Planted Patches not producing AOL fruit

It costs money to gather and disseminate news, even when you don't have a newspaper to print and deliver. Tim Armstrong, the CEO at AOL Inc., has become painfully aware of that reality.

Mr. Armstrong, perceiving an opportunity to provide news coverage in competition with local newspapers facing innovatory technical and business challenges, launched Patch in June 2009, a "hyperlocal" news-business model he founded before joining AOL.

In the process the CEO, hired in 2009, has sought to transform AOL from a subscription-based Internet-access service into a digital-media business supported by display advertising on websites such as Patch. AOL has planted hundreds of these Patch online sites across the country, including some in southeastern Connecticut. News is generated by small staffs of reporters and editors operating from their homes and also by nonprofessional online contributors.

Now an aggressive investor is telling Mr. Armstrong and the AOL Board of Directors that the project is a failure dragging the company down and undervaluing its stock price.

Starboard Value LP, an investment management firm that seeks to invest in undervalued and underperforming public companies and turn them around, has purchased about 4.5 percent of AOL shares, making it one of the largest shareholders. In a letter to Mr. Armstrong and the board, Starboard Managing Member Jeffrey C. Smith outlines what he sees as the problems at AOL and seeks a meeting to consider a change in course.

AOL, with share prices off 36 percent this year, would be successful if not for "the company's massive operating losses in its Display business, which they state could be in excess of $500 million, as well as continued concern over further acquisitions and investments into money-losing growth initiatives like Patch," writes Mr. Smith.

"AOL acquired Patch, a news and information platform for small towns, from an investment firm that you (Mr. Armstrong) founded," states Mr. Smith, digging in the knife. "We believe that Patch may alone lose as much as $150 million in 2011 based on heavy fixed expenses of $160 million…"

Mr. Smith argues AOL can return to profitability by focusing instead on its legacy business, subscription-based dial-up Internet access, which while "in secular decline … has a long tail" of cash generation still to come. An AOL advertising network and its deal with Google to tap advertising revenues the search-engine generates on AOL properties are also successful, Starboard contends.

Coming just two months before a Feb. 25 deadline for nomination of candidates for AOL's board, the cannonball fired by Starboard could make things interesting. All eight directors are up for re-election.

This is not to gloat about a new entry's struggles in the local news business. Local newspapers with deep community roots face their own difficulties in a rapidly changing industry, The Day among them.

The point, rather, is that there will be no simple model for swooping in and capturing the local community news market that newspaper companies have long dominated through the advent of radio, TV and now digital communication. You still have to generate revenue to support news gathering and AOL and Patch are, so far, having a hard time of it.

After a century of relative stability, the local news industry is going through transformational change. How it plays out will have major implications for communities and for the democratic process, so dependent on an informed electorate.

These are interesting times, indeed.

The Day editorial board meets regularly with political, business and community leaders and convenes weekly to formulate editorial viewpoints. It is composed of President and Publisher Tim Dwyer, Editorial Page Editor Paul Choiniere, Managing Editor Tim Cotter, Staff Writer Julia Bergman and retired deputy managing editor Lisa McGinley. However, only the publisher and editorial page editor are responsible for developing the editorial opinions. The board operates independently from the Day newsroom.

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