Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

AOL@Home?
To Deal Or Not To Deal (Part 1)

by Nico Detourn (TMF Nico)

SILICON VALLEY, CA (July 19, 1999) -- Earnings season is in full bloom, and some of the Rule Breaker port's most well-followed companies report quarterly results this week. Tomorrow is Excite@Home's (Nasdaq: ATHM) turn. Wednesday is a double-header, with both America Online (NYSE: AOL) and Amazon.com (Nasdaq: AMZN) turning in report cards for the hopefully proud and delighted perusal of their investors. Their announcements will give us a concise snapshot of these companies, so do peruse, all. In case you missed any of last week's RB reports, Jeff Fischer did separate previews for both AOL and Excite@Home.

As Jeff noted, Tuesday will be the first time @Home reports its quarterly results since acquiring Excite, which brings several new factors to our attention. For example, in addition to the all-important cable homes-passed (meaning ready for service) and @Home subscriber counts, Excite's registered users are now a leverageable company asset, and page views are of greater competitive significance now that the "new @Home" is in the big-time portal biz.

One question that comes up regularly on the Excite@Home and AOL message boards is whether a deal can be done between the two companies and what that might look like. This intriguing possibility has been hovering out there almost since @Home's inception but really came forward late last year with reports that talks between the companies had stalled.

Things have changed since last year, though. Excite@Home in particular is a stronger company, with greater revenue and audience "reach" potential than either @Home or Excite were able to claim separately. AOL has also made several acquisitions since then. These developments would naturally add some complexity to deals between what nevertheless remain two rather complementary companies.

Another factor is AT&T's (NYSE: T) controlling interest in Excite@Home, which it places near the center of its high-stakes broadband strategy. Although this wouldn't necessarily preclude a variety of deals, it could be an issue for AOL, which has achieved and so far maintained its industry-leading position due in good part to its independence.

Many good arguments can be made for a deal -- some even speculate a merger -- between AOL and Excite@Home. But would the companies really want or need deals similar to some of the ones that have captured the imagination of investors and Internet watchers? As much as the pieces would fit, when I look at the situation, I don't believe either party currently sees a compelling reason to accommodate the other.

The "Dumb Pipe" Impasse

If AOL and @Home had both wanted a deal, they probably could have had one last year.

Talks between the two hit an impasse last November over what @Home's Chairman and CEO Tom Jermoluk said was AOL "insisting that @Home be a dumb pipe," a mere conduit for delivering AOL's service over @Home's high-speed infrastructure. I've always found that quote rather telling. It's more than just a colorful phrase and a bit of industry gossip, especially since it is one of the few pieces of information we have about the AOL-@Home talks.

Of course, from a purely technical point of view, all pipe is "dumb," getting its "smarts" only from the data or content it carries. It would only be called "dumb" when making that very point, or when assigning relative value and importance to access and content. And although we don't know whether the words "dumb pipe" were first said by AOL to describe @Home, or by Jermoluk to characterize AOL's attitude, the understandable frustration expressed in Jermoluk's public comments leaves little doubt that whatever words were used by whom, AOL hit a nerve by "insisting" @Home accept a status beneath its ambitions.

So what happened? Is it possible AOL set out to deliberately insult @Home?

Round and Round

What seems certain is that AOL would have approached @Home from its own unique perspective on how a relationship might be structured between an aggregator of content and commerce services with a massive user base and high-value brand, and an access provider with a relative lack of all three of those essential assets. America Online had the installed customers and presumably would need only let them know of a "new and improved AOL Plus" for them to turn their eyes toward AOL's broadband partner.

For its part, @Home entered negotiations from the perspective of the premier provider of high-speed services, on the leading edge of the interactive future. Yes, it wanted to fill its state-of-the-art pipes with content for paying subscribers -- it was negotiating with America Online, after all. But it also wanted more visibility than "just" being AOL's broadband provider would allow for, especially if AOL saw the relationship as similar to its other network services deals, in which Internet access was resold and rebranded as AOLnet. That wouldn't leave much room for @Home to achieve its undoubtedly intensifying ambitions.

The more AOL negotiated from its advantage, the more it insisted that @Home be limited to pipe status. Round and round they went, according to Jermoluk, for a year and a half.

"What would be acceptable to you?"

"What if we tried this?"

"Why should we give you this when you're only providing us with that?"

"How can you accomplish what you want without our unique resources?"

Either party could have made any of those statements, and both probably did at different times. Eventually, negotiations broke down.

Are You Reading Me?

Tom Jermoluk's frustration speaks to @Home's interest in doing a fair and less lopsided deal. That apparently depended on AOL's real interest and motivation in the negotiations. Based on the evidence, we might conclude AOL could have had a cable broadband deal last year had it really wanted one. It apparently did not.

One interesting aspect to all this, as the talks went back and forth, is that it's more likely that @Home's ambitions, its overall position, and the outline of its vision, became known to AOL. And although these ambitions were surely no surprise, their subtleties and the course of their evolution could have been inferred by an outsider, such as AOL, only through a careful and intentional reading over time of @Home's reaction to the insistence that their ambitions be limited and subordinated.

At the same time, @Home knew that what it brought to the table was no small thing. High-speed connectivity was unquestionably the future. AOL knew that, too -- it was negotiating for that very thing. Or so it seemed.

And just as AOL was reading @Home and psyching-out @Home's strategies and intentions, @Home's post-game analysis of AOL's stubborn arrogance on the dumb pipe point must surely have influenced its view of how it might navigate the high-speed changes of this brave new medium. Indeed, some serious changes loomed just over the horizon.

Tune in tomorrow. Same Fool time. Same Fool channel. There are Exciting times ahead. We'll consider them next.

07/19/99 Close
Stock  Change    Bid 
------------------ 
AMGN  -4 3/16    73.44
AMZN  -5 15/16  131.69
AOL   -  15/16  119.00
ATHM  +1 1/8     46.75
CAT   +1 5/16    60.25
CHV   -  1/2     95.13
DD    -  13/16   71.06
DJT   +  1/16     5.50
EBAY  -5 9/32   117.69
GT    -  1/8     58.50
IOM   +  1/16     4.56
SBUX  -  3/8     25.00
TDFX  +  1/8     16.25


                  Day     Month  Year   History   Annualized 
      R-BREAKER  -1.93%   1.81%  30.98% 1214.66%   68.23%
        S&P:     -0.78%   2.54%  15.09%  221.34%   26.58%
        NASDAQ:  -1.19%   5.37%  29.08%  293.00%   31.83%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91    119.00   12993.47%
   9/9/97  1320 Amazon.com     6.58    131.69    1901.56%
  5/17/95  1960 Iomega Cor     1.28      4.56     256.33%
 12/16/98   580 Amgen         42.88     73.44      71.28%
  12/4/98   900 Excite@Hom    28.04     46.75      66.73%
  4/30/97 -1170*Trump*         8.47      5.50      35.06%
  2/23/99   300 Caterpilla    46.96     60.25      28.29%
  2/20/98   260 DuPont        58.84     71.06      20.76%
  2/23/99   180 Chevron       79.17     95.13      20.15%
  2/23/99   290 Goodyear T    48.72     58.50      20.09%
  2/26/99   300 eBay         100.53    117.69      17.07%
   7/2/98   470 Starbucks     27.95     25.00     -10.57%
   1/8/98   425 3Dfx          25.67     16.25     -36.69%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 261800.00  $259800.53
   9/9/97  1320 Amazon.com  8684.60 173827.50  $165142.90
 12/16/98   580 Amgen      24867.50  42593.75   $17726.25
  12/4/98   900 Excite@Hom 25236.13  42075.00   $16838.87
  5/17/95  1960 Iomega Cor  2509.60   8942.50    $6432.90
  2/26/99   300 eBay       30158.00  35306.25    $5148.25
  2/23/99   300 Caterpilla 14089.25  18075.00    $3985.75
  4/30/97 -1170*Trump*     -9908.50  -6435.00    $3473.50
  2/20/98   260 DuPont     15299.43  18476.25    $3176.82
  2/23/99   180 Chevron    14250.50  17122.50    $2872.00
  2/23/99   290 Goodyear T 14127.38  16965.00    $2837.63
   7/2/98   470 Starbucks  13138.63  11750.00   -$1388.63
   1/8/98   425 3Dfx       10908.63   6906.25   -$4002.38

                              CASH   $9924.87
                             TOTAL $657329.87
 
Note: The Rule Breaker Portfolio was launched on August 5, 1994, with $50,000. Additional cash is never added, all transactions are shared and explained publicly before being made, and returns are compared daily to the S&P 500 (including dividends in the yearly, historic and annualized returns). For a history of all transactions, please click here.

</THE RULE BREAKER PORTFOLIO>

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