AOL hasn't turned the corner yet

A less awful earnings report has the stock flying. Don't buy it.

By InvestorPlace Jul 26, 2012 9:46AM
By Jonathan Berr

Shares of AOL (AOL) climbed sharply Wednesday, jumping more than 7% to close at $29.48, after hitting a multiyear high. Clearly, investors bet that CEO Tim Armstrong’s turnaround is taking hold after the Internet media company posted better-than-expected quarterly results.

I'm not ready to join the bandwagon yet.


The New York-based company is producing mediocre results instead of god-awful ones. So, yes, while that's an improvement, it also shows that Armstrong has plenty of work to do. AOL earned $970.8 million, or $10.17 per share, reversing a year-ago loss of $11.8 million, or 11 cents. But that was thanks mostly to the company’s recent $1.1 billion patent sale to Microsoft (MSFT).


Excluding one-time items, profit was 23 cents, meeting expectations of analysts surveyed by Bloomberg News. Revenue fell 2% to $531.1 million, ahead of analysts’ expectations of $519.36 million, even as AOL cut costs for the fourth straight quarter.


AOL, which recently beat back a challenge from an activist investor Starboard Value, is good at tooting its own horn. In the press release, the company brags that its revenue decline is its lowest in seven years and that ad revenue rose for the fifth consecutive quarter on a year-over-year basis. Revenue at its much-maligned Patch hyperlocal news network surged 100%.


Still, investors need to remember a couple of caveats.


First, much of the gain in ad sales -- some 19% -- came from AOL’s Third Party Network, which probably carry lower margins than ads carried on the company’s own sites, where sales were flat in the quarter. Domestic display advertising, where AOL gets most of its revenue, was also little changed.


AOL also reported a 4% gain in traffic from the first quarter on its properties, which include Huffington Post and TechCrunch. That performance is an improvement compared with the flat growth it had seen earlier. HuffPo showed double-digit gains by itself.


Patch, which was the focus of the recent failed proxy fight, remains as big a question mark as ever. During the earnings conference call, Armstrong reiterated AOL’s guidance that Patch will generate between $40 million and $50 million in revenue this year. Said the CEO: “We just signed one of our largest deals in the history of Patch from a national advertiser on their fourth renewal.”


Of course, he didn’t provide specifics and didn’t dwell on the fact that many analysts expect the hyperlocal effort to lose money. He seems motivated to prove wrong the naysayers, including me, by broadening the Patch offering.


“We basically want to have an ongoing multi-decade relationship with consumers in those marketplaces,” Armstrong continued. “They don’t move, and we don’t want to move either."


Odds are strong that Armstrong may close some poorly performing Patch sites and merge others in the coming months.


Maintaining ad sales growth at AOL and other media companies will be difficult if economic growth continues to slow. That's because ad spending is one of the first things companies cut when times are tough. AOL, though, at least seems headed in the right direction.


One of AOL’s hidden strengths is that it’s not Yahoo (YHOO), whose strategy is a confused mess. Armstrong’s vision for a content-based company remains clear. How legacy services such as MapQuest and Moviefone fit with that vision isn't obvious, so it wouldn’t surprise me if Armstrong unloaded them -- as he has unloaded so many other non-core businesses.


No matter. Until more evidence emerges that Armstrong can walk the walk and not just talk, investors should stay clear of the stock.


Jonathan Berr is a former AOL contract writer. He does not own share of the listed companies. Follow him on Twitter @jdberr.


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