Patch - Aol's Hyperlocal Experiment

INTRODUCTIONOn April 10th 2012, Starboard Value, a money manager that owns a 5.3% stake in America Online (AOL), sent a letter to AOL's board of directors applauding the sale of over $1B in patents to Microsoft and also warning them of an upcoming proxy fight for the election of directors to the AOL board. On the positive side, the letter applauded the patent sale as a big first step towards realizing the full value of AOL. Counteracting the applause, however, and serving as justification for the challenge of board composition, was the mention that the real problems of poor performing acquisitions and investments were still outstanding.When addressing poor performing acquisitions, the letter made specific mention of Patch, the local news service AOL bought in 2009. While the initial investment in Patch was small, approximately $7 million, AOL spent hundreds of millions of dollars on the service in the following years. According to estimates presented by Starboard Value, approximately $150M was spent per year on Patch since acquisition. The letter also describes Patch as an unproven and, thus far, unsuccessful business model that is draining valuable resources from the Company.1 What was it about Patch that made it a centerpiece of Starboard's opposition to AOL's acquisitions strategy? Was Starboard justified in challenging AOL's leadership on its unwavering support of Patch?The hyperlocal news market has served communities throughout the United States for many years. Most operations were weekly newspapers that evolved to blogs and news websites with the onset and growth of digital media. These operations existed mostly at a small scale on minimal budgets supported by local advertising dollars. Patch, along with efforts launched by The New York Times and Washington Post, has attempted to develop local operations with national support networks, capitalizing on economies of scale and revenue growth buoyed by the addition of national advertising dollars. Profitability has proved difficult to attain leading to a key question yet to be answered: Can a hyperlocal news operation find success operating on a national scale?The Patch Story Begins for AOLPatch was the brainchild of AOL's Chairman and Chief Executive Officer, Timothy M. Armstrong. The idea came to him on a Saturday morning in 2007. He was driving through his hometown of Riverside, Connecticut when he spotted a group of signs in the ground that advertised events around town. When he got home, he checked online and could not find a calendar of events for Riverside. Armstrong's first response was to call the editor of the local paper and suggest he build an events calendar for the paper's website. The paper's editor promptly replied, don't really need any help. We have a fine business.2 Armstrong's disagreement with this position prompted him to start a company around local news and event listings. He called it Patch.When Armstrong accepted the position of chief executive of AOL in 2009, he did so with the caveat that Time Warner acquire Patch and make it a centerpiece of AOL's portfolio. Time Warner agreed and purchased Patch in the summer of 2009 for $7M. Armstrong did not participate in the negotiations to purchase Patch and asked that his start-up investment in Patch be returned to him in the form of AOL stock. The acquisition was in line with AOL's strategy at the time: reinvent itself as a content provider beyond its legacy dial-up Internet business. AOL split from Time Warner in late 2009, promptly announcing that it would be investing $50 million in 2010 into the startup of the Patch.com network. After AOL split from Time Warner to become a public company, Armstrong handpicked the board of directors, so convincing them to approve investing heavily in Patch was not a difficult task. AOL spent another $160 million on Patch in 2011. By most estimates, the board allowed AOL to invest a total of $500 million in Patch between 2010 and 2013. …