Monday, February 07, 2011

AOL overpaid for HuffPo. Can deal pan out?

AOL is vastly overpaying for Huffington Post from a strict financial point of view. So, the big question is: Will this deal ever make financial sense?

A once-massive Internet service provider that is struggling to turn itself into a content powerhouse, AOL is paying $315 million for HuffPo, or approximately 10 times the
reported HuffPo sales of $31 million in 2010.

With the stock of AOL trading at a bit under 1x its revenues for the last 12 months, Arianne Huffington and her fellow owners will get a 10x larger share of AOL than HuffPo’s sales would have contributed to AOL in 2010.

Financial analysts call this a dilutive transaction, because it transfers value away from the rest of the stockholders and delivers it to the owners of the acquired company. From a strict financial point of view, therefore, AOL significantly overpaid for HuffPo.

Why would AOL chief Tim Armstrong do this? Because he evidently believes HuffPo’s sales will rise much faster than those of his own company – and that the affiliation with AOL will accelerate HuffPo’s growth even more than if it had remained independent. Here’s his likely thinking:

With approximately 3.7 times more web traffic than HuffPo’s 13.4 million monthly unique visitors, AOL can steer additional traffic to HuffPo from a wide array of sites ranging from Patch.Com to TechCrunch to Moviefone. The graphic below from HuffPo illustrates the vision for the combined companies.

AOL also has a far larger ad sales operation than HuffPo, which ought to be able to surpass the $50 million to $60 million in revenues that HuffPo likely would have achieved this year if it remained a free-standing company.

If HuffPo’s revenues triple this year to $90 million, then Armstrong can tell his shareholders he paid “only” 3.5x more for HuffPo than its sales are worth. If HuffPo sales triple again to $270 million in 2012, then the value of the deal is likely to be about 1x HuffPo’s revenues at that point and Armstrong, assuming he remains on the job, can tell the skeptics he was right.

The question to ask yourself in evaluating the long-term financial benefit of the acquisition to AOL is whether you think HuffPo is capable of bringing in a $270 million in annual sales within a couple of years. Do you?


Blogger Jim Hopkins said...

If Arianna Huffington and her fellow owners are so confident about this merger, why did they take only $15 million in AOL stock, and the rest of the $300 million in cash?

12:51 PM  
Blogger Steve Ross said...

AOL perhaps should also be looking at newspapers to get the eyeballs it needs to compete with Google and Yahoo.

The HuffPo revenue doubling could be wishful thinking. The overall economy is expected to grow 4-5%. That usually means an increase in advertising volume overall, in the entire economy, of roughly 10%. So to get to $60 million, AOL has to take volume from someplace else. Absolutely possible, but absolutely not easy.

The culture of AOL (pretty analytical) and the culture of Huff ("we start new businesses by gut feeling where we see an opportunity") may be hard to merge. But AOL is currently losing about $20 million a year on several sites that can be killed off in favor of HuffPost. And AOL needs all the heft it can get. So HP is worth more to AOL than to a typical investor.

But all-in-all, a web operation with roughly a tenth the revenue of the Boston Globe and about the same total profit (small) has just sold for $315 million, and $300 million of that was in cash! HP's projected operating profit margin in 2011, pro forma, is 16%, same as the industry average for all newspapers at the end of 2007 (18% for publicly held dailies, 20% for the overall newspaper industry).

The internal rate of return for AOL's investment is projected at about 3% (maybe 10% after efficiencies like closing two AOL sites that today lose money, but that's not the normal way an investor counts IRR).

Bottom line: Great success for HP investors. Makes sense for AOL only if everything goes right -- and AOL now has a strong management team, so it might.

7:03 PM  
Blogger rjl said...

AOL may have elevated its credibility by purchasing HuffPo which has a remarkably loyal and seemingly growing audience. If the future in "journalism" lies in conglomerate blogs like HuffPo, then AOL has made a good bet. The newspaper industry is scrambling to figure out how to survive and HuffPo provides a solid template for such success. For AOL, it offers a key to the future...something it badly needed.

7:43 AM  

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