3 billion so it has no earnings on which to calculate a P/E. Moreover, its
earnings are forecast to decline 3% from $1.11 in 2011 to $1.08 in 2012 . With
all the other bad news, a 4% increase in display advertising seems like a
pretty thin reed on which to base a turnaround bet. Peter Cohan has no financial
interest in the securities mentioned.