Jan 20, 2000 at 12:00AM
"If at first the idea is not absurd, then there is no hope for it."
The quote is attributed to Albert Einstein, a man whose ideas were typically, initially, seen as crazy as well as absurd. Imagine trying to convince somebody about the theory of relativity with only a chalkboard and a piece of chalk. Einstein was originally discounted and criticized by many scientists because his vision was beyond what they could readily comprehend.
Then there's America Online (NYSE: AOL) and its vision. The company announced strong earnings last night and provided few surprises. (Richard McCaffery covered the news in this morning's Breakfast With the Fool: AOL Looks AOK.) Revenue grew 41% from last year's second quarter, to $1.6 billion, while earnings rose 162% to $224 million, or $0.09 per share. Subscriber numbers grew by 1.8 million, meaning that AOL and its properties now have 23.8 million paying subscribers. This is all well and good, but studying these numbers lacks meaning given the pending merger.
I'm still considering the numerous implications behind AOL's combination with Time Warner (NYSE: TWX), so I've been reluctant to publicly give a judgmental opinion on it. Many others, including Tom and David Gardner, had an immediate reaction that was, and remains, negative. Most people don't like the debt, the widely spread asset base, and the presumed diluted growth rate that Time Warner brings to AOL's table. And, Tom argues that AOL could have done this merger a few years from now at a much lower cost to its shareholders. He may be correct, but now we'll never know.
I believe that America Online moved quickly partially because it is obsessed with developing a broadband strategy that includes cable access, and Time Warner provides the largest solution outside of AT&T (NYSE: T). Secondly, I believe that AOL (especially Steve Case and Bob Pittman) has long seen itself as a future media giant in ways that most shareholders had not. (Thus, the widespread shock at the disclosure of this merger.)
Shareholders, myself included, have focused on AOL's subscriber numbers because each new subscriber means new access revenue for AOL. And since Internet access revenue dominates AOL's business model, the company is viewed by investors as primarily an Internet Service Provider (ISP). Of course, shareholders also focus on commerce and advertising revenue because these are high-margin sales. However, these revenues rise mainly as subscriber numbers rise (rather than rising because AOL happened to offer more or better content), so the focus has always come right back to subscribers and to Internet access. What I'm driving at is this: investors' focus has almost never been on AOL's content. Therefore, a content acquisition of this magnitude is jarring to outsiders.
But to Case and Pittman, it makes perfect sense. To become the media giant that AOL wants to be, an all-encompassing content strategy is crucial. The ultimate objective is "AOL Anywhere," including AOL TV. Developing its own content for AOL TV to compete with the likes of CNN, Sports Illustrated, HBO and so forth, would have been extremely expensive and time consuming. Buying the already leading content is relatively quick and easy. If the goal is multimedia dominance (and not just Internet access dominance), the most certain way to attain the goal is through acquisition.
Oh. But wait. Many people believe AOL should have simply continued to partner with content companies and collect high margin content hosting fees. There's logic in that. However, in a world where all content will become interactive, owning that content will prove extremely lucrative.
Now, consider AOL in its current position, alone, by itself. Without a wide array of good content, the main quality that AOL offers to consumers is Internet access. Because, really, how many AOL subscribers use much of AOL's content? I rarely have. AOL is a convenient e-mail account and Internet access product that works around the world. Unfortunately, though, Internet access (especially dial-up access) will almost certainly become a marginalized business in the future.
Yet, AOL relied on dial-up access for 69% of its revenue last quarter. Meanwhile, the company's broadband strategy is far behind schedule as Digital Subscriber Line (DSL) access rolls out quite slowly. So, taken by itself, AOL's near-term future (3 years) can look pretty spotty given the anticipated demand for broadband and AOL's slower than anticipated solution, and given the potential decline in attractiveness of dial-up access. And in this business, if you lose your leading edge, you lose your advantages quickly.
AOL's COO, Bob Pittman, has said that they believe they can grow earnings of the combined AOL Time Warner company about 30% annually in the near term (perhaps 3 to 5 years). He also said that if they didn't believe they could grow the combined companies more quickly than they could grow AOL alone, over the long term, they'd be idiots to make this deal.
So, could AOL grow more quickly over the next ten years relying essentially on itself and dial-up access, broadband access (to what extent and by offering what content?) and on ad and commerce revenue, or can AOL and Time Warner pool resources and grow more quickly combined over the next ten years? AOL believes the latter. That so many people see the merger as absurd anyway (on AOL's part) is perhaps a good sign.
Please click the following link for the AOL second quarter press release, and this link for the conference call replay. (By the way, a new service, Motley Fool Stock Research, will launch in February and I'll be providing regular coverage of America Online. We'll have more information on this exciting new Fool service soon! Other stocks that will be covered in regular Fool reports include eBay, Amazon, Amgen, Wal-Mart, EMC, Starbucks, Nike, Gap, Yahoo!, Cisco Systems, Dell, Apple Computer, and more.)
Moving away from AOL (is that applause I hear?!), Excite@Home (Nasdaq: ATHM) deserves a spotlight. This evening, the company announced the first profitable quarter in its history. (It should be noted, however, that operations still ran at a small loss, and it was interest income that nudged the company into profitability. Next quarter, operations should do the trick alone.) Fourth quarter revenue rose 76% to $128.8 million, and net income totaled $514,000, which was small enough to round to $0.00 per share. This matched the consensus estimate. Subscriber numbers grew by 36% from the previous quarter, and more than tripled from last year, to 1.15 million.
For the Excite@Home press release and conference call replay information, please click here. We'll likely have more on the results in tomorrow's column, while the Excite@Home message board has much more in the immediate! And, by the way, the changing of positions for ATHM's CEO is not a big deal, in our opinion. It's not surprising and it may prove good for the company.
Following Excite@Home, eBay (Nasdaq: EBAY) announces quarterly results January 25, Starbucks (Nasdaq: SBUX) January 27, and Amazon February 2. Finally, today Celera (NYSE: CRA) announced a two-for-one stock split that will be distributed on February 18. Please see our FAQ on splits if you have questions about the practice of splitting stocks. It ain't like splitting atoms.
--Jeff Fischer, TMF Jeff on the message boards
Jeff Fischer (TMFFischer) is advisor at Motley Fool Pro and co-advisor at Motley Fool Options.
- Jan 20, 2000 at 12:00AM