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AOL-Time Warner
Myths and Facts

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By StephenAa
April 29, 2002

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Myths and facts about AOL:

(1) Myth: The America Online service is the growth engine for AOL Time Warner Inc.

Fact: America Online is, for now at least, just another premium subscriber service provided by AOL. The real growth engine for this company, right now at least, is its cable division. Through cable, AOL will offer pay-per-view movie services, premium high-speed Internet service, bundling options which could increase magazine sales, etc. America Online stands to grow revenues by exploiting AOL's broadband properties -- and not the other way around -- in the near future.

Moreover, online subscriber growth is slowing as the industry matures toward saturation. Cable, by contrast, is expected to continue to grow dramatically, both in terms of new subscribers and as a result of new services providing an increasing number of revenue streams.

This could change, of course, if consumer sentiment were to shift away from cable broadband access to DSL, satellite, or some other technology. Broadband is not expected to become widespread until about 2005-2008, and the real profits may not come until the wireless Internet takes off through the use of Microsoft's ".NET" and/or AOL's "Magic Carpet" services. (So far, it bears noting, AOL trails Microsoft badly in developing these services, although AOL's hefty lead in current online subscribers nonetheless gives it a formidable advantage toward keeping these customers.) DSL and/or satellite may yet make a dent in cable's dominance as the means by which people are obtaining broadband online services.

But for now, it is generally conceded that cable access could shape the limits of AOL's broadband service offerings in the decades to come.

(2) Myth: AOL is not heavily dependent on the advertising market.

Fact: AOL is extremely dependent on advertising. Every division in the company feeds off advertising, and in a better ad market, AOL might actually have made its numbers. The advertising swoon has also led, indirectly, to a credibility gap for the company: To fill unsold advertising space, AOL has sold advertising from one division to another (e.g., America Online and CNN advertise on one another). This has raised questions about how AOL accounts for these sales, and AOL's reluctance to specifically address these concerns division by division has cost AOL the confidence of some analysts and some of its larger shareholders.

(3) Myth: AOL wants ISP service access to AT&T Broadband's and Comcast's cable pipes as soon as possible and its failure to strike a deal so far is cause for alarm.

Fact: Shareholders certainly want this deal ASAP because of their concerns about AOL's seeming lack of appreciation for the expected future shift to broadband services, but AOL will almost certainly wait to strike a deal, at least until the merger (assuming it is approved) closes. First, its major leverage in striking a deal is its offer to buy out the 25% of TWE that AT&T Broadband currently owns. AOL is likely to use this to buy its way into the combined enterprise, rather than make a deal now just for access to the AT&T properties. Second, AOL will likely wait to see if federal regulators will deny the merger or insist on open-access requirements that could give AOL additional leverage in striking a deal for access on favorable terms.

(4) Myth: Microsoft's financial support for Comcast will render the company unwilling to strike a deal for offering America Online.

Fact: At this point, AT&T Broadband is a debt-laden, money-losing enterprise, albeit one expected to grow revenues dramatically in the future, hence its high price tag. Comcast wants to immediately "monetize" its customers to pay off the debt. An immediate source of cash would be an AOL buyout of AT&T's share of TWE, and Comcast is eager to strike such a deal. Further, Comcast sees AOL's high share of online subscribers and wants the opportunity to direct those customers in its cable-serviced areas toward higher premium services like broadband Internet access, from which it, too, can profit. Comcast and AOL thus have a common interest in striking a deal for access. If AOL cannot strike a deal with Comcast, it will likely look to expand its cable holdings by going after, say, Cox. But this would likely be a move of last resort, rather than a preferred option.

(5) Myth: AOL lost $54 billion last quarter.

Fact: AOL's market capitalization lost more than $200 billion since the merger, of which, approximately $54 billion can be attributed to "good will" that can no longer legitimately be regarded as a bona fide asset given the company's current market cap, and thus which, under recently adopted accounting rules, must be accounted for now rather than amortized over the next 20 or so years. In terms of money changing hands, AOL virtually broke even last quarter, beating consensus earnings estimates handily but failing to meet some of the more optimistic cash flow growth scenarios.

(6) Myth: AOL paid too much for Time Warner Inc.

Fact: Both companies were heavily overvalued at the time of the merger. But market interest in the America Online division has declined far more dramatically than has interest in the original TWX conglomerate properties, and had AOL not made the deal it struck, questions over AOL's broadband strategy, lack of a cable partner, and ability to continue to survive a long-term battle in its single industry, ISP service, with Microsoft would leave it valued far lower than it is today.

(7) Myth: AOL will come back.

Fact: Maybe, maybe not. I personally believe that AOL is oversold, but I've believed that since it fell below 30. Still, history suggests that the market tends to overshoot fair value, both on the way up and on the way down. As Prof. Hirschey says in his profile, "In the stock market, it's fairly easy to tell what will happen; it is impossible to tell when." He's probably been more accurate than anyone else the past two years in calling AOL's market plunge, and he's now bullish at AOL's current value, so far be it from me to disagree with him.

(8) Myth: AOL will not come back.

Fact: Again, maybe, maybe not. I can't think of a company better positioned to surge as a result of its cross-platforming advertising potential once advertisers return. But hey, I could be wrong. (It happened once before, I think. On second thought, no it didn't -- I'm wrong to say that I was ever wrong!)

(9) Myth: AOL is in danger of going bankrupt.

Fact: Nonsense.

(10) Myth: Historical trends suggest that there will be resurgence in the market the second half of this year.

Fact: Yes, they suggest it, but they don't guarantee it. We may have a war with Iraq this year or next year, which could destabilize the markets. (I saw it penciled in on CNN's fall schedule!) We could be struck by another terrorist attack at any time. And even if the market itself roars back, there is no guarantee that AOL will participate in the comeback (although such a recovery would probably bring advertisers back, which in turn should improve AOL's bottom line substantially). But what will tomorrow bring? No one knows.

(11) Myth: AOL makes terrible movies that a decadent public flocks to see.

Fact: WB movies aren't very good, for the most part, but HBO makes excellent movies. New Line Cinema and some of the other smaller divisions make some good productions, too. Just a point I thought I'd throw in.

(12) Myth: The AOL Time Warner merger has failed.

Fact: Too soon to tell. The original Time Warner merger didn't do well at first, then suddenly performed very well. On the other hand, Disney's purchase of Capital Cities/ABC has yet to prove workable. Of course, one can never be sure about the benefits of an acquisition until years later. AOL's acquisitions of CompuServe and ICQ were initially questioned; now they look brilliant. AOL's acquisition of Netscape, if nothing else, means AOL isn't at Microsoft's mercy. By contrast, Yahoo's failure to reach a merger agreement with eBay now looks like a catastrophic mistake for that company. And it is too soon to tell whether AOL will similarly rue its failure to obtain AT&T Broadband.

Fool on,

SBA


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