• by Gavin O'Malley  @mp_gavin, December 21, 2011

Despite a recent ad turnaround, an activist investor demanded on Wednesday that AOL take “immediate action” to curb shareholder losses.

In a lengthy, data-rich press release, Starboard Value -- which now claims a 4.5% stake in AOL -- lambasted top management and accused the company’s display ad business of “staggering” annual operating losses of $500 million.

"AOL shareholders have already suffered substantial losses, due to the pursuit of the failing display strategy. Immediate action must be taken to address this issue, as the company continues to invest good money after bad without an acceptable return on investment," Starboard Value CEO Jeffrey Smith said Wednesday. 

Obliged to defend itself, AOL said in a statement: “Over the last two years, AOL has significantly reduced costs, sold non-core assets, made significant investments for our future, and also recently repurchased over 10% of outstanding shares.” 

“AOL has a clear strategy and operational plan to provide our consumers and customers with exceptional value, which we believe will lead to the creation of shareholder value,” the company stated, adding that it “will continue to aggressively execute on our strategy in 2012 as we continue the turnaround of AOL.” 

AOL declined to elaborate on Starboard’s charges on Wednesday. 

This isn’t the first time an activist investor has taken aim at a high-wattage Web giant. Among other agitators, Carl Icahn made several blustery attempts to shake up Yahoo.   

AOL, for its part, has faced an uncertain future for years. More recently, company head Tim Armstrong confirmed retaining two big M&A specialists -- investment banker Allen & Co, and law firm Wachtell, Lipton, Rosen & Katz -- but said there were currently no deals on the table. He reiterated in September that AOL's core strategy has not changed. 

Just last week, Armstrong told Bloomberg said that AOL plans to combine its dial-up Internet access business with its Web services, including AOL Instant Messenger.

(According to an AOL spokesperson, the company announced the changes last month upon news that Brad Garlinghouse, president of AOL’s applications and commerce group, was on his way out.)

Either way, the planned change doesn’t go far enough for Starboard.

Added Smith: "While we understand and appreciate that the company's access business is in secular decline, we do not believe this serves as justification for continuing to pursue a money-losing growth strategy in the display business that has repeatedly failed to meet expectations and drained corporate resources."

Also last week, Jim Norton agreed to head up ad sales at AOL. Effective immediately, Norton is now responsible for sales across all of AOL’s owned-and-operated properties, including AOL.com, The Huffington Post, Engadget, Stylelist and MapQuest.

Turning around a series of disappointing quarters, AOL recently reported an 8% jump in third-quarter ad sales, which it attributed to a dual strategy of third-party network sales and enhanced premium display ad sales related to Project Devil.

While the ad revenue surge came amid a third-quarter earnings release showing a 6% decline in AOL’s total revenues, the drop was mostly attributed to non-advertising sales-related areas, and its Web access subscriptions business in particular.

Putting the turnaround in the context of AOL’s disastrous marriage to (and divorce from) Time Warner, Norton told Online Media Daily: “We’ve done a lot of work with back-end legacy systems. It’s no secret that when you come out of a merger, there might be certain legacy systems that might not be best for everyone.”

Based on its own due diligence, Starboard said it sees “substantial and actionable opportunities” to dramatically enhance shareholder value at AOL.

“At the current price, we believe that AOL's market value reflects only the value of the company's highly profitable access business and its net cash position,” Starboard said in its release. “This implies that investors are ascribing no value to AOL's media assets, including its Advertising Network, Search business and extensive portfolio of Display properties. We believe that this valuation discrepancy is primarily due to the Company's massive operating losses in its Display business, as well as continued concern over further acquisitions and investments into money-losing growth initiatives like Patch.”

In fact, Starboard estimates that Patch may have lost as much as $150 million in 2011, “based on heavy fixed expenses of $160 million and immaterial estimated revenue contribution of $10 million to $20 million.”

Starboard characterizes itself as an investment management firm with an interest in undervalued and underperforming public companies.