"There's been a lot of swirl about the advertising market, particularly about the so-called dot-com shakeout. I want to separate the swirl from reality."With that, America Online (NYSE: AOL) Chairman and CEO Steve Case addressed the specter that's haunted Internet investing for most of this year. Case's comment came in the conference call following the release of AOL's first-quarter financial results last Wednesday.
With most of this year's news and commentary about AOL having focused on its pending merger with Time Warner (NYSE: TWX), the impact of the dot-com shakeout started coming forward only as the Q1 announcement approached. The company wasted no time Wednesday acknowledging the continuing market environment that has left many companies and investors feeling "discomfort and pain."
But while Case and other AOL execs mentioned this repeatedly throughout the call, their references were offered in contrast to the situation AOL believes it is in. If anything is certain, it's that those who find Case and Co. arrogant will not be dissuaded from their view.
Separating swirl from reality was Steve Case's way of separating his company from the rest of the industry for which it is seen as a bellwether. The growth in advertising of both AOL and Time Warner (which also reported its quarter on Wednesday) was right on target, Case said. The combined company will be "uniquely positioned with premium brands in the fastest-growing segments."
Flight to quality
Case then offered a key piece of the logic -- or perhaps the epitaph-cum-punchline -- that has driven shares of Internet companies to excess. "In fact, the current advertising environment benefits us because it will drive a flight to quality."
Later in the call, Case said again the situation should play out well and be "quite healthy and constructive, and ultimately good" for the company. The current environment will be a positive one for AOL, he said, and will present new opportunities for basic strategic alliances, investments, and "in some cases perhaps some additional acquisitions."
Indeed, "flight to quality" was one of the themes of AOL's conference call. Though some may blanch at the association of "quality" with a company still often called "the Internet on training wheels," here the word refers to scale, reach, and ability to leverage.
But, it also refers to the "last one standing" approach that will characterize the next phase in the settling of the online frontier, as land-grab survivors slog through and out of the puddled remains of the dot-com meltdown.
Un-swirled, but not unscathed
Even if the meltdown has left America Online un-swirled, it has not left the company's stock unscathed. It hit new 52-week lows in the days ahead of Wednesday's earnings announcement and traded down on Thursday.
If any one reason can be found for that, it was reaction to the company's Q1 advertising and commerce backlog -- revenue that has not yet been booked -- being flat with the previous quarter. This is an important indicator of the health of this part of the business, basically telling us how many nuts have been stored up for the winter.
In September, AOL's ad/commerce backlog stood at $3 billion, same as last June, when it was up from $2 billion in June 1999. A bad sign? Not necessarily.
It was reiterated during the conference call that the flat backlog reflected the changing profile of its client base, and how this was being managed through a mix of shorter- and longer-term deals.
AOL is dealing with the growing number of mainstream advertisers, and said that such deals have typically been of shorter duration. Average contract length has recently declined by a quarter, and is now about 2.5 years. This reflects the inherent leverage of these bigger companies, as does the fact that AOL takes in less upfront cash on these deals, all of which helped keep the backlog down.
Yet, AOL says this is a "conscious decision," giving it more flexibility and promising increasing revenues from faster, high-priced contract renewals with its best clients, for whom partnership with AOL and placement in front of AOL's audience is increasingly important. Mike Kelly, the company's chief financial officer, said he was "extremely confident about the quality and composition of the backlog," which, on the basis of overall quality, "has never been better."
This is an aspect of the "flight to quality" by companies looking to advertise and market online; such companies will "gravitate to the leaders," Case said. As Chief Operating Officer Bob Pittman said, the company has "never been keen on taking money from people who we think are going to give it to us one time and not have it later on," or work with companies whose business "can't be figured out on a piece of paper."
To hear AOL tell it, they've been preparing for this dry season, are not surprised by it, and are prepared to reap the benefits. Of course, you wouldn't expect them to say anything else. Still, whatever weaknesses can be found in the numbers from this difficult quarter don't persuasively argue against that view. The business dynamics that emerge from the company's conference call, and that can be glimpsed amid the ongoing swirl, tend to argue for the benefit of the doubt.