Avoid This Tech Value Trap

More than anything else, managers determine returns. They set strategy, hire key team members, oversee operations, and cash paychecks. Every move they make either enhances or destroys shareholder capital.

It pays to know who these men and women are, how they're paid, whether they, too, are owners, and how they perform versus competitors in certain key metrics. In this regular column, I'll examine all that and more with the goal of enhancing our understanding of some of the top stocks in Fooldom.

Next up: America Online (NYSE: AOL  ) . Is the executive team of this would-be media empire builder doing all it can to earn you outsized returns?

Foolish facts

Metric

America Online

CAPS stars (5 max)

*

Total ratings

199

Percent bulls

32.5%

Percent bears

67.5%

Bullish pitches

12 out of 42

Highest rated peers

Radvision, WebMediaBrands, Marchex

Data current as of March 18.

Fools say no, and recent history says they're right. AOL's adventure in the media business has led to little more than losses and layoffs. Returns on capital fell more than 4 percentage points last year as a $249 million profit turned into a $783 million loss. Cash from operations declined 35% over the same period.

And that's not even the worst part. Fixing AOL's finances means meeting unreasonable editorial targets. In February, CEO Tim Armstrong told employees in a presentation that his aim is to lift the company's monthly publishing output by 63% and quadruple per-article views to 7,000 each.

The first part's easy. AOL's $315 million buyout of megablogger The Huffington Post will boost traffic by adding 25 million unique visitors monthly. The hard part will be to get these readers to engage more deeply with AOL's content. Only then will page views rise, and 7,000 is a HUGE number. Believe me, I know. I write for one of the most popular financial sites on the web.

Bulls will tell you that AOL doesn't need to make good on Armstrong's ambitions in order to make money for shareholders. The company generates hundreds of millions in free cash flow to go along with the more than $700 million in cash on its books after subtracting debt. AOL had $12.89 per share in tangible book value as of December.

Sound enticing? Wait, it gets better. Tangible book value doesn't include the potential brand value of high-traffic properties such as DailyFinance, TechCrunch, and Engadget. Figuring in goodwill and other intangibles raises book value to $21.42 a share, a 16% premium to yesterday's close.

Management overview

Executive

Years

Cash Compensation

Shares Owned

Tim Armstrong, Chairman and CEO

2

$734,849

876,511

Arthur Minson, Chief Financial Officer

2

$2,620,795

116,369

Source: Capital IQ, a division of Standard & Poor's. Compensation is for 2009. Share counts exclude any indirect holdings. Data current as of March 18.

The trouble with this thesis is that it assumes management has a viable plan to unlock value at AOL. By itself, cranking up the content mill like an old-fashioned ditto machine doesn't equal creating value.

Or maybe it does, and we Fools just don't realize it. Several insiders have bought shares in recent months. CEO Armstrong, in particular, purchased 477,000 shares at $20.97 apiece in February, within days of the announcement of the HuffPo buyout. Votes of confidence don't come much bigger than that.

Management analysis versus competitors

Company

Insider Ownership

Gross Margin

ROC*

ROE**

AOL

1.89%

41.7%

8.4%

(29.6%)

CBS (NYSE: CBS  )

0.44%

36.1%

7.4%

7.7%

Google (Nasdaq: GOOG  )

20.63%

64.5%

14.7%

20.7%

Yahoo! (Nasdaq: YHOO  )

9.39%

58.5%

4.1%

9.9%

Source: Capital IQ, a division of Standard & Poor's. *Return on capital. **Return on equity. Data current as of March 18.

Maybe Armstrong's right, but I can't figure out how AOL generates a competitive advantage by pumping out content. It's the Demand Media (NYSE: DMD  ) model on steroids, and only slightly less susceptible to the whims of Google's search engine wizards.

Before you cry foul at the comparison between Demand's how-to bloggers and pro scribes who type up excellent work for AOL's sites, consider that Armstrong is letting a lot of these pros go in order to lower costs even further. Roughly 200 staffers in the U.S. and 700 more worldwide got kicked to the curb last week. 

So there's a shift going on. AOL is getting Huffington-ed, with more content produced at a lower cost. That's bound to unlock some short-term savings. Longer term, gains in readership, reputation, and ultimately cash flow could prove to be more elusive.

Do you agree? Disagree? Let us know what you think about AOL's content, business, and the impact of Google's search changes using the comments box below. You can also rate America Online in Motley Fool CAPS.

Finally, don't forget to keep tabs on America Online by adding the stock to the My Watchlist tool, our free, personalized stock tracking service.

Both our Motley Fool Inside Value and Motley Fool Rule Breakers services have recommended members purchase shares of Google. Yahoo! is a Motley Fool Global Gains pick. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He owned shares of Google at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Google and is also on Twitter as @TheMotleyFool, and its disclosure policy is managing just fine, thanks.


Read/Post Comments (3) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 18, 2011, at 9:34 PM, jimmy4040 wrote:

    Huffington is no fool. She took the buyout in cash not AOL stock.

  • Report this Comment On March 19, 2011, at 12:00 PM, BroadwayDan wrote:

    Terrible Tim - great write up, and I'm glad to get some bearish views, because FWIW, my Spider senses are saying there's something promising developing here - solid, tech savvy CEO, Huffington's charisma, some sub revenue still coming in and the possible promise of an Oprah-like mini empire. I am not at all 100% convinced of future glory, but the downside looks like mediocrity while the upside - generating articles, turning them into profitable sites, books, TV, movies, seems entirely possible to me. This could be a multibagger. I think the death of content has been greatly exaggerated - with mobile phones, iPads, DVRs, Cable, and a still-booming movie business all with global reach, the demand for quality content is massive. Huffington can own a huge hunk of the more liberal-minded, youth and women. I also like the idea of doing as much as they can to provide localized content globally.

    My biggest concern is all these indy-minded bloggers and editors never fitting into the behemoth culture. But if Huffington can win them over, get all oars rowing in the same direction and lean on her web DNA savvy team could be something here. I also seriously hope Armstrong committs to a major rebranding - new logo, new tag line and kill that vile little obnoxious yellow guy. They should buy the rights to Mr. Bill and have that little yellow guy tortured.

    I also think conservative-leaning folks - a large % of investors, are so anti-liberal, they are mocking this Huffpo deal senseless from an emotional and non-business standpoint.

    Bottom line - this one will be great to watch. I'm thinking of going in with a position betting on them figuring things out before they actually do.

  • Report this Comment On April 09, 2011, at 5:42 AM, abubakerjalil wrote:

    i like your post it is very nice i found alot of information thanks and keep it up <a href="http://www.tajweedseeker.blogspot.com"> tajweed</a>

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