AOL's Puzzling Drop

 | Feb 09, 2014 | 12:00 PM EST
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Late last week, after AOL's (AOL) earnings report, it seemed as if the big thing people wanted to discuss was that CEO Tim Armstrong had cut some benefits for employees.

It's still hard for me to understand why the stock sold off Thursday and Friday. It surely couldn't have been because of the Obamacare comments that Armstrong made. More likely it was because a few analysts downgraded the stock after earnings. It's hard to understand the logic of those analysts, as the quarter seemed very good to me, and several other analysts agreed with that stance. Brian Pitz of Jefferies said AOL was one of his top small-cap picks and raised his target price to $66 from $60. Telsey Advisory Group took their target on AOL to $70.

So there's obviously a lot of disagreement about the health of AOL these days. That aside, though, let me tell you what I saw in the results.

For the longest time, people have made fun of this company because a great deal of subscribers continue to pay AOL each month for dial-up Internet. This business generated $209 million in revenue in the fourth quarter and $146 million in operating income before depreciation and amortization. For a long time, all of AOL's typical OIBDA of $500 million a year came from dial-up, or the membership segment.

The knock against AOL was that this income stream was eventually going to dry up. Surely even the folks in Middle America would catch on to the fact that they had the option to get their Internet from other providers. Fortunately for AOL shareholders, though, the company has been amazing at figuring out ways to reduce churn and hike prices.

But what about the rest of the company? This is the part of AOL on which Tim Armstrong has focused most heavily since he came aboard in 2009. Basically there have been two key areas: brand and AOL Networks.

Brand has to do with big, premium brand destinations like Huffington Post and TechCrunch. AOL has bought some great brands over the years, and it continues to draw big traffic to them. The Networks part of AOL is really where the firm's advertising technology resides, including newer premium video ad capabilities.

Armstrong has really made some astute acquisitions over the years for AOL Networks: 5min Media, and now

But despite the good traffic that has been building over the years, many have pointed out that neither of these two segments has been making any money. So the company's earnings stream before interest, taxes, depreciation and amortization had all essentially been from dial-up -- and, if a company such as Yahoo! (YHOO) were looking to buy AOL, that's what it would get.

But in these fourth-quarter numbers, there was a seismic shift in growth when it came to the brand and Networks businesses. While brand revenue grew just 4% year over year to $222 million, its OIBDA hit $35 million for the quarter -- a new record for the group. Networks' sales showed even more impressive growth, shooting 50% higher to $275 million. The segment's OIBDA went to $6 million.

If these trends can continue, AOL has two real businesses on its hands here -- and the company might become a lot more interesting as an acquisition target for Yahoo.

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