After announcing the acquisition, CEO Tim Armstrong famously made a 477,000 purchase totaling $10 million. We know how he feels about Arianna Huffington joining the team, but I can’t help but be skeptical of the company, the direction it’s taking, and the future prospects for the stock. After AOL’s merciful spin-off from Time Warner (TWX) at the end of 2009, there was a case to be made that some value could be unlocked by a more focused and nimble management. Not only that, but their balance sheet was outstanding, with no debt and decent cash generation prospects. Unfortunately ad revenue continued to decline and the company’s inability to keep its audience coupled with continued strong competition prompted them to take a path towards ownership of content. I don’t disagree with that direction, necessarily, but they’ve been paying a heavy price for it since their spin-off.
This brings us to the Huffington Post acquisition. We saw just last week how little of a moat a site like Huffington Post has when Google (GOOG) changed their algorithm to cause aggregator sites to appear lower than before. Some brief background on this: Some websites that aggregate stories from publishers are search engine optimized so well that those articles on the aggregator sites were appearing above the actual original story listed on the publisher’s website. Google knew this was a problem and made some tweaks to enhance search results. Huffington Post both publishes and aggregates. It’s debatable how much Huffington Post was hurt by this change, but the point is that much of their traffic is beholden to the whims of other sites like Google and to a lesser degree, Bing. AOL paid a rich price for a site that has a large degree of uncertainty involved with it.
After that $315 million purchase, AOL’s cash hoard has been severely depleted. Its once strong balance sheet now has been cut from about $800 million down to $500 million with immediate returns on the investment relatively low. In order for the transaction to make sense, traffic will have to ramp up considerably in the next few years. It could happen, but it may not.
Despite Armstrong’s personal $10 million investment in AOL, I can’t stomach the risk. Before this transaction the company was sitting on $8/share in cash and, admittedly, poor prospects. Now, in my opinion, the company is sitting on $5/share in cash and slightly better than poor prospects. A good capital allocator probably could have found dozens, if not hundreds, of ways to invest that $300 million in a way that promised higher returns with less risk than Huffington Post. Even more scary is the prospect that AOL continues to be on the prowl for new acquisitions.
Disclosure: Long GOOG