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AOL - One Of The Only REAL Internet Businesses

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By dvdguruisme
March 9, 2001

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How many times has the world said AOL was going to the grave? I remember back in 1996 when huge growth, poor customer service, and endless busy signals from an exploding Internet were choking AOL to death. The stock plunged and the vultures circled. I was convinced that AOL was doomed, and they escaped the jaws of death.

Then came free ISPs. This was going to be the next death of AOL. Free ISPs would capture demographic information and through a bar on the screen rotate banner ads to make their revenue. Surely people wouldn't mind the ads. Others, like Alta Vista, banked on the users of the free ISP to also use their portal services, many of which have fees paid by the partners as well as media and advertising deals.

However it was all flawed and yesterday we saw banner ads as a business model take its death kneel and a final bow. The party is over -- their ain't no more gold in them thar hills. When you compare AOL to YHOO, AMZN, RNWK and EBAY for the last year, the chart says it all.

Why did free ISP's die? Because banner ads don't work -- the whole business model is flawed. If you do the math it becomes so clear. For example:

For banner ads at $25 CPM, 1,000 ads with a 1.5% click through rate (industry average) = 15 clicks per thousand.

For 100 click-throughs, 2 to 3 will actually buy something (this is also industry average).

That means you have to run about 2,100 impressions (assuming 3 per 100 click-throughs buy something) before receiving a sale.

2,100 X $25 CPM = $52.50

Even if you drop the CPM to $10, your average sale needs to be $210 to cover the costs. $5 CPM, $105. It doesn't start working until you hit $2 CPM, when the average sale needs to be $42.  [Here is a different view from curtiswiggins.]

If you're building brand and don't care about revenue that's fine. But a lot of the dot-gones (think Pets.Com) didn't have the bank accounts of McDonalds -- building brand was a farce, they needed to be building revenue, not paying the likes of Yahoo! $100 for CPM (their maximum rate during the height of Babylon).

So a lot of folks in the world expected AOL to die, and gasp, "Who would keep paying for terrible service and occasional busy signals when you can get better for free?" But here is the GENIUS of how AOL works and makes its money. I know today they said they have 28 million subscribers -- but my math is based off of their old data with 27 million so hang in there:

AOL with 27 million subscribers is bringing down $440 million dollars EACH MONTH. That's before advertising, before partnerships, before placement fees, before e-commerce, before technology deals -- that is pure revenue from subscriptions. When you look at it that way, it starts to become clear that AOL actually has a lot of common with it pretty bride, Time/Warner. So as banner ads died, the free ISPs died with them -- and AOL just kept growing.

And in there lies the other bit of genius. Either Steve Case is one of the brightest businessmen in the world today, or he sold his soul to the devil in exchange for financial success. BEFORE the bubble burst, before the stock value plunged, he made the move and pulled off the coup of 1999 buying Time/Warner. In doing this he elevated his ISP/Portal to media giant status, has an endless supply of "free" content for his web portal (free in the sense that it is all internal accounting), and can drive and extend his powerful brands across the entire media network. Total genius.

Yahoo! had the same opportunity, but didn't budge. CMGI's Alta Vista had the same opportunity, but didn't budge. Even Lycos could have pulled something off, but no dice. They wanted to stay independent; they didn't feel the time was right. Well, now the vultures are circling and it's all too late.

So what's going to happen? Yahoo! is in far worse shape then they are telling. Sure they expect to do $170 to $180 million this quarter, but $117 million of that is DEFERRED income from 2000! That is over 70% of the revenue. To make matters worse YHOO insiders are saying they have almost nothing sold so far this year -- that deferred income will continue to dry up with nothing left.

Alta Vista is already plunging into obscurity. They've done two rounds of layoffs, ended almost all of their portal features, and gone back to the basics. All the while they neglected their core business, the search engine technology they license and the quality of their meta data in their search engine.

Disney is shooting Go in the head. The pretty redheaded Ingrid isn't going to save NBCi, regardless of how many ads they run on Must-See-TV. The only thing keeping MSN afloat is the BILLIONS of dollars Microsoft has. If they didn't have the money and the muscle, they would be in the same boat as the other major portals/ISP's.

So where will all this end? AOL is clearly Tarzan, King of the Internet Jungle. A jungle that is getting clear-cut faster than a Brazilian rainforest. MSN from Microsoft will continue to be number two. Netscape Netcenter will grow in strength, largely due to the fact it is owned by AOL. Yahoo! will be bought out or merge with someone for survival before the end of 2001. CMGI will continue to bleed to death at an alarming rate, and Alta Vista may get sold off yet again, or simply get sucked down a black hole. We already know the fate of Go -- and I see NBCi facing a similar fate before the end of 2001. By the end of this year it's going to come down to:

AOL
MSN
Netscape
Google

So I raise a glass to Steve Case and AOL -- they have proved me wrong once in 1996, and I was VERY fortunate to get in on the big dip prior to their last split and the Time/Warner merger, and to buy in below 90. It has been one of my only bright spots in my portfolio for 2000 and early 2001. Here's to AOL: one of a handful of REAL businesses on the web!