What's Wrong, AOL?

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If something smells funny in Time Warner's (NYSE: TWX) third-quarter report, it's just the pungent odor of a rotting AOL.

Time Warner's online arm is in a funk at the media giant, joined by the company's languishing publishing business. Oh, and just because Time Warner finally plans to spin off AOL next month doesn't necessarily mean that the stink will go away.

As a whole, Time Warner's quarter was uninspiring. Revenue fell 6% to $7.1 billion. Its adjusted profit of $0.61 a share fell just a few pennies short of last year's $0.65 a share showing.

Time Warner's network showed steady improvement. Its film studio was mixed, with a slight top-line dip more than offset by marginal growth on the bottom line. The company's publishing arm was a mess, but let's take a closer look at how AOL has let itself go in recent years.

AOL's revenue and operating income fell by 23% and 50% respectively. The company's fading access business is old news. It peaked years ago, so it's not much of a shock to see just 5.4 million "You've Got Mail" accounts, or 2.1 million fewer subscribers than a year ago.

It's inexplicable to see AOL kill this business off slowly, when it could have sold it to Earthlink (Nasdaq: ELNK) or United Online (Nasdaq: UNTD) while it was still worth buying. However, there's no use crying over lost customers.

The real shame at AOL is it figured that it could make up for subscriber losses by tearing down its walls and becoming a more open ad-supported portal.

Well, that's not going so well. Ad revenue has taken an 22% hit over the past year. That certainly doesn't hold up well against Google's (Nasdaq: GOOG) growth during the same three-month period.

Sure, that's not a fair comparison. Pitting a display-advertising player against Google is like stacking your prom date against Megan Fox. However, AOL is a laggard among laggards. Yahoo! (Nasdaq: YHOO) and IAC's (Nasdaq: IACI) media and advertising revenue fell by 8% and 12% respectively this past quarter.

With any luck, the spinoff will do AOL some good. The division has brought in capable leadership from Google and Yahoo! And it may be willing to take more chances as a stand-alone entity. It needs to, quite frankly. When even Yahoo! is laughing at you, something has to change.