AOL Jumps 7%: Bulls Cheer Expanding Margins, ‘Patch’ Prospects

Shares of AOL (AOL) continue to be strong following Friday morning’s better-than-expected Q4 results. The shares are up $2.41, over 7%, at $36.13.

Jefferies & Co.’s Brian Pitz reiterates a Buy rating and raises his price target to $50 from $44, writing that the company’s “core assets are being under appreciated and [we] think this story continues to get better.”

“The company has started showing the results” of its “rationalizations and transformations,” Pitz thinks.

Noting that the company’s adjusted pre-tax profit of $123 million was “significantly higher than the Street’s $115 million,” Pitz opines that “the best is yet to come”:

During 4Q12, AOL demonstrated top-line Y/Y growth for the first time, with healthy OIBDA margins, and we think that the best is yet to come. AOL should benefit from strong secular tailwinds in hyperlocal, mobile, Adtech & video by as evidenced by improving audience engagement, investments in products & tech, and strong content partnerships. Additionally, the BOD has clearly demonstrated a series of smart capital allocation decisions that have proven to be value accretive.

Pitz raised his estimates for this year to $2.22 billion and $425 million in Ebitda from $2.19 billion and $400 million.

Needham & Co.’s Laura Martin reiterates a Buy rating as well, and a $40 price target, arguing that AOL is shrewdly going after brand advertisers that want premium inventory:

Some branded advertisers do NOT want to introduce themselves to their next client via a discount. Many premium brands spend millions of dollars a year in TV, radio, magazine and newspaper advertising creating a price-premium brand. The discounting focus of the Internet is one reason that the largest advertisers have been largely absent from the Internet to date, in our view. AOL�s �Project Devil� is targeted at capturing this unmet monetization demand. AOL has excellent relationships with large brand advertisers and is delivering what they are asking for�a safe environment of content with only one advertisement per page. The Devil ads are flexible enough to include still pictures, video, text and a mapping function showing the closest retail store. These sections are changeable by advertisers real-time. How big an opportunity is this? Total TV advertising was approximately $60B in 2011 (as per Magna Global) vs display advertising was about $10B (IAB), meaning there should be another $50B that potentially could move online from the traditional TV media. These large brand advertisers do not want to risk that the 85% of their advertising budgets spent on TV to build their brand message is undermined by discounting on the Internet (15% of spending).

The opportunity from AOL’s “Patch” local news properties could be even better, writes Martin:

We estimate that Patch charges a $50 CPM vs Devil at a $35 CPM. We believe that Patch markets are profitable within 12 months. How big an opportunity is this? About 80% of total household spending is done within 12 miles of home. Patch is a community network. We think the upside here could be enormous.

Martin raised her estimates for this year to $2.25 billion in revenue this year from a prior $2.14 billion, and raised her EPS estimate to $2 from $1.51.