'AOL Has to Do Something Quickly'
Passing on MediaOne could hurt its Internet-access push

For America Online Inc., the nation's premiere online service, the coming era of broadband communications represents both a fantastic opportunity--and a grave risk. If it can gain access to high-speed broadband lines, it can start offering all sorts of new digital fare. On the other hand, if it can't move to broadband ahead of competitors, it could start losing the 17 million customers who for now are willing to put up with poky dial-up connections and conventional online fare.

That's why AOL's CEO, Stephen M. Case, pounced when he saw that AT&T (T) was trying to trump Comcast Corp.'s bid for MediaOne Group (UMG), an Englewood (Colo.) cable operator. By teaming up with Comcast (CMCSA) in a sweetened counter-offer, the online service could get a toehold in the cable industry. But AOL got cold feet and backed out even before AT&T clinched the MediaOne deal. That sent AOL's stock tumbling 4.5%, to $127 1/8 on May 4 before recovering slightly on May 5. ''This is a blow to them,'' says Michele Pelino, an Internet analyst at Yankee Group. Adds Miran Chun of ZD Infobeads, another market researcher: ''AOL has to do something quickly. You can't be a laggard in this space.''

''INFLATED PRICE.'' Suddenly, the holes in AOL's strategy are out in the open. Without a cable deal, AOL (AOL) is in danger of being late to the broadband future. For now, it will rely on local phone companies to supply high-speed links through their digital subscriber line (DSL) technology. But that technology isn't nearly as widespread as cable modems, which are available to some 10% of cable subscribers. And it doesn't look as if DSL will catch up soon: According to Yankee Group, there will be some 4.3 million cable-modem subscribers in 2002, vs. 2.7 million DSL users.

AOL President Robert W. Pittman says the company backed out because it wouldn't have been able to generate adequate returns from its investment. ''We weren't willing to pay an inflated price,'' he says. But analysts say AOL--with just $2.7 billion in cash reserves--did not have the wherewithal to take on AT&T, which has inked a cash and stock deal. ''They didn't have the bargaining power to be a dominant force in these negotiations,'' says Abhi Chaki, a broadband analyst at Jupiter Communications.

AOL insists that its current plan to pave the way for high-speed access is working. It has already teamed up with Bell Atlantic Corp. (BEL) and SBC Communications Corp. (SBC). And Pittman argues that since the Bells and the cable companies are selling their services in the same markets, it won't matter to the consumer who provides their speedy access. More deals will be announced with Baby Bells in the next few months.

But the cable route to broadband service has more advantages than simply a headstart. Internet-over-cable service costs about $40 a month, vs. $50 to $60 for the Bells' DSL service. If it takes too long for AOL to jump on the cable bandwagon, ''their opportunity to capitalize on their brand may have gone,'' says Chaki.

And, until it nails a cable deal, AOL may be stuck with a huge disadvantage: The companies that offer cable modems usually bundle them with a service such as Road Runner or At Home. Customers who want AOL, too, now have to pay a monthly fee on top of that. AOL is pushing Washington to force cable companies to provide equal access to high-speed lines, and Representatives Bob Goodlatte (R-Va.) and Rick Boucher (D-Va.) were set to introduce such a bill on May 6.

AOL does have one compelling advantage: 17 million subscribers. ''AOL is still in a good position to find broadband distribution over cable,'' says Cynthia Brumfield, president of Broadband Intelligence Inc. ''Any cable operator would be thrilled to offer AOL service through its pipes.'' But for now, with AOL dealt out of cable, that thrill is gone.

By Catherine Yang in Washington, with Heather Green in New York and Andy Reinhardt in Silicon Valley

To read a letter to the editor about this story, click here.

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AT&T: What Victory Means

TABLE: The AT&T Deal for MediaOne

PHOTO: C. Michael Armstrong

The Man Behind AT&T's Coup

TABLE: The Hostetter Saga

``AOL Has to Do Something Quickly''

TABLE: How AOL Plans to Fight Back

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