The report's author, J.P. Morgan analyst Imran Khan, also plans to raise the bank's estimate for cost of revenue "to incorporate our expectation of growing traffic acquisition costs."
"Our new Adjusted (Operating Income Before Depreciation and Amortization) estimate of $1.43 billion, 11% below our previous number, drives a 3c reduction in 2009 EPS to $1.13," Khan writes in the report. "We now expect AOL advertising revenue of $2.4 billion in 2009, an increase of 8% year-over-year--compared to our previous estimate of a 12% improvement."
The discouraging report comes at a particularly bad time for AOL, with parent company Time Warner rumored to be nearing a sale of the unit to rival Web portal Yahoo.
The new projections still imply growth at Platform A, AOL's ad unit, of 9% next year, following a projected organic revenue increase of 24% this year.
"We believe that traffic acquisition costs (TAC) will drive year-over-year gross margin compression and an Adjusted OIBDA decline in 2009," Khan writes. "We think the implication of a $100 million year-over-year increase in TAC in the first half of 2008 due to a change in accounting may have been overlooked by the Street."
The analysis shows that TAC will grow 26% for the entirety of this year, and 7% next year. Assuming that AOL's cost of revenue excluding TAC has stabilized, Khan arrives at an Adjusted OIBDA estimate of $1.43 billion--11% lower than the bank's previous forecast.
J.P Morgan expects TAC to increase next year to $810 million, up from $604 million in 2007 and $759 million this year.
"We are lowering our '09 Adjusted OIBDA estimate by $176 million," added Khan. "While our '08 Adjusted OIBDA forecast remains largely unchanged at $1.5 billion as lower revenue is offset by a reduction in SG&A expenses, we now expect a materially lower 2009 Adjusted OIBDA due to reduced expected advertising revenue and continued gross margin compression."