Yahoo, AOL, And The Sad Truth About Online Publishing OR How I Learned To Overcome My Fear And Love Snapchat

By Ariel Steinlauf, Managing Partner, Onyx Venture Advisors
February 19, 2014

In recent weeks I’ve seen many articles about Yahoo! and AOL, two of the most venerable giants of the early-internet era. The two companies have known many ups and downs, and these days are global corporate behemoths. However, a closer look at their core business – running enormous online media networks – reveals that it is not a particularly lucrative one to be in.

Let’s begin with the smaller of the two – AOL. The days of the mega-merger with Time Warner are long gone as AOL, currently with an enterprise value of only $3.5 Bn, is a standalone company operating two distinct businesses: a declining, yet profitable, dial-up subscription service, and an online advertising business. The subscription business generated $650 MM in 2012, down from $705 MM in 2012, and AOL is using the cash flow it generates to fund the growth of its online advertising business. The only problem is – it’s not growing so fast.

AOL’s online advertising business generated $1.6 Bn in 2013, up from $1.4 Bn in 2012. It is comprised of owned & operated (O&O) properties, which are further divided into display ads and search ads, and a 3^rd-party network. While the latter is growing by double digits (30%), the O&O part is only growing by single digits (5%). Furthermore, 40% of the O&O revenue is attributed to search, powered by Google. As if to exacerbate the situation, the online advertising business is not terribly profitable. A look at AOL’s cost breakdown by segment (which closely mimic the revenue streams) reveals that the O&O segment is barely profitable, while the 3^rd-party network is losing money.

Moving on to Yahoo!, the picture doesn’t get much better. While Yahoo!’s enterprise value is nearly $37 Bn, that value is largely attributed to its 24% stake in Alibaba, the Chinese e-commerce giant slated to go public later this year. With analysts projecting Alibaba’s value at $120 Bn to $150 Bn, one thing is certain – Yahoo! stands to make a boatload of money out of that IPO, and investors value to the company accordingly.

Meanwhile, its core online advertising business isn’t faring so well – the company generated $4.7 Bn in 2013, down from ~$5 Bn in 2012. Similarly to AOL, Yahoo! derives most of its revenue from display ads and search ads, the latter powered by Microsoft. Both revenue streams have been stagnant and most recently have declined. I could go into further analysis of display vs. search or O&O vs. affiliate sites, but the outlook won’t be any rosier. Deducting its Alibaba stake, Yahoo!’s core business is trading at ~1X revenue.

Interestingly, all these numbers serve to highlight is one sad truth – online publishing, even at scale, is not such a great business to be in. This stems from several reasons:

• Content production is expensive
• CPMs are low and getting lower due to
• More accountable models (e.g., CPC, CPA)
• Programmatic buying and real-time bidding (RTB) putting downward pressure on CPMs

 The scale of an online media network is no longer enough to make money, as the content served needs to be coupled with additional data about the user viewing it for advertisers to be willing to pay. That’s why Google’s search ads are more valuable than display ads and why Facebook’s native ad formats are so appealing – both companies have unique, highly relevant information about the user viewing the content and they use it for their advertisers’ benefit. More importantly, they didn’t pay a penny to produce their content.

To keep up with Google and Facebook, AOL and Yahoo! have made, and need to continue making, substantial investments in ad technologies, either developing them in-house or acquiring them (mostly the latter). But, they still need to produce their content as well, while Google and Facebook don’t. Plus, AOL and Yahoo!’s balance sheets don’t support recruiting engineering talent away from these two tech darlings. And without great engineers, their internal platforms are doomed to be at a disadvantage.

If running an online media network is such a terrible business, what business would you rather operate in order to capture all of those coveted digital advertising dollars?

There are three answers to this question:

(1)   Focus solely on producing premium content

The Wall Street Journal and the New York Times are examples of companies who realized they had unique, highly desirable premium content that they can also charge for, separately from putting advertising next to it. They also realized they can’t develop their own independent ad tech platforms and opted to outsource that function. And so, they erected pay-walls. AOL is actually seeing initial positive signs from its own AOL On video platform, but it’s too early to tell.

(2)   Focus solely on creating an ad tech platform that can serve many players

AppNexus, and recently SOVRN, are examples of companies that provide the means for advertisers to engage in RTB and programmatic buying. SOVRN is actually a spin-off from Federated Media, a company that decided to sell its online media network and focus on developing an ad tech platform to serve many players. AOL has recently acquired Adap.tv and instantly became a strong player in the growing video ad serving space.

(3)   Develop a new media platform and invent new kinds of ad formats

Which finally brings us to Snapchat, the new kid on the block that everybody wants to play with, sometimes offering $3 Bn for the pleasure to do. Is Snapchat really worth $3 Bn? Certainly not today, but it might be in a few years if it plays its cards right. All Evan Spiegel et al need to do is figure out how to retain their users’ attention and how to put native forms of advertising in front of them. If they do, they might become the next Facebook. All the while, not paying a penny for the content they serve.