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Patch won't stop flow of red ink at AOL

by Richard Morgan  |  Published December 22, 2011 at 4:10 PM
AOL Inc. no doubt thought it deflected criticism Wednesday, Dec. 21, with its quick response to an open letter posted several hours earlier by New York hedge fund Starboard Value LP. But the response that AOL "has a clear strategy" seems awfully light, both in substance and in word count, given the heaviness of charges leveled against the company in Starboard's 3,000-plus-word epistle.

Most damaging therein was Starboard's dissection of AOL's display business, consisting of such Web content properties as Huffington Post, Patch and TechCrunch. The company monetizes online content generated by these and other properties, which leadership considers AOL's future, by selling advertising against it.

However, if Starboard's estimates are to be believed, AOL is losing about a $1 in Ebitda for every $1 in revenue that stands to be allocated to display in 2011. And when it comes to Patch, the hyperlocal news disseminator that Starboard calls a "local community platform," the Ebitda-to-revenue ratio sinks to a black hole beckoning negative 10.

"We believe that Patch may alone lose as much as $150 million in 2011 based on heavy fixed expenses of $160 million and immaterial estimated revenue contribution of $10 million to $20 million," posits the letter signed by Starboard CEO Jeffrey C. Smith. The hedgie then makes it personal by reminding the letter's official addressee, AOL chairman and CEO Tim Armstrong, that Patch was acquired "from an investment firm that you founded."

While that's true, a review of AOL's purchase of Patch for $7 million in June 2009 shows a sale made in extremely good faith. A regulatory filing even discloses that Armstrong, although entitled to 75% of the purchase price, "waived his right to receive any transaction consideration in excess of his original $4.5 million investment, opting to accept only the return of his initial investment."

The problem today isn't that Armstrong the media entrepreneur picked a good time to sell Patch. No, the problem today is that Armstrong the media mogul embarked AOL on a bad patch by buying it. Or so Starboard contends despite acknowledging the company must ultimately transition out of its legacy business as an Internet service provider of the destined-for-obsolescence dial-up variety.

"While we understand and appreciate that the company's access business is in secular decline," Smith writes in his letter, "we do not believe this serves as justification for continuing to pursue a money-losing growth strategy in the display business that has repeatedly failed to meet expectations and drained corporate resources."

Although Smith would appear to have taken the gloves off before writing the letter, it can also be argued he didn't hit AOL as hard as he could have. He didn't even mention, after all, that AOL's awful display results would have been much worse if so many of Huffington Posters didn't work for free.

Tags: AOL Inc. | Ebitda | Ebitda-to-revenue ratio | Huffington Post | Jeffrey C. Smith | Patch | Starboard Value LP | TechCrunch | Tim Armstrong

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