Making Money in a Declining Business

One of the lessons we learned at business school is that there can still be money to be made in a declining business.  Today's case in point:  AOL.  The butt of much Internet-related humor, did you know that AOL still has 3.9 million US subscribers?  To give a sense of scale, that makes its subscriber base about as large as Charter Communications, a not insignificant 6th place player in the cable TV market.  Its income statements are a total mess, cluttered with enough special charges and unusual income items to scare me off from touching the stock, but it looks like it is still making about $50 million a quarter on about $500 million in sales.  Not what it once was, but not an awful business either.

A company like this run for cash flow could do well for quite a while for shareholders.  Of course, companies like that are seldom run for cash flow -- that is not how corporate management incentives work.  Corporate managers are going to want to take the cash flow from the declining business and try to build some new kind of empire on the corpse of the old one.  Shareholders can reasonably ask why they are not just dividended the cash to make their own reinvestment, but insiders benefit much more if the cash is reinvested within the company.  And sure enough, AOL seems to be buying a ton of small companies.

  • nehemiah

    Probably the least understood and most dangerous investment risk is re-investment risk. That would be management rolling its free cash flow into new markets, services, products, etc. Not always a bad thing depending on who is calling the shots. I'd be happy to leave my investment in the hands of Buffet or Icahn. However, as a rule these forced expansions do not work out well for investors. I like to see a company announce stock buyback programs for this very reason. An acknowledgement that they do not see a productive use for the capital.

  • a_random_guy

    Millions of small businesses run this way: They do what they do, remain stable, and earn income for their owners. Practically every mom'n'pop operation works this way. Graduates of business schools are unable to accept this kind of thing: they have absorbed an unstated assumption that every business must grow.

  • ErikTheRed

    I own a high-end retail business, and there seems to be a strong correlation between very high income (7+ figures) and AOL e-mail addresses. Basically, these people got onto the Internet during the AOL day and find it to be too much of a hassle to switch addresses. I couldn't care less, except for the really bizarre spam filtering that AOL uses that bounces much of our customer correspondence (last I checked they wanted you to pay them to whitelist you - a slippery slope we're unwilling to travel down).