Fool Portfolio Report
Friday, October 11, 1996

by Jeff Fischer (MF BudFox)

ALEXANDRIA, Va., October 11, 1996 -- The market had a great day.

Many Fool stocks kept pace with the rising tide of the market's surge, except for a few laggards, most notably America Online (AOL), which lately appears to be drowning. In the last month, America Online had recovered from $25 a share to briefly rise above $35, only to fall in the last several days to $24. Today the stock made a new 52-week low. It trades at only 2X sales, and at 24 times 1997's estimated earnings.

The stock began to drop in earnest again last week when the company's 10-K disclaimers were presented by the media as news. But let's not kid ourselves. Of course that isn't the only reason the stock is falling, and that has nothing to do with the stock dropping from a high of $71 earlier this year. Numerous concerns have plagued the company, none being solely responsible for the stock's fall. The most recent catalyst seems to be, again, at least on the surface, the reappearance of Microsoft Network in the news.

Yesterday Microsoft unveiled their new Web-based Microsoft Network service (MSN). The service itself isn't exactly new news, but it is probably hurting AOL's stock -- perhaps by rubbing salt in the wounds of uncertainty AOL shareholders must feel.

You may remember when Microsoft Network was first announced some time ago; America Online's stock fell sharply on the day. AOL's Steve Case welcomed Microsoft, though, saying, as I recall, something to the effect that it legitimized the existence of the vast online market. AOL's stock eventually recovered, and the debut of Microsoft Network was far from smashing, inflicting arguably little damage to AOL or Compuserve (though Microsoft says it is now the third largest online service worldwide).

That's the past. What matters is the present and the future. Microsoft does not and will not disappear -- but it is leaning the way of the Internet with its new Web-based Microsoft Network, much like Prodigy and Compuserve. According to Randy Befumo (MF Templar), Microsoft is going to the Web because they can't build a proprietary network fast enough to catch up with AOL, while Prodigy and Compuserves' best financial interests rest with Web-based formats. On the other hand, America Online's "hybrid" network (instead of Web only) is superior and can be internal only or can go out on the Web. Currently, AOL is remaining to itself, but skeptics wonder how America Online can compete with the Internet?

Well, of course America Online doesn't see itself competing with the Internet. Their new advertising campaign states AOL is "The Internet and More." And that it is. But then why doesn't everyone subscribe to AOL? Why go straight to an Internet-only provider? How many teenage Internet freaks truly hate AOL? Only that many? Well, then, why else go straight to an Internet provider? Price?

AOL's pricing structure continues to be considered, and the company acknowledged this again last night. AOL said yesterday evening that they will make announcements regarding the service, including pricing, "very soon." They were responding to Microsoft's relaunch of MSN and Microsoft's new pricing structures, one of which includes a $19.95 flat fee per month. The fact that MSN and many internet access providers (including Netcom and AT&T) offer unlimited access for a flat fee, intimates that AOL will soon provide members unlimited flat-fee service as well. They'll need to, right? In that case, how will it affect earnings? What kind of margins can AOL show in the coming years? Or will member revenues even be extremely important to them in the future? According to CEO Steve Case, no.

This fall AOL is announcing new initiatives. One initiative, announced in September, is to generate revenues by offering advertisements and electronic commerce. The trick in attracting large advertisers and retailers lies in providing them a mass audience -- and AOL has the 6 million accounts. Though consider in the June quarter AOL signed up 1.8 million new U.S. members, but a whole 1.5 million dropped the service, for a net gain of only 300,000. This is more than a 50% slowdown from the previous quarter. So, how do you keep members? Another initiative, which involves the pricing issue, is the "new member experience." That's all the detail I've found on this initiative, but it sounds to be an all-encompassing prospect.

Which should take us to content. Content is key, and content is what Tom and David have talked fairly often about in past recaps. America Online has an abundance of content, but that doesn't mean it is entirely useful. The Internet is loaded with... well, with an entire world of content -- the world on a platter (or a network). How much of it do you use?

Typically, people employ search engines to find what they're interested in and leave it at that. AOL has more than enough content, but too much of the content seems too "general" -- to me -- so that the Internet actually seems more fruitful in finding specific interests. Perhaps in an attempt to keep up, AOL seems to keep growing with "general interest" content. AOL, in fact, often appears to be employing a shotgun approach when it comes to content (and in their marketing strategies, as well). I feel this is wrong. In fact, a shotgun approach with content could be considered trying to "compete" with the Internet on a content level, which is impossible. If AOL has an abundance of "general" content that it wishes to sell advertising space on (and they will be competing with Web sites for advertisers), wouldn't it make sense for the advertisers to go the Web, where more eyes are likely to view it?

The point is, when anyone can obtain all the content they could ever wish for on the Internet, and AOL already offers the Internet, doesn't it then make sense that the added content that its service offers more specific and original and "community-driven" content, rather than shadow in any way the sprawling general content the Internet offers? Why be a mini-Internet yourself? It isn't needed.

AOL should differentiate itself from the Internet, both in terms of content and services. Content should inspire members to join and "assimilate," and even inspire them to see the Internet as merely a bonus they get with AOL, rather than the other way around. Sound impossible? I think you'd be surprised. Just belonging to one or two healthy communities, such as the Fool, can make the Internet pale in comparison for true value and enjoyment. Think yourself of where you spent most your time.

America Online has already taken great strides in providing excellent tools and services for unlocking the potential of the online world for the average consumer. The user-friendly environment provided by AOL makes navigation of the online world much easier for people who think that ethernet is an anesthetic.

By offering various "premium" communities, a user-friendly environment, and the Internet as well, with pricing that matches those of strictly Internet providers, it would only make sense to join AOL (and to advertise on the premium sites offered only on AOL). The Internet is a rather cold world. Make AOL your home, your community, and have the Internet at your backdoor.

Or, as Randy (MF Templar) suggests, "AOL should flat fee the Web and charge an additional surcharge (like HBO) to view their premium channels." That may work. But AOL's premium channels need quite a bit of work before they can be worth the price paid above a flat Internet fee, with so much out there on the Internet.

Fool "VictoriaIM" writes in the Fool AOL board, "Is it just me, or has this reached a new level of excitement?"

A new level, yes. Of both excitement and complication. America Online has done many things correctly to become the number one online provider, by far, in the world. It will be interesting to see what they do next.

As for the remaining Fool stocks, good old 3Com (COMS) reached a new closing high today of $68. KLA Instruments (KLAC) continued to recover, rising 7% today, and short Quarterdeck (QDEK) dropped nicely to an ask price of $6 3/8.

For the week, the Fool outperformed the averages, gaining 1.28% against a drop in the S&P and a very slight gain in the Nasdaq.

Have a Foolish weekend! Keep it simple, unlike this recap!

Transmitted: 10/11/96

Today's Numbers

Day Month Year History FOOL -0.18% -3.63% 47.10% 174.68% S&P 500 +0.88% 1.94% 13.76% 52.85% NASDAQ +0.91% 1.74% 18.64% 73.33% Rec'd # Security In At Now Change 5/17/95 2010 Iomega Cor 2.52 23.00 813.07% 8/5/94 680 AmOnline 7.27 24.75 240.31% 8/13/96 250 3Com Corp. 46.86 67.88 44.85% 8/11/95 125 Chevron 50.28 65.75 30.76% 9/27/96 -890 Quarterdec 7.08 6.38 10.01% 8/12/96 110 Minn M&M 65.68 71.88 9.44% 10/1/96 42 LucentTech 47.62 48.50 1.86% 8/12/96 130 AT&T 39.58 38.88 -1.78% 8/12/96 280 Gen'l Moto 51.97 50.13 -3.56% 8/24/95 130 KLA Instrm 44.71 24.38 -45.48% Rec'd # Security In At Value Change 5/17/95 2010 Iomega Cor 5063.13 46230.00 $41166.87 8/5/94 680 AmOnline 4945.56 16830.00 $11884.44 8/13/96 250 3Com Corp. 11714.99 16968.75 $5253.76 8/11/95 125 Chevron 6285.61 8218.75 $1933.14 8/12/96 110 Minn M&M 7224.44 7906.25 $681.81 9/27/96 -890 Quarterdec -6304.75 -5673.75 $631.00 10/1/96 42 LucentTech 1999.88 2037.00 $37.12 8/12/96 130 AT&T 5145.11 5053.75 -$91.36 8/12/96 280 Gen'l Moto 14552.49 14035.00 -$517.49 8/24/95 130 KLA Instrm 5812.49 3168.75 -$2643.74 CASH $22563.12 TOTAL $137337.62 Transmitted: 10/11/96