Shares of AOL Time Warner (NYSE: AOL) began this year at $34 and by the end of January reached $55. This portfolio was dancing in the streets.
For much of this summer the stock bounced around the high $40s, but in recent weeks the shares have tumbled faster than a gymnast, landing in the mid- to high-$30s. The tumbling stock follows the concern that management's $40 billion revenue goal for 2001 is too ambitious, especially because advertising sales remain weaker than hoped, and total sales grew just 3% last quarter.
On Tuesday, advertising research company CMR reported that all media advertising slumped 6% the first half of the year. That doesn't sound horrible, but it creates an extremely difficult environment in which to grow ad sales. Ad sales at the AOL service grew a robust 26% last quarter nonetheless, but AOL-TW's old media departments (Networks, Print) were flat to down. About the only way for the company to have grown ad sales in these mature markets was to grab market share. It didn't grab enough.
Fool writer Rick Munarriz and I recently battled the bull and bear arguments for AOL Time Warner in a Dueling Fools. And Friday David Gardner questioned the company's synergies and predicted that it would sell or spin-off several businesses in the next few years.
I'll add to that: If AOL Time Warner doesn't eventually free itself of underperforming, slow-growth divisions, it could ultimately risk a hamstrung stock price for an extended time, just as slow-growth, debt-heavy brother Disney (NYSE: DIS) has.
Why? Because in some eyes you're only as strong as your weakest link, and collective Wall Street, when being the cynic, loves to focus on negatives. For example, if one quarter AOL Time Warner sees a strong showing from its movie division, its magazine division might be soggy, and cynics can print that. If the company's cable division lines up a home run, its music division might fall flat, and cynics can play that whine. With a media giant operating in half a dozen businesses, there is almost always something to complain about. AOL Time Warner will almost never be "perfect."
But what was the alternative?
In a way, simplicity was part of the beauty behind AOL circa 1998, 1999. It basically had just two businesses, subscriptions and advertising, and both were growing rapidly. That said, I was in favor of the Time Warner merger from the early going, unlike David, partly because I believed that AOL's best growth days were receding behind it. Subscription growth would slow, and advertising, as we've since seen, would fall from triple-digit growth to 26% growth. So, where would that have left the company when on its own?
Well, sans Time Warner, AOL could have sold real estate to content providers, who would then be responsible for earning their own advertising revenue, but that wasn't likely to be a long-growing business despite its high margins. Plus, the deep-pocketed content providers such as Time Warner could put up their own websites and use existing brand power to make their sites worthwhile.
Or, AOL Time Warner could have set up partnerships for content with a company like Time Warner, but in this environment I believe AOL would eventually be in a position of weakness, relegated to sharing some ad dollars, which may not amount to much. Finally, AOL didn't offer cable access until merging with Time Warner. We haven't seen the benefits that should result from AOL over cable, but over the years, we should.
So, all in all, I'm still in favor of the new company, partly because I believe that AOL had to move forward in late 1999 and early 2000, just when everyone else was confident that the Internet alone would rule forever. Plus, with just a modest upturn in the advertising market (some predict one next year, for what it's worth), AOL Time Warner's stock should come to life again.
2001 goals not so out of reach?
As for the present, management has said that it should still make its 2001 goals. It appears they could, although most analysts are skeptical. (Why do we collectively listen to them anyway, though, given their track records?) After six months, the company has $18.2 billion in sales toward its $40 billion goal, so it's nearly halfway there; it has $4.7 billion in EBITDA toward its $11 billion goal, so it's 42% there going into the strong half of the year; finally, free cash flow is already 66% of the way to the $1.8 billion goal, so the company could surpass that goal with ease.
Given this agreeable performance during the weak part of the year, the falling share price is baffling until you consider that most people are expecting the second half to be about as weak as the first, rather than accelerating as it normally does, with the fourth quarter sometimes amounting to as much as 35% of a year's income. Expecting a weak second half, skeptics estimate that AOL will miss its goals. I'm still in the small, quiet camp that thinks the company could pull it off, though, as I argued in Dueling Fools. And if it does make its goals, even by the slimmest margins, the stock could be back into the $50s, up handsomely from its 2001 start.
That's just one Fool's opinion. Visit the AOL board for many more and to share yours.