AOL Pitches Strong Ad Business - TheStreet

Editor's Note: This is a bonus story from Cody Willard, whose commentary usually appears only on

RealMoney

. We're offering it today to

TheStreet.com

readers. This column first was published on March 16. To read Willard's commentary regularly, please click here for information about a free trial to

RealMoney.

Earlier this week, there was some good news for online advertising, and it actually came from America Online, a not-so-tiny division of

Time Warner

(TWX)

. Ted Leonsis, vice chairman of AOL, announced that the company is likely to exceed the 20% to 25% growth that most analysts expect for the U.S. online ad industry, and although the company said in a short press release on Tuesday that it would actually just match industry expectations, the fact remains that online advertising is a high-growth business.

The answer is a resounding yes, although ever since Jordan Rohan of RBC downgraded

Yahoo!

(YHOO)

and

Google

(GOOG) - Get Report

, there's been a whole lot of doubt about that growth and there's been a major pall hanging over the Internet stocks. His downgrades sparked fears that online advertising growth isn't increasing fast enough to justify the extremely high multiples of stocks like the two Internet bellwethers.

The bears and shorts started growling and moving in for the kill after his move. In fact, there's been a lot of rumbling that these two companies will actually miss revenue and earnings estimates -- forget about meeting them -- for the first quarter of 2005. It all culminated in a report in

Barron's

over the weekend, in which a stereotypical hedge fund manager was quoted as saying he believes that Google would be closer to fair value at $25 per share than at the current quote of $176 or so. Yowza.

Certainly, nobody in his right mind would argue that there's not a lot of high expectations priced into Google and Yahoo! here. The sell-side consensus is that Google will earn about $4 per share this year, which puts the forward P/E multiple above 40, and Yahoo! is trading at an even higher P/E multiple of about 60.

Weighty P/Es Weigh On the Mind

In some sense, P/Es that high are a signal to let you know that the market thinks the sell-sider models are wrong. The market's looking for upside to those current estimates, and if these stocks only meet those sell-side estimates, then the stocks are probably going to go lower, perhaps in a hurry.

On the other hand, if the companies actually end up growing faster and earning more than the consensus, that forward P/E will shrink unless the stocks run higher at an equal pace to the reality of the earnings.

I'm not sure that the consensus and AOL estimates of 20% to 25% growth in online advertising for the industry will end up being accurate from a secular aspect -- there's a whole lot of advertising money that could move online from offline. But if AOL were to exceed that growth rate in its own right, I expect that the entire market would be exploding higher, and it's certainly noteworthy that AOL partners with little old Google for search and some of its advertising. So as AOL's business grows, so too will Google's.

For my part, I'm staying the course with Google and will trade around my sizable core position. I've only recently added Yahoo! as a long position, and will look to build it up over the next few months. Heck, I even consider Time Warner a buy here, although I'm sticking with the two pure plays.

As originally published, this column contained errors. Please see

Corrections and Clarifications.

At time of original publication, the firm in which Willard is a partner was net long Google and Yahoo!, although positions can change at any time and without notice.

Cody Willard is a partner in a buy-side firm and a contributor to TheStreet.com's RealMoney.

He also produces a premium product for TheStreet.com called

The Telecom Connection and is the founder of Teleconomics.com. The firm in which Willard is a partner may, from time to time, have long or short positions in, or buy or sell the securities, or derivatives thereof, of companies mentioned in his columns. None of the information in this column constitutes, or is intended to constitute, a recommendation by Willard of any particular security or trading strategy or a determination by Willard that any security or trading strategy is suitable for any specific person. Willard appreciates your feedback and invites you to send it to

cwillard@thestreet.com.