Post of the Day
December 27, 1999

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America Online

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Subject:  Can There Even Be an AOL/ATHM Deal?
Author:  jandras

This may repeat much of what's already been said, but here goes...

I'd like to see a deal between AOL and ATHM (I own both). Unfortunately, I don't believe that it will happen anytime soon because I believe neither company's present needs can fulfilled by the other's present offerings.

ATHM Needs Line-Shortening Solutions, Not Just More Subs in Line:

The usual argument is: ATHM needs more subs. AOL has lots of subs. So, ATHM needs AOL. This deduction is flawed. It assumes that ATHM would sign up more subs per unit of time if only it would join ranks with AOL to increase the demand. It ignores the fact that ATHM's signup rate is naturally limited by plant upgrades and by installation bottlenecks. The length of the lines that are driven by the already ongoing demand, therefore, is more than enough to satisfy ATHM's present rate of consumption, now and for the foreseeable future.

ATHM is already growing its subs as fast as it possibly can, all by itself and without any sort of AOL partnering. What ATHM needs to do is solve the bottlenecks in its upgrading and installation processes, i.e. to increase the rate at which ATHM can provide access to the people (including many AOL subs I'm sure) who are already waiting in line.

Unfortunately for any possible deal, therefore, AOL's subs do not have any intrinsic worth to ATHM. Simply put, even if they made an earth-shaking deal this month, ATHM couldn't even begin to absorb a large percentage of AOL's customers next month.

ATHM's problem is the length of its existing lines, not the lack of lines altogether. The solutions are supposedly arriving as we speak in the form of "self-install" cable modems (so-called DOCSIS modems). Maybe these new modems will reduce the length of ATHM's lines, and thereby change ATHM's viewpoint on "needing" AOL's subs.

ATHM has another reason to reject any AOL offer to buy connectivity - the development of its own content.

In particular, ATHM is trying to develop compelling broadband content to draw and retain customers that can be used to generate secondary ad revenue. Frankly, I'm not yet impressed with any visible outcome of that effort, but allowing a third-party like AOL to prematurely divert what would otherwise be @home customers, before they've even had the opportunity to view @home's content, would be completely antithetical to @home's long-term effort to leverage a content offering out of its exclusive contracts and overall first mover advantage on cable connectivity. An AOL deal, it could be argued, would quite literally stunt ATHM's long-term content growth over what it could be without AOL.

For all of these reasons, AOL will have to offer something that ATHM can't get on its own. That something, however, isn't just more subs and simple subscription dollars, especially if its merely wholesale dollars that short-circuit @home's ability to leverage additional revenue out of its own broadband content.

ATHM doesn't presently need what AOL is presently willing to offer.

AOL Needs to Sell Connectivity, Not Just Content Over Foreign Carriage

AOL needs to provide cable connectivity where AOL, and AOL alone, generates the bill. AOL must acquire the sole billing position with its customers. AOL cannot tolerate a two-bill situation. If the customer gets one bill for cable connectivity and one for BYOA access to AOL's content, it will glaringly underscore the cost of AOL's content relative to what is available for free. Moreover, even if he sticks around, the BYOA customer will less frequently use AOL's proprietary browser and become less valuable in terms of generating secondary advertising revenue. If you don't believe this, ask yourself why AOL is concerned about "open access" when it only leases connectivity and when it can already price its content to sell on a BYOA basis.

Unless it migrates its content toward a free to all, Yahoo-like portal, AOL must inextricably intertwine connect and connectivity under one, price-competitive bill. The Yahoo-like option is interesting to think about, but it would constitute a fundamental change in AOL's business. AOL must successfully execute the one-bill option in order to support today's market valuation of its stock. AOL needs cable connectivity that it can bundle with content and then resell as one package.

The deal-making environment is complicated because ATHM doesn't pay the cable partners for access. It's the other way around (making me laugh when I hear an open access advocate say that AOL is "willing to pay what ATHM pays."). A typical cable customer pays $29.95 per month for connectivity. That sum is billed and collected by the cable partner, not by ATHM. The cable partner keeps sixty?five percent ($19.47) and pays ATHM with the other thirty-five percent ($10.48). In essence, the cable company pays ATHM for a service that it resells to its own customers.

AOL simply wants to pay somebody, anybody, for wholesale access to cable connectivity. AOL could care less if it pays the cable partners, or ATHM, or both - as long as it gets connectivity at a wholesale price and the right to resell that connectivity in combination with AOL content.

Under their contracts with ATHM, however, the cable companies cannot let anybody but ATHM enable high-speed internet access over the cable lines until June 4, 2002. If AOL is to make some sort of deal that gets it cable before mid-2002, therefore, the deal with have to involve ATHM. It is also likely that ATHM will be involved in any deal that might be reached for carriage after 2002 because: (1) ATHM already provides the back-bone connectivity to the cable "head ends"; and (2) the cable partners own major stakes in ATHM that they cannot sell, even if they wanted to, until after mid 2003.

ATHM is already willing to provide internet carriage to AOL's BYOA subs in that an @home sub can go absolutely anywhere he wants and he can use the AOL software over the @home link. In other words, the @home sub already has "open access" as @home likes to define the term. AOL, however, needs to bundle connectivity and content. AOL needs a complete billing relationship with its future cable subs, not more BYOA customers that are just as likely to go as they are to come. ATHM will gladly let a BYOA customer get to AOL.

AOL doesn't presently need what ATHM is presently willing to offer.

Conclusion

Where does AOL fit in? Who does AOL deal with? If the deal let AOL directly bill its own subscribers the same $29.95 per month now charged by the cable company, such deal would require ATHM, or its cable partner, or both, to get less. How much does AOL keep? How much does ATHM get? How much does the cable company get?

In fact, If you're ATHM or the cable partner, what can AOL offer you that would make you take less money per month for a sub you could get without AOL, while simultaneously losing secondary ad revenue from that sub? I can't think of anything. Absent some monumental merger, therefore, AOL will need to negotiate a secondary revenue share before ATHM and its cable partners will even begin to consider a deal.

ATHM want to sell "open access" of the go-wherever-you-want BYOA variety. It doesn't want to take less money. It doesn't want to foreclose content-related revenues. Unfortunately for ATHM, AOL isn't buying what it's selling.

AOL wants to "sell" its subs. It doesn't want to pay for connectivity through revenue sharing. Unfortunately for AOL, ATHM isn't buying what it's selling.

Just my thoughts... Maybe I'm just too near sighted to see a creative deal that accounts for the future that all companies might agree is likely. Maybe there's some monumental merger in the works that would satisfy the needs of all concerned by such a merger. Shouldn't it be reasonably obvious though?

Happy holidays!

Regards,

Joe (jandras)

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