AOL Closes on HuffPo. Will Acquisitions Become a Death Spiral?

Last Updated Mar 7, 2011 12:35 PM EST

First AOL put $75 million into building up Patch, its hyperlocal news service. Then it bought the Huffington Post for $315 million, a deal that closes today.

Now CEO Tim Armstrong pushes to create content deals with big Hollywood names, including Heidi Klum, Queen Latifah, Ellen DeGeneres, Kevin Smith, and, yes, the Jonas Brothers. Can't lose the vital tweenager demographic. There will be New Celebrity Branded Web Sites! Cross Promotion with Celebrity Television Shows! Video Highlights of Celebrity Podcasts!

Such arrangements aren't cheap. The Hollywood partnership that Armstrong has sought probably cost between $1 million and $10 million each, according to the Hollywood Reporter. As revenues continue to fall, could the company put its cash flow and, ultimately, itself into danger?

Not that AOL is trying to fund everything out of pocket. This is Hollywood! There are advertisers, people. Only, they won't completely eliminate the financial strain, as Armstrong tries to get more compelling material online quickly to make AOL the popular happening place online. The more deals Armstrong does, the more money AOL will have to pony up, unless those in Hollywood are willing to take stock. Heaven knows, HuffPo didn't. Almost all of the $315 million was cash.

AOL's double whammy: Falling dialup, ad revenues
Unfortunately, AOL is in an uncomfortable financial situation. Between 2008 and 2009, according to the company's financial filings, revenue was down 21.8 percent. It dropped an additional 25.5 percent by 2010. Not only is dial-up Internet access subscription revenue dropping precipitously, but so is advertising, which dropped 26.1 percent on its own. That's right, advertising is shrinking faster than even the dial-up business.

As this graph from Compete.com suggests, AOL's traffic fell last year:


It may be that HuffPo will help replace much, although not all, of that traffic drop. And yet, the site produced $31 million in revenue last year. That's less than 4 percent of AOL's revenue loss between 2009 and 2010. In other words, AOL will continue to have an income problem.

Look at AOL's at cash flow. Cash provided by continuing operations was $593.5 million. That's down almost 35 percent from the previous year. Revenue continues to drop, cash spun out by operations drops, and AOL keeps buying. The HuffPo deal alone took nearly 40 percent of the cash on hand at the end of 2010 and can't possibly replace it. And that doesn't include the high-profile new hires Arianna Huffington is pursuing.

Matthew Ingram at GigaOM says that AOL has bet its future on Hollywood, but I don't think that's quite right. Armstrong has bet the farm on media growth in general. He's in a race to quickly add enough new media properties to drive up revenue before the money runs out.

Only problem is that, given what he's added, the chance of bolstering corporate income faster than old revenue streams dry up seems unlikely. Unless something turns around but fast, that money will go away pretty quickly. At which point, Armstrong and his execs may be hearing a new twist on AOL's famous alert: "You've got fail."

Related: Image: morgueFile user runron, site standard license.
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    Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.