Video Content Helps AOL's Ad Revenues But It's Not Enough
AOL's ( AOL ) stock declined by 9% during trading on May 8 as its Q1 CY13 results failed to enthuse investors. The company reported a 2% y-o-y increase in total revenue to $538.3 million. The growth in total revenue was driven by growth across its advertising revenue lines. While the company reported a 9% y-o-y increase in search and contextual advertising revenues for the quarter, display ads revenues increased by 8% y-o-y. These two divisions are important since they contribute ~40% to AOL's estimated value.
We have increased our price estimate for AOL from $25 to $27 based on the overall ad revenue growth, but it still remains substantially below the current market price. Overall, we are encouraged by AOL's results and think that the business is back on the growth path, but the current market valuation can only be justified by unreasonable growth rate assumptions for its various divisions. The focus on premium video content lifted AOL's display ads revenue, and we think the company can see higher valuations if it can sustain a high growth rate in the display ad segment, which is worth 27% of its total value as per our estimates.
Video Content Bolsters Display Ads Revenue
According to our estimates, the display ads division constitutes approximately 27% of AOL's value. Revenues from this division were around $1.05 billion in 2012, and we think they will continue to increase and reach $1.37 billion by the end of our forecast period. The key drivers for this division are unique visitor count, revenue per page view ( RPM ) and page view per unique visitor.
In line with our expectation that the display ads division would see revenue growth fueled by AOL's premium video content offerings, the company reported 8% y-o-y growth in display ads revenues to $140.4 million during the quarter. (See: AOL Pre-Earnings: Will Video Content Boost Q1 Results? ) The primary reasons for this growth were the increase in the number of video ads sold on AOL's properties and an increase in revenue per ad related to videos.
During Q1, AOL focused on improving user engagement by offering premium video content for different domains such as tech, style, business and sports. Its video content was well received by the users as the total number of videos viewed was over 800 million a month across devices. The improvement in video offerings translated into overall growth in display ads metrics. While the number of unique visitors across AOL properties increased by 3% y-o-y to 112 million, AOL also reported improvements in page views and RPM. We currently forecast that the RPM on AOL properties will increase from $2.96 in 2012 to $3.49 by the end our forecast period.
International Display Revenues Grow
AOL continues to expand outside the U.S. and this will be a key driver for growth in its display ads revenue going forward. While AOL launched Huffington Post in Japan, TechCrunch expanded its offerings to Europe and Asia in Q1. International ads revenues were only 16% of total ad revenues, but posted y-o-y growth of ~16%. While the primary countries in which display ads posted growth were the UK and Canada, we think that AOL has a good opportunity in emerging markets if can successfully leverage its brand name.
Asia is another market that AOL has its eyes on as the region has 45% of the world's Internet users while penetration is at a measly 28%. As Internet penetration grows in this region, we expect AOL to continue to post growth in unique visitors. We will be closely watching its international ad revenues in the coming year since their contribution to total ad revenues has been growing with each quarter.
Cost Cutting Measures Boosts Profitability
Although AOL's overall revenue increased by 2% y-o-y, it reported a 334 basis points improvement in operating income margins from 5.93% in Q1 CY12 to 9.27% in Q1 CY13. Operating income increased to $49.9 million from $31.4 million in the same last year, primarily due to a $16 million decline in costs as AOL reduced its employee count and scaled back some of its marketing efforts. AOL stated that it will focus on eliminating non-core activities in the coming quarters, and we expect this will lead to a further reduction in corporate expenses.
We currently have a $27 price estimate for AOL , which is approximately 25% below the current market price.