June 18 (Bloomberg) -- After more than five years of reporting on school-board meetings and community bake sales, AOL Inc.’s Patch is now at the center of another story: whether the company’s bet on local news can be profitable.
Patch, with more than 900 sites supplying news to communities or neighborhoods, has become a test case for both the online-news industry and AOL’s ability to transform itself from a dated dial-up service to an ad-driven Web publisher.
Chief Executive Officer Tim Armstrong has spent more than $600 million on media content in recent years, half of that on the money-losing Patch venture. The rest was for the Huffington Post, acquired in 2011 for $315 million, and other sites such as the technology blog TechCrunch.
Following investor complaints that Patch has been holding back AOL’s turnaround, Patch now faces a do-or-die year in 2013, said Benjamin Schachter, a media analyst with Macquarie Securities USA Inc. in New York. If the company can’t make Patch profitable, it may close down the division, he said.
“Investors have been frustrated for a long time,” said Schachter, who has a neutral rating on AOL. “If they don’t get to profitability, they’ll probably cut it. It’s going to be a challenge.”
Armstrong vowed that Patch will break even by the fourth quarter of this year -- a feat that would probably require both a big sales gain and a sharp reduction in expenses. Still, he made clear that won’t be easy.
“What you’re going to see as we get to Q4 is us trying to get to the finish line of profitability,” he said last month on a conference call with analysts. “And we will use all means possible to get there.”
Shares of New York-based AOL rose less than 1 percent to $36.76 at the close in New York. The shares have climbed 24 percent this year, beating the 16 percent gain of the Standard & Poor’s 500 Index.
Each Patch site zeroes in on a community -- whether it’s Waukesha, Wisconsin, or Brooklyn’s Park Slope -- and tries to become an indispensable source of local news. The content, everything from concert listings to crime blotters, is generated by both on-staff editors and unpaid contributors.
The company has about 160 sales representatives covering the 900-plus Patch locations, said Steve Kalin, CEO of the Patch division. He has plans to hire more.
At the same time, Patch is cutting costs elsewhere.
It eliminated 40 staff positions last month, a person familiar with the move said at the time. Patch also collapsed the editorial structure, reducing the count of 20 regional editors down to nine. The push for profitability has forced Patch to put single editors in charge of multiple sites, increasing burnout.
Still, the business will need sales to at least double this year to be profitable -- even assuming AOL slashes Patch’s budget in half. Patch pulled in just under $35 million last year, missing its sales target by about 13 percent, due in part to Hurricane Sandy, according to Armstrong. While Sandy increased demand for news, some local businesses reduced advertising orders in the wake of the disaster -- a storm that cut a path across 329 Patch towns in the Northeast.
Even so, Patch more than doubled its revenue last year from the $16 million in made in 2011. At that growth rate, the unit would have sales of about $70 million this year, or $78,000 per Patch. The average cost to operate each site is $140,000 to $180,000, Armstrong told investors in June, leaving a wide chasm between revenue and expenses.
Armstrong put up $4.5 million to start Patch, which started in 2007 with three townships in northern New Jersey. The startup eventually added more sites, and two years later, Armstrong sold Patch for $7 million to AOL, which was then still part of Time Warner Inc. As AOL’s CEO, Armstrong recused himself from the deal and forfeited the $750,000 he made in profit. He also returned the $4.5 million he recouped from the sale in exchange for AOL shares after it split from Time Warner.
“Patch is always something I’ve believed in,” he said about the transaction. “And I knew it could grow within AOL.”
Patch’s future may hinge on applying the lessons of Greenwich, Connecticut -- Armstrong’s hometown and the location of one of the company’s more successful sites.
The Greenwich Patch, started in 2010, benefits from an affluent population, a steady stream of stories and an engaged local government. The Greenwich First Selectman, Peter Tesei, sometimes uses Patch to make government announcements.
“It can sometimes be faster than sending out a press release,” he said.
Armstrong is a user of Patch’s hyperlocal updates himself. He recalls working from home in Greenwich last October when he smelled smoke. It was the week Sandy was lashing the East Coast and Armstrong became concerned there was a fire. After calling neighbors and looking out his window -- without learning anything -- he got an e-mail from Patch: Three nearby homes were in flames.
“The alert came before I even thought to check for any news online,” Armstrong, 42, said in an interview. “Shows you how crucial Patch can be.”
Ultimately, Patch’s success hinges on advertising -- an area where it’s trying to broaden its focus. In addition to courting ads from local businesses, Patch has landed national advertisers such as Sony Corp. and the Rock and Roll Hall of Fame. It’s also going after regional advertisers, including the WNBA’s Connecticut Sun team and the Cook County Department of Public Health.
Major advertisers are slowly starting to spend more on locally targeted campaigns, said David Cohen, an executive with media buying agency UM, a division of Interpublic Group of Cos. “It’s only matter of time before we see dollars flowing into this area,” Cohen said.
In the meantime, Patch is adapting to the shift to social media and mobile devices. The company is developing a mobile app that allows readers to post photos and videos, making Patch into more of a Facebook for communities -- as opposed to just a local newspaper. That increased social activity can also add traffic, relieving pressure on staffers to generate page views.
The embrace of social media can lead to some questionable content.
A February post from a Patch blogger in Avon Lake, Ohio, said that deer crossing signs in her neighborhood were a waste of taxpayer dollars because “deer cannot read.” The item became fodder for blogs such as Gawker to mock Patch.
“There may be posts that are odd or unusual or funny,” Kalin said. “We accept that.”
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