Time Warner set to drop AOL

Online firm's challenges include declining Internet access biz

Time Warner is set to spin off AOL this week in a move that finally will undo the much-maligned AOL-TW merger.

Wall Street thinks highly of AOL chairman and CEO Tim Armstrong, a former top Google executive. And although analysts cite what is expected to be a low valuation compared with some peers, many have doubts about the financial outlook and the stock after the online firm becomes a stand-alone company.

RBC Capital Markets analyst Ross Sandler recently initiated coverage of AOL shares with a "sector perform" rating and a $27 price target but quickly lowered it to $24.

The reduction in the target came after a recent analyst day hosted by AOL that made Sandler reduce his operating cash flow projection for 2010.

"Few financial metrics were provided, but management noted that margins and revenue will decline for the foreseeable future," he noted.

Sandler predicts 2009 revenue of $2.69 billion and 2010 revenue of $2.33 billion. Profit will fall from $435 million this year to $379 million, he forecasts.

Among key challenges for AOL are the continuing decline of its Internet access business, a decrease in search market share and display ads and the fact that it is "not participating in the faster-growing segments on the Internet today, namely social media."

Among key opportunities that Sandler cited are cost cuts and "a unique content-creation strategy wrapped with industry-leading display capabilities."

How much will AOL be worth when its shares begin trading on the New York Stock Exchange on Thursday?

Sandler values the Internet access business at $1.4 billion and the rest of the business at $900 million-$1.4 billion for a total value of $2.3 billion-$2.8 billion.
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