AOL: A Candidate for Private Equity?

As Stock Falls, Company Is Cheap Relative to its Assets

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For a private equity firm that 's looking for the cheapest way to get online, AOL is trading for 57 cents on the dollar.

The internet pioneer spun off from Time Warner in 2009 plunged to a record low last week after cutting this year's profit forecast because of slowing growth in display advertising sales. With its market capitalization reduced to $1.3 billion from a peak of $3.1 billion last year, New York-based AOL is now the cheapest relative to its net assets of any U.S. web company with a value of more than $500 million, according to data compiled by Bloomberg.

AOL has posted net losses of almost $800 million in less than two years as a standalone company as the profitable dial-up internet business becomes obsolete and online advertising sales on websites from the Huffington Post to Moviefone fail to make money. With AOL trading at a 43% discount, the company may now attract private equity buyers that can still extract $1.5 billion in cash out of the access business within three years, according to B. Riley & Co.

"Private equity could look at the business," Ken Sena, an analyst at Evercore Partners Inc. in New York, said in a telephone interview. They may "decide that the company is worth a lot more than its current price tag," he said. "It would take them about three years to pay off. The question is , between now and when the access business ultimately declines, will they be profitable enough?"

Maureen Sullivan, a spokeswoman for AOL, declined to comment on the prospect of a sale.

Takeover candidate
AOL has fallen 57% from its peak in April 2010 to $12.45 yesterday. The shares tumbled a record 26% Aug. 9, hitting an all-time low of $10.22 the next day after AOL lowered its annual forecast for adjusted operating income because of lower revenue from the display advertising.

"It's possible, now that the stock has fallen, that the company could be a takeover candidate," David Joyce, an analyst at Miller Tabak & Co. in New York, said in a phone interview.

At 0.57 times book value, or assets minus liabilities, AOL is cheaper than the 43 other U.S. internet companies that have market capitalizations greater than $500 million, data compiled by Bloomberg show. It's also trading at the least expensive price-to-earnings multiple.

Four Wall Street analysts recommend buying the stock, while eight suggest holding and only one says to sell, according to data compiled by Bloomberg. The shares may reach $19.45, based on the average of their estimates, 56% higher than the closing price yesterday.

"The entirety of AOL is more compelling for private equity today, whether to take it over or buy it and split it up," Clayton Moran, an analyst with Benchmark Co. in Boca Raton, Florida, said in a phone interview.

An acquisition of AOL may command about $1.5 billion, based on the discount a buyer would likely pay relative to the present value of the company's estimated cash flow, Sameet Sinha, an analyst at B. Riley in San Francisco, said in a phone interview. Such an amount would be in line with the 41% premium paid in takeovers greater than $500 million of U.S. internet companies in the last 12 months, data compiled by Bloomberg show.

The access business will generate a total of about $1.5 billion in earnings before interest, taxes, depreciation and amortization from 2011 to 2013, even as customers continue to abandon the older dial-up technology, estimates Mr. Sinha. That means the access business' cash flow alone may be enough to pay off an acquisition within three years, Mr. Sinha said.

"Everything after that is pure profit," Mr. Sinha said.

AOL's access business had 3.4 million subscribers as of June 30, down 23% from a year earlier, according to regulatory filings. The business may wind down by 2015, estimates Evercore's Mr. Sena.

Banking on HuffPo
Chief Executive Officer Tim Armstrong, 40, is banking on display ad sales on the Huffington Post, TechCrunch, MapQuest and Patch's local community news websites to help the advertising business reach profitability before the earnings from the access business vanish. Mr. Armstrong acquired the Huffington Post in March for $300 million, a price tag that represents almost a quarter of AOL's current market value, data compiled by Bloomberg show.

"They hope that the display advertising and ad network businesses will basically compensate for that loss and become profitable," said B. Riley's Sinha. "The Huffington Post is essentially the cornerstone of their branded display strategy."

Mr. Armstrong, who previously ran Google's ad sales in the Americas, was hired as AOL's CEO in March 2009. Since the separation was completed in December of that year, AOL has fallen 47%.

AOL's earnings have "cratered" with net losses amounting to $788 million since the spinoff in the fourth quarter of 2009, and investors are losing confidence, said Keith Wirtz, Cincinnati-based chief investment officer at Fifth Third Asset Management, which oversees $16.7 billion.

"Private equity firms may not be stepping in because they don't see an end game," Mr. Wirtz said in a phone interview. "This is a cash cow that 's melting like an ice cube."

AOL's share of U.S. display ad sales is projected to decline to 4.2% this year, down from 6.4% in 2009, according to New York-based research firm EMarketer Inc. Facebook Inc. will command almost 18% of the market in 2011, while Yahoo is expected to draw 13% and Google 9.3%, according to EMarketer.

"I have no doubt that AOL is at a level that private equity buyers are currently looking," Michael Holland, chairman of New York-based Holland & Co., which oversees more than $4 billion, said in a phone interview. "They have to be. It's possible that AOL can be recreated into something more profitable."

--Bloomberg News--

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