Reality Check
A Look at America Online

By Yi-Hsin Chang (TMF Puck)

Warning: The following report is not for the faint at heart. If you are a diehard follower of America Online easily upset by any negative commentary on the company, you should probably skip this report. The following expresses the views of the author and does not necessarily represent the views of this portfolio's managers.

Alexandria, VA (July 7, 1999) -- Judging from the Sunday New York Times article trumpeting the future of America Online (NYSE: AOL), the company and its chairman and CEO, Steve Case, are in dire need of a reality check. Don't get me wrong, I do think AOL is one of the best Internet companies and brands around, but, unlike Steve Case, I don't believe AOL will be "the next Microsoft" (Nasdaq: MSFT).

The Times article calls AOL "the biggest, most powerful company on the Internet." It claims that 39% of Americans' time online is spent using services America Online controls, which is 10 times that of its nearest competitor Microsoft. I'm not sure if I buy that 39% figure. It seems a bit high.

If you ask me, there are several companies that could be in the running for that "biggest, most powerful" title -- Yahoo! (Nasdaq: YHOO), for instance, or, even better, its parent Softbank, whose properties include E*Trade (Nasdaq: EGRP) and Ziff-Davis (NYSE: ZD)n. Now that's the granddaddy of Internet companies. Plus, there's CMGI (Nasdaq: CMGI), another big player online.

Now, there's no question that AOL is an industry leader. It was the first Internet company to be added to the Standard & Poor's 500 Index, and it expects to hit $5 billion in revenues this year. This would be quite a milestone, as it would catapult the company into next April's Fortune 500 list at around 320 or so (that is, if we're talking about reaching that $5 billion mark within this calendar year), making it the first Internet company to break into the prestigious list. The current Fortune 1,000 has AOL at No. 535.

According to the Times, AOL aims to double the number of subscribers (now at 17 million) of its flagship AOL service over the next five years. It wants to keep users online for up to three hours a day (the average now is 55 minutes), and it plans to make the service available on TVs, cell phones, and other devices.

AOL's mission is "To build a global medium as central to people's lives as the telephone or television." Sounds good, except it's comparing apples to oranges. The global medium here is more accurately the Internet as a whole. AOL is to the Internet what AT&T or MCI WorldCom is to the telephone and what Fox or NBC is to TV. Despite what Steve Case would like to believe, AOL is not the Internet.

In the article, Case talks about making AOL the most valuable company in the world with the largest market capitalization, ahead of Microsoft. A major part of the plan is AOL TV, scheduled to debut next year. Never mind that Microsoft's investment in WebTV has been less than stellar -- it has signed up just 800,000 subscribers since paying a hefty $425 million for it in 1997.

What the people who see PCs merging with TVs don't seem to understand is that these are very different devices used in vastly different ways. Watching TV is a communal experience. You watch TV with your family. You invite friends over to watch a favorite program or a sporting event. You don't surf the 'Net with your family or friends. It is a one-person-to-a-computer experience. It is often private. You might use the Internet to communicate with others online, but it's no fun watching over someone else's shoulder.

True, many of us watch TV while we're online, but I prefer having a powerful PC that's separate from my TV. They serve totally different functions. TV is a passive experience (hence, the couch potato), while the Internet is completely interactive. I can't imagine anyone except the greenest Web users wanting to subscribe to AOL TV.

So when Steve Case says: "Windows is the past. In the future, AOL is the next Microsoft," I can't help but raise an eyebrow. While I don't think it's impossible in this crazy world of Internet valuations for AOL to attain the largest market cap in the world, I don't believe it will be the next Microsoft in terms of world presence and domination in its field.

Through its Windows operating system and software, Microsoft literally reaches virtually every corner of the globe. AOL is as likely to do the same as AT&T or Deutsche Telecom is to dominate the global telecommunications market. It ain't happenin'. While I'm opposed to government regulation, I'm not silly enough to think that regulators will let something like that happen. If Steve Case means that AOL may be the next target of the Justice Department's antitrust arm, then he just might be right.

The truth is that AOL's flagship service appeals to non-tech-savvy users new to the Internet. Once they become accustomed to the new medium, they are likely to move on to something else -- maybe something cheaper or with faster connections or more sophisticated technology. So what happens when society as a whole becomes more used to going online? Will AOL be able to maintain its growth in number of subscribers? I think not. As Excite@home's (Nasdaq: ATHM) CEO Tom Jermoluk told the Times, "More than half our new customers are ex-AOL users."

Don't get me wrong, I'm not making any predictions for the downfall of AOL or even a slowdown anytime soon. I don't know when we will become a 'Net literate society. All I know is that AOL may be a lot of things, but it won't be the next Microsoft.

To discuss this column, or anything to do with Rule Breakers, visit the Breaker Board.

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07/07/99 Close

Stock  Change    Bid 
AMGN  +3 13/16   62.81
AMZN  -5 1/8    121.88
AOL   +1 1/8    122.50
ATHM  -2         54.94
CAT   +2 13/16   62.13
CHV   +1 3/8     99.69
DD    -  13/16   69.94
DJT   -  1/6      5.00
EBAY  -2 1/2    138.25
GT    +1 1/16    58.31
IOM     ---       4.50
SBUX  -1 9/16    25.00
TDFX  -  3/16    14.94

                  Day     Month  Year   History   Annualized 
      R-BREAKER  -0.61%   2.29%  31.59% 1220.79   68.97%
        S&P:     +0.56%   1.68%  14.13%  218.76%   26.57%
        NASDAQ:  +0.23%   2.12%  25.10%  280.89%   31.24%

    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91    122.50   13378.57%
   9/9/97  1320 Amazon.com     6.58    121.88    1752.42%
  5/17/95  1960 Iomega Cor     1.28      4.50     251.45%
  12/4/98   900 Excite@Hom    28.04     54.94      95.92%
 12/16/98   580 Amgen         42.88     62.81      46.50%
  4/30/97 -1170*Trump*         8.47      5.00      40.96%
  2/26/99   300 eBay         100.53    138.25      37.53%
  2/23/99   300 Caterpilla    46.96     62.13      32.28%
  2/23/99   180 Chevron       79.17     99.69      25.92%
  2/23/99   290 Goodyear T    48.72     58.31      19.70%
  2/20/98   260 DuPont        58.84     69.94      18.85%
   7/2/98   470 Starbucks     27.95     25.00     -10.57%
   1/8/98   425 3Dfx          25.67     14.94     -41.80%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 269500.00  $267500.53
   9/9/97  1320 Amazon.com  8684.60 160875.00  $152190.40
  12/4/98   900 Excite@Hom 25236.13  49443.75   $24207.62
 12/16/98   580 Amgen      24867.50  36431.25   $11563.75
  2/26/99   300 eBay       30158.00  41475.00   $11317.00
  5/17/95  1960 Iomega Cor  2509.60   8820.00    $6310.40
  2/23/99   300 Caterpilla 14089.25  18637.50    $4548.25
  4/30/97 -1170*Trump*     -9908.50  -5850.00    $4058.50
  2/23/99   180 Chevron    14250.50  17943.75    $3693.25
  2/20/98   260 DuPont     15299.43  18183.75    $2884.32
  2/23/99   290 Goodyear T 14127.38  16910.63    $2783.25
   7/2/98   470 Starbucks  13138.63  11750.00   -$1388.63
   1/8/98   425 3Dfx       10908.63   6348.44   -$4560.19

                              CASH   $9924.87
                             TOTAL $660393.93
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.


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