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Why Long-Suffering AOL Is Doomed to Go the Way of Palm

AOL is following Palm's example as a company spinning its wheels, unable to get competitive or financial traction, and ultimately selling out to survive.

And just as Hewlett-Packard has agreed to acquire Palm for $1.2 billion to advance its mobile strategy , it's only a matter of time before AOL is scooped up by Microsoft, Yahoo or another Internet player in need of more online content and a little search.

AOL CEO Tim Armstrong says the company is looking for a search partner by year's end, when its existing search alliance with Google expires. "We have a need for revenue, distribution and a holistic long-term partner," Armstrong concedes. Like AOL, Yahoo has been hiring more journalists and bloggers to bolster its original content, and Microsoft is looking for ways to strengthen its Bing search effort.

The AOL-Palm parallels are notable. Palm has been stalled for more than a year, seeking to escape shrinking market share and revenues despite the release of new products.

The reasons why AOL's solo flight will be short-lived were painfully evident in its latest quarterly results and a new round of negative data points, including a 58 percent decline in net earnings. Here is why AOL's days are numbered:

  • AOL's core revenue sources continue to decline. Its first quarter advertising revenues fell 19 percent and its subscription income plummeted another 28 percent. The company says it will be another year before it sees growth in domestic display advertising, which was supposed to help offset the expected demise of its dial-up subscription business.
  • Continued decline in high margin revenues from subscriptions and search (down 27 percent in the first quarter) is contributing to the deterioration of AOL's free cash flow, which plunged 55 percent from a year ago to $125 million.
  • All of the company's financial dynamics are jammed. AOL explained in its earnings press release that its content users search less than its dwindling subscribers. That is dragging down its highly profitable search, which only has about three percent of the market. AOL's content and advertising businesses have higher overhead costs and lower profits.
  • AOL has become just another amorphous Internet content aggregator in search of a business model. The premium, niche content business on which it has a laser-like focus has yet to gain significant traction. NIche content must be supported by advertising, which AOL is having difficulty selling even in a gradually recovering economy.
  • Armstrong spins a better story than he delivers. Much like his predecessor CEOs, Armstrong is promising to transform AOL into an ad-supported "Time Inc. of the 21st century." Every quarter, there are new reasons why he can't execute, which sound a lot like the old reasons -- a problem Armstrong awkwardly defended in this week's earnings call. Larger and more nimble content competitors are racing past AOL, which can't seem to transform itself fast enough.
  • As part of yet another restructuring, AOL continues its chronic cost-cutting , demonstrating that companies cannot prosper by expense reductions alone. AOL most recently shrunk its work force to 5,000 from 7,000 and is looking to cut more jobs outside the US.
  • AOL is shedding noncore assets such as Bebo and ICQ, which makes it a leaner, more focused acquisition target. AOL is selling ICQ to Russian-based Digital Sky Technologies for $179 million in cash, and says it soon will sell or shut down Bebo, which it acquired for $850 million in 2008. AOL could use the sale proceeds to make tuck-in acquisitions such as Associated Content or Foursquare.
  • AOL can't seem to keep a consistent management team in place that is empowered to effect change. the company is a revolving door for middle management executives, none of whom have the authority to be more enterprising. It has been siphoning executives from Google, who reportedly are complicating AOL's revolving door dilemma with a new-hire screening process.
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