An AOL angst to haunt digital media

Its direct impact on the Australian digital advertising market may be minimal but, indirectly, the fortunes of the US based internet player AOL are an important indicator of the challenges facing domestic digital media companies.

Why is this? Well, overall forecasts for the digital advertising market use projections that are market-wide. So while the overall fortunes of the digital advertising market are generally positive and set for robust growth, the numbers are impacted greatly by the extraordinary performance of a handful of players – primarily Google, Facebook and LinkedIn – as well as the dramatic and rapid growth of the 'demand side platform' ecosystem which includes media agency-controlled and operated trading desks. 

In that sense digital advertising is a two-speed economy – a handful of players growing at a 30 per cent plus clip, and the rest of the industry struggling to realise single digital growth (and in many cases stay alive at all).

AOL falls into the ‘rest of the industry’ category – a mid-sized internet company that has pegged its future growth and earnings on the fortunes of the advertising market. The company made its name in the dial-up internet business over a decade ago, and funnily enough it’s still the dial-up internet part of AOL that is most profitable.

The diversity of AOL’s media portfolio provides good insight into the fortunes of the various categories within the digital advertising market. AOL owns and operates a bunch of well-respected brands within highly regarded categories such as news and finance (Huffington Post, AOL Finance), technology (TechCrunch, Engadget) and entertainment (Games.com, AOL Music, Stylelist) on which it sells display advertising. This is called ‘the brand group’. It also operates what it calls ‘AOL Networks’ which covers the ADTECH business as well as the advertising.com network, the AOL On video syndication product, the Buysight customer acquisition and retargeting business as well as the Pictela advertising content management system. Basically, the networks group covers third party ad sales platforms and technology.

In a nutshell, AOL has its finger in two advertising pies. One involves it creating content in selected categories and selling advertising around this content. The other involves it either selling advertisements on other companies' website and/or providing ad technology services to other companies.

The financials released overnight covering the three months ending March 31 are an interesting set of numbers. Most interesting is that, as mentioned earlier, the dial-up internet subscription business remains AOL’s best earner. Despite a year-on-year drop of 9 per cent, the dial-up subscription business generated $165 million of revenue and contributed $146 million in OIBDA (OIBDA being that unusual and unaudited metric internet companies enjoy quoting which is basically operating income before depreciation and amortisation). Despite being a relic of the past, dial-up is the only division of AOL that turned a profit in the quarter.

The brand group reported a revenue increase of 12.5 per cent year-on-year, generating $189 million for the quarter. In 2012 this revenue was down on the same period in 2011. However, the brand group reported a loss of $4.9 million for the quarter.

Since the start of 2011 the brand group component of AOL has lost $86.1 million, which has raised the question of whether this component of the business can ever be a meaningful contributor. Brands such as TechCrunch, Huffington Post and Engadget are not new businesses, they are well established with large audiences and should be contributing more to earnings than they are. The problem is the economics of producing premium content on the internet – it is simply costing more to produce than its owners can generate in advertising.

An added conundrum is that each and every day there is more supply being added to an already oversupplied market, decreasing yield and stacking the odds more and more in advertisers' and agencies' favour. AOL’s brand group performance clearly outlines this – well respected brands in lucrative verticals that continue to grow audiences that are, unfortunately, still unable to break even let alone realise a return. One could argue that in hindsight AOL might have better used the $315 million it paid for the Huffington Post on acquiring a business with revenue streams outside of advertising.

Ultimately, an increase in advertising revenue is meaningless when it comes with an even larger increase in costs.

Meanwhile, AOL's networks component was up 8 per cent year-on-year in revenue to $160.9 million, however OIBDA was down $3.4 million, the group reporting a loss of $2.5 million for the three-month period. Analysts were expecting the networks group to achieve around $2.5 million in OIBDA, the figure dragged down due to investments in technology around video and programmatic trading. After losing more than $70 million over 2010 and 2011 the networks group generated a profit of $7.3 million in 2012. This first quarter result is disappointing and hopefully not an indication that, like its brand group, AOL needs to spend more than it earns to maintain a competitive market position.

The results indicate two key things that continue to challenge the majority of the digital advertising players. One, it is increasingly difficult to maintain a premium brand position and generate positive income through advertising alone. Despite AOL’s brand portfolio and efforts to bolster its ad formats and sales approach, it still cannot make money in this area.

Secondly, in the booming world of programmatic trading and ad technology you need significant access to both elite engineering talent and cash to compete. Sure, AOL is growing its networks business, but in the first quarter it reported a loss and historically has not been able to generate a return to investors. How AOL can compete with the likes of a Google in this area, which is adding around $1 billion a month to its warchest, remains a mystery. AOL has some good assets in this area but due to the rapid technological advancements in data and trading, can it keep them relevant and current?

It's not suprising Wall Street punished AOL after the results, the stock down over 8 per cent at close.

Ben Shepherd is a media and technology consultant. He can be found on LinkedIn and on Twitter.