Can AOL Turn Things Around?

tdp2664
InvestorPlace
It’s 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 stock’s future. So should you invest in AOL stock? AOL’s 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 AOL’s 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. AOL’s 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 AOL’s troubles are not its fault. The company’s 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. AOL’s content is targeted at a different segment of the population than those who actually subscribe to AOL’s 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 AOL’s subscriber base. The strategy to reverse AOL’s decline rests on Arianna Huffington who started the Huffington Post and now runs AOL’s 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 it’s 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.