AOL Stock Rallies as Armstrong Plots Portal Comeback

Oct. 4 (Bloomberg) -- Timothy Armstrong, chief executive officer of AOL Inc., discusses the company's growth strategy and outlook. Armstrong speaks with Deirdre Bolton on Bloomberg Television's "In the Loop." (Source: Bloomberg)

AOL Inc. (AOL), still struggling to resurrect its brand in the eyes of Internet users, is having no trouble appealing to investors.

After adding more than 4 percent last week, AOL’s shares have almost tripled in the past 12 months, eclipsing the performance of Apple Inc., Google Inc. and Microsoft Corp. The stock hasn’t seen that kind of gain since the dot-com boom in 1998, three years before AOL merged with Time Warner Inc.

The shares got their biggest boost from a deal on April 9 to sell patents to Microsoft for $1.1 billion, money that AOL is returning to shareholders through buybacks and dividends. Even after a surge that day, the stock has climbed an additional 39 percent since then, signaling that investors have growing faith in Chief Executive Officer Tim Armstrong’s plan to turn AOL into an advertising-driven Web portal and news publisher.

“AOL is in the early innings of our strategy,” Armstrong, a former ad executive at Google, said in an interview. “Our team is working hard to rebuild America’s first Internet company and the brand that took the world online. We have a lot more to do, and we’re doing it.”

The shares gained 188 percent in the past 12 months before today. That compares with 72 percent for Apple, 44 percent for Google and 12 percent for Microsoft. AOL dropped 3 percent to $35.49 today amid a global decline in stocks.

Staying Power?

The question now is whether AOL’s fundamental business can maintain the rally. Victor Anthony, an analyst with Topeka Capital Markets Inc. in New York, is still waiting for a rebound in display advertising. Those ads -- including banners, videos and other visual marketing -- make up most of AOL’s revenue.

Analysts estimate that AOL’s total sales will drop 2 percent to $2.15 billion this year, according to data compiled by Bloomberg. That follows declines in the previous two years under Armstrong, who took charge of AOL in 2009.

“We are not ready to chase the stock at these levels because we still need evidence that the core display advertising business has been nursed back to health,” said Anthony, who has a hold rating on the stock. “To date, we have not seen that.”

Other analysts are skeptical as well. Out of 16 analysts tracking the stock, nine have a hold rating. The average price target is $35.47, below AOL’s current level, signaling that the rally may be peaking.

Still, the dividend has attracted investors who wouldn’t have considered the stock before, said Ronald Josey, a New York- based analyst at ThinkEquity LLC.

“Clearly, AOL has natural buyers from that dividend,” said Josey, who has a hold rating on the shares.

Dial-Up Roots

AOL, based in New York, was once the dominant provider of Internet access to U.S. consumers, back before the shift from dial-up connections to broadband eroded its main source of revenue. The Time Warner-AOL merger in 2001 was meant to create a new-media powerhouse by unifying a dot-com company with a traditional publisher. Instead, the $124 billion deal triggered record losses, declining sales and shareholder lawsuits.

When AOL was spun off from Time Warner (TWX) in 2009, Armstrong set out to rebuild a company with slumping sales and erratic profits. He has invested more than $600 million in content, acquiring the Huffington Post last year for $315 million and spending more than $300 million to develop Patch, a local-news division that Armstrong said should bring in about $50 million in sales this year.

Sales Slump

The effort has yet to reignite revenue, which is projected by analysts to be little changed next year. The sale of patents, though, will boost profit in 2012 by about $1 billion. To return that cash to investors, AOL announced a $600 million accelerated stock buyback agreement and a special cash dividend of $5.15 a share in August.

Even after the run-up, AOL remains a relative bargain compared with other Internet companies. AOL’s shares are trading at 8.5 percent times the company’s profit for the past four quarters. The compares with 22.4 times for its peers and 14.5 for the Standard & Poor’s 500 Index. Yahoo! Inc., another Web company trying to rebuild its image and business, trades at 16.8 times profit.

Despite its focus on advertising, AOL is still holding on to its shrinking dial-up business. The company has been working to stem the decline in dial-up subscribers by offering them additional services. AOL also continues to invest in the Huffington Post. The news site has added a live, online video news channel, and AOL’s TechCrunch and Engadget blogs plan to expand outside the U.S. Today, AOL introduced a video-game site with 5,000 online titles.

‘Further Along’

ThinkEquity’s Josey is optimistic the company could see revenue growth in the coming year, thanks to climbing advertising sales and the more moderate decline in the dial-up business. That puts the company in a better position than some of its peers, including Yahoo, he said.

“AOL is further along in their turnaround than Yahoo is,” Josey said.

AOL also has cut overhead costs to increase profit margins. Armstrong reduced general and administrative costs 14 percent in in the first six months of this year, compared with the same period a year earlier.

Armstrong faced a shareholder revolt earlier this year when activist investor group Starboard Value LP fought to install three board directors. Starboard CEO Jeffrey Smith criticized Armstrong’s content strategy, estimating that Patch lost as much as $147 million last year and that the display-advertising business loses as much as $500 million annually. Starboard amassed 5.3 percent of the shares at the time.

At AOL’s annual shareholder meeting in June, Armstrong persuaded investors to reject the proxy bid, overcoming one of his toughest challenges since taking charge of the company. Armstrong disputed Starboard’s assessment of Patch’s business. He now predicts that it may profitable by the second half of next year.

“They’re definitely better off than they were a year ago,” said Anthony DiClemente, an analyst with Barclays Plc in New York. “They’re more of a real company now.”

To contact the reporter on this story: Edmund Lee in New York at elee310@bloomberg.net

To contact the editor responsible for this story: Nick Turner at nturner7@bloomberg.net

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