Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

AOL@Home? (Part 2)
Creating Competition. Plus, @Home's Earnings

by Nico Detourn (TMF Nico)

SILICON VALLEY, CA (July 20, 1999) -- Yesterday's Rule Breaker Portfolio looked at a possible partnership or merger between America Online (NYSE: AOL) and Excite@Home (Nasdaq: ATHM). We focused in particular on talks between the two that broke off late last year, prior to @Home's merger with Excite and the creation of Excite@Home. The new company reported its quarterly results today after the market closed, and Jeff Fischer's first take on that can be found below.

According to @Home Chairman and CEO Tom Jermoluk, the sticking point in negotiations with AOL was AOL's insistence that @Home's role be limited to being a provider of high-speed network services, thus reducing its visibility and status to that of a "dumb pipe."

AOL's insistence on this point created a less than amicable negotiating environment, suggesting AOL's interest in crafting a deal was less than @Home's, and less than it was generally thought to be. Although we can never be certain, this further suggests that a deal could likely have been done had AOL been motivated. Yesterday's RB Port also noted that the negotiations over a year-and-a-half provided each company with valuable insight into the other's strategy and vision for how the Internet might evolve.

In order to get a better view of how the two companies might have partnered, or might yet do so, we need to look at other events that took place at the same time and subsequent to their aborted negotiations.

In particular, America Online's acquisition of Netscape Communications and @Home's acquisition of Excite need to be examined. To fully place these events in context, though, we also need to look at AOL's relationship with Excite, as well as Excite's relationship with Netscape -- a tangled web by any measure.

AOL and Excite and Netscape

Just as we might conclude that AOL could have done a 1998 deal with @Home had it wanted to, the same can be said of a deal between AOL and Excite.

America Online at one time owned approximately 20% of Excite. One of the original Web search engines, Excite had for about two years been the exclusive co-branded Internet search and directory service on AOL and at AOL.com. Excite's first Instant Message program was licensed from AOL. AOL's President and Chief Operating Officer Bob Pittman had been an Excite board member prior to joining AOL, and AOL's Steve Case had also been on Excite's board.

At the time the AOL-@Home negotiations hit the wall in November 1998, AOL was also negotiating to acquire Netscape. In that acquisition, announced in late November, AOL inherited an extensive May 1998 partnership between Netscape and Excite. The arrangement, laid bare for AOL in its due diligence of Netscape, essentially called for Excite to manage and operate large portions of Netscape's Netcenter, integrating Excite search technology, content, and interactive marketing know-how in a late attempt to rejuvenate the neglected portal.

Suffice to say that America Online, which by all appearances operates in continuous-acquisition mode, knew Excite well, and was in a position to determine what Excite could add as part of AOL's growing portfolio of online operations.

In addition, we know that Excite was at the same time starting to shop itself, or, as the @Home-Excite merger prospectus puts it, "pursue a business combination and/or strategic partnership with a range of companies." Indeed, America Online and Excite were reportedly in negotiations as late as mid-December, two weeks after the AOL-Netscape deal had been announced.

Of course, none of this means Excite would have sold itself to AOL on AOL's terms. Nor does it mean AOL could have swallowed both Netscape and Excite in such short order. All things considered, though, if AOL had wanted to acquire Excite within that general time frame, it most likely could have.

Creating Competition

In one of the other prime quotes from this period -- a companion to "dumb pipe" -- Excite's George Bell acknowledged that AOL's Netscape acquisition helped him realize that Excite could not "out-Yahoo! Yahoo!." It would in addition leave Excite vulnerable to America Online, which would now own one of Excite's largest strategic partners.

It was also at this time that @Home's Tom Jermoluk began pursuing mergers with content companies in a strategic reassessment surely influenced by his recently ended stand-off with AOL. In a rapidly consolidating industry dominated by America Online, Jermoluk's new course would broaden @Home's operations and allow it to more effectively compete.

As we've seen, AOL would have had a good sense of how @Home and Excite were positioned and what they were capable of. What's more, knowing that its acquisition of Netscape was about to reconfigure the industry, AOL was actually driving the logic that was about to motivate Bell, Jermoluk, and others.

From AOL's perspective, which given what it knew was at least one step ahead of the game, an @Home-Excite merger would be the shortest distance between where those two companies were, and where they needed to be.

Powered by @Home and its cable partners, Excite could more effectively stand against Yahoo!, AOL, AOL's Netscape, and others. Likewise, with the media savvy and content of Excite providing "smarts" to @Home's high-speed pipes, Tom Jermoluk could recreate his company according to his vision, rather than yielding to what AOL had insisted it be during their aborted negotiations.

The great irony that falls out of this analysis is that America Online's actions in November and December 1998 virtually ensured the creation of its main competitor in January 1999. In fact, Excite@Home is the strongest and, I believe, the first significant single competitor AOL has faced to date.

Opportunity Lost?

Was not dealing with @Home an error on AOL's part?

It could play out that way. But it is better to influence events than to simply wait for events to happen, especially if future competitors can be identified. Surely Excite and @Home would be around in one form or another no matter what. The advance of cable and other broadband services could not be stopped. Accepting the inevitability of this competition, and surveying the possibilities, America Online made decisions and took actions that in turn influenced the actions of its competitors, entailing the risk that competitors end up strengthened.

Both AOL and Excite@Home are today going down their own road, no doubt hoping the other stumbles, if not working to bring that about. On the surface, at least, they both appear reasonably confident. A future merger between America Online and Excite@Home remains an intriguing possibility. But the interesting thing about the present situation is how it can be seen as resulting from deals that were not done, but that involved the identical cast of players.

In the end, America Online's decisions not to deal separately with either @Home or Excite helped create the possibility of dealing with them in combination at a later date. Whether those decisions add up to an opportunity lost or an opportunity deferred remains to be seen. Certainly neither America Online nor Excite@Home will be vacating the scene any time soon.

Today's News
by Jeff Fischer (TMF Jeff)

Excite@Home (Nasdaq: ATHM) announced $100 million in pro forma (continued operations) second-quarter revenue, an increase of 140% from the prior year. Total @Home subscribers leapt to 620,000, up more than 300% from the second quarter, 1998. These results exceeded average estimates of $90 million in revenue and 610,000 subscribers, while homes made ready for cable reached the expected 17 million mark, as we discussed last week. Excite@Home lost a pro forma $0.02 per share, matching the estimate.

Excite's website also performed well, although page views didn't rise as much as some expected. The 81 million June page views was a modest climb from 77 million in March. Estimates ran as high as 87 million. However, registered Excite users climbed 36% to 38 million -- great results during the slower quarter two period.

With $433 million in cash and investments, including $50 million invested in five Internet startups, Excite@Home is in a great financial position as it builds towards year-end profitability. And build it is. Like wildfire. The company's press release explains everything that Excite@Home is doing -- and we do mean everything -- and on the Fool, this news is followed by comments from various readers. The beginning of the thread (the press release) can be found here.

Elsewhere in the news, certainly you saw that the Nasdaq declined 3.4% today. The decline follows several days of record highs, the last of which was Friday. This week hasn't been a picnic. Living up to its volatile reputation, in two days the Nasdaq Composite has fallen 4.95% below its high. If you're not long-term, that hurts.

Falling with the stock market has been Amazon.com (Nasdaq: AMZN). The company should report a widening loss on July 21. It costs money to build, and it is easy to criticize a work in progress, especially when you can't visualize its completion. Picture a half-painted Picasso, or any novel half-written. The best of these are often criticized in their beginning by critics who can't envision a completed work. I don't see Amazon being treated much different.

Meanwhile, news that America Online (NYSE: AOL) will offer a free Internet service in the U.K. didn't raise eyebrows. It will be called Netscape Online -- and that's instant brand recognition. Nice. We reported on the possibility here twice in the past few weeks before yesterday's announcement.

Finally, despite the market's maelstrom, many companies are coming public this week. What we're seeing is amazing. This week's list includes these higher-profile companies:

All of these companies have message boards at http://boards.fool.com. Visit any you wish. Always free.

Fool on!

07/20/99 Close
Stock  Change    Bid 
------------------ 
AMGN  -  7/16    73.00
AMZN  -11 9/16  120.13
AOL   -5 5/16   113.69
ATHM  -1 11/16   45.06
CAT   -  1/16    60.19
CHV   -1 13/16   93.31
DD    -  1/4     70.81
DJT   -  1/8      5.38
EBAY  -4 3/4    112.94
GT    -  7/8     57.63
IOM   -  1/8      4.44
SBUX  -  1/8     24.88
TDFX  -1         15.25


                  Day     Month  Year   History   Annualized 
      R-BREAKER  -4.78%  -3.05%  24.73% 1151.87%   66.53%
        S&P:     -2.17%   0.31%  12.61%  214.67%   26.03%
        NASDAQ:  -3.47%   1.72%  24.60%  279.37%   30.87%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91    113.69   12408.94%
   9/9/97  1320 Amazon.com     6.58    120.13    1725.82%
  5/17/95  1960 Iomega Cor     1.28      4.44     246.57%
 12/16/98   580 Amgen         42.88     73.00      70.26%
  12/4/98   900 Excite@Hom    28.04     45.06      60.71%
  4/30/97 -1170*Trump*         8.47      5.38      36.53%
  2/23/99   300 Caterpilla    46.96     60.19      28.16%
  2/20/98   260 DuPont        58.84     70.81      20.34%
  2/23/99   290 Goodyear T    48.72     57.63      18.29%
  2/23/99   180 Chevron       79.17     93.31      17.86%
  2/26/99   300 eBay         100.53    112.94      12.35%
   7/2/98   470 Starbucks     27.95     24.88     -11.02%
   1/8/98   425 3Dfx          25.67     15.25     -40.59%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 250112.50  $248113.03
   9/9/97  1320 Amazon.com  8684.60 158565.00  $149880.40
 12/16/98   580 Amgen      24867.50  42340.00   $17472.50
  12/4/98   900 Excite@Hom 25236.13  40556.25   $15320.12
  5/17/95  1960 Iomega Cor  2509.60   8697.50    $6187.90
  2/23/99   300 Caterpilla 14089.25  18056.25    $3967.00
  2/26/99   300 eBay       30158.00  33881.25    $3723.25
  4/30/97 -1170*Trump*     -9908.50  -6288.75    $3619.75
  2/20/98   260 DuPont     15299.43  18411.25    $3111.82
  2/23/99   290 Goodyear T 14127.38  16711.25    $2583.88
  2/23/99   180 Chevron    14250.50  16796.25    $2545.75
   7/2/98   470 Starbucks  13138.63  11691.25   -$1447.38
   1/8/98   425 3Dfx       10908.63   6481.25   -$4427.38

                              CASH   $9924.87
                             TOTAL $625936.12
 
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>

Are you a Foolish investor?
The Motley Fool Recommends... Check Out These Other Fool Products...

Subscriptions
Primers
Reports
Investing Tools
Books
Fool Gear

Rule Breaker Portfolio Reports
The nightly scoop on the Rule Breaker Portfolio, delivered straight to your e-mailbox. Get more info or order.
Industry Snapshot
New format! A stock idea, industry overview, top players, and financials -- every two weeks! Get more info or order.
Foolish Eight Stock Screen
Here at Last! Foolish Eight Stock Screen. Get more info or order.
Shop FoolMart!

Read More Rule Breaker Reports