Dueling Fools

Dueling Fools

America Online?
Bear Argument

By Rick Aristotle Munarriz (TMF Edible)
November 3, 1999

OK, let's dance. Three-word Duel. Check this out:

Jeff: AOL Rocks!

Rick: Not!

That might be all one gets out of this week's Duel. Three words for a three-letter stock. I'm not conceding defeat or fasting from substance. I am a realist. This is an emotional subject where most of you come with burned-in preconceptions depending on your point of entry. If you got here from AOL, you will probably side with the home team. If you have been singed by busy signals, slow-loading ad artwork, or generally ashamed of your former aol.com e-mail address, you're mine.

I am none of the above. I have stuck with AOL long after I have outgrown its training wheels. However, I appreciate it for reasons today that will probably be obsolete tomorrow.

AOL's ace card, its fast-loading proprietary content, is turning into a deuce that once laid golden eggs. The proprietary content has now been duplicated and enhanced on the Internet's public domain. The quickness, which was already deteriorating with perpetual banner ad speed bumps, will become a moot point as access speeds improve universally.

That brings us to our first meaty diversion, the future of access. AOL missed the boat on broadband so it decided to stow away on slower secondary vessels. While AOL is trying not to put all of its tarnished eggs in one basket, it seems to have found equally desperate partners in the telco players like Bell Atlantic and Southwestern Bell. Their game is DSL, slower than cable modems and an option where data degradation grows fierce if one doesn't live within two miles of the telephone company's central office. And the more expensive DSL has one bound to existing phone lines. I can see why the telcos need this to assure survival. Why does AOL?

Why is AOL betting on a bunch of three-legged long shots rather than going for even money on the favorite? Pride? Ignorance? This summer AOL invested $1.5 billion in Hughes for satellite solutions. Unfortunately it will be another four years before that service becomes feasible for the two-way access that broadband features today.

Broadband is the way, and sadly, it appears that even under the best-case scenario AOL will be a tenant and not a landlord. That comes as a harsh reality to a company that has struggled to master economies of scale.

AOL is the biggest online service, so logic would dictate that it is also the most cost efficient. Not so. AOL winds up paying about $0.35 in network costs for every hour a subscriber spends online. Shrewd competitors have been able to shave that down to around $0.25 an hour. With online usage per subscriber creeping higher, 17% higher as of the last quarter, I'll let you do the math.

Foul, you say. Rick is sneaky. He just tried to play off the global obsession with spending more time online as a negative. True. But because of AOL's flat-rate pricing, that extra time is on AOL's dime -- literally, and that's a dime more an hour than the quarter players.

The savior here should be advertising. Over the past year ad sales have gone from 16% to 24% of AOL's revenues. But while everyone is out celebrating the $2 billion backlog in advertising, $500 million more sequentially, am I the only one who sees a problem here?

The root of this backlog stems from the fact that AOL can't grow its eyeballs fast enough. The merchant push is there. The consumer pull is not. AOL members, you whose patience has been tested as your online gateway tries to shoehorn ad after ad into your monitor space, guess what? You're not enough.

On a percentage basis, subscriber growth is slowing. The reasons for the eyeball drought are many. For starters, after claiming more than 19 million users, the market for those willing to pay $21.95 a month for an online provider with questionable customer service is drying up. Meanwhile, the competition has gotten smarter and cheaper.

AOL's hara-kiri ways are also part of the problem. One of the perks of America Online used to be the one-on-one communication afforded to its members. ICQ leveled that exclusivity by allowing folks to chat online regardless of ISP. So what does AOL do? It buys it. It would be a smart move if there was actually a feasible way to cash in on ICQ's and now the AOL Instant Messenger audience. There isn't -- unless AOL wants to bulk it up toward bloated obsolescence. Wait, that almost makes strategic sense. Can't be.

Another self-inflicted flesh wound comes from the front line of PC retailing. First time computer buyers, the novice crowd AOL used to feast on, have turned to $400 rebates from vanilla ISP's like Prodigy and AOL's very own CompuServe. Over the last quarter, CompuServe 2000 signed up 378,000 users, tripling its customer base. AOL calls these new sales "incremental" but how twisted is that mindset?

The flock heading towards CompuServe 2000, after AOL cuts them a $400 rebate check, will wind up paying half of what they would have for America Online. Incremental? Please. Does AOL really believe, absent the vulture ISPs waving greenbacks, that its namesake offering would not have landed at least half of those new buyers?

Incremental? I don't like the sound of that at all. It means that the company is either misleading its shareholders or that AOL really does feel that the days of subscriber growth for its proprietary service are numbered so it's OK to aggressively market its cut-rate alternative and boast about its success.

I prefer to define incremental another way. The industry pricing pressure, not only with the value-priced ISP options but with OEMs and banks subsidizing access completely to gain customers? Incremental. The ad backlog as cyber-billboards go unseen? Incremental. The connection speed, a game in which AOL will be lucky to run with the pack? Incremental. The competition for e-commerce bragging rights, as heavy hitters like Yahoo! (Nasdaq: YHOO) and Amazon.com (Nasdaq: AMZN) continue to beef up their shopping portals? Incremental. AOL's prospects through all this? Nope, sorry, that's detrimental.

Next: The Bull Responds