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Is hubris hurting AOL Time Warner? In January, when the two finally tied the knot after a yearlong regulatory logjam, Chairman Stephen M. Case and CEO Gerald M. Levin proclaimed that the one-of-a-kind union of New and Old Media would usher in the Internet Century. Its dazzling services would combine AOL's powerful online franchise with Time Warner's venerable media brands. With no less bombast, the executives thumbed their noses at the weakening economy, vowing that the new entity would easily generate $40 billion in revenues and $11 billion in cash flow in its first year.
Eight months later, it's time for a reality check. With the slowdown in ad, subscription, movie, and music sales, Wall Street has knocked 20% off the stock since its recent high of $51 in May. On July 18 alone, investors pushed the stock down 10% in several hours after the company reported second-quarter revenues $500 million shy of analysts' estimates. But if the market is sending a message, no one at headquarters is heeding it. And that could have repercussions with a Street that is increasingly merciless when companies miss their numbers.
WHAT IF? AOL Time Warner Inc. still insists it will make good on its ambitious promises. But it remains bullheaded at its peril. Consider the worst-case scenario: By sticking to increasingly unrealistic targets, the company sees its vision of supersynergy fade in a haze of disappointing profit reports. Shareholders begin to see the marriage as just two companies clinging to each other to mask slowing sales, rather than as a match-up of winners. Expectations aren't managed, and a drop in stock price leads to the loss of the company's cachet and eventually higher costs to raise equity and debt. The result? AOL Time Warner loses the ability to invest in new technologies and make strategic acquisitions to fulfill its dreams.
Of course, AOL Time Warner is far from that scenario today. But investors are already scratching their heads over its self-stated goals. "The ramp-up to hit its numbers is just too high," says Ajay Mehra, a portfolio manager at Columbia Management, the unit of FleetBoston Financial Corp. that sold 2 million of its 6 million AOL shares in May. It wasn't alone: A handful of AOL's top brass also took the opportunity to sell high. Case, Co-Chief Operating Officers Richard D. Parsons and Robert W. Pittman, Executive Vice-President Kenneth B. Lerer, and Vice-Chairman Ted Turner sold off a total of nearly $60 million worth of AOL holdings, not including stock options they exercised, according to Securities & Exchange Commission filings. A spokesperson says the selling is part of their long-term financial planning.
Case and Levin concede they will come in a shade below their pledge of 12% to 15% revenue growth, at $40 billion. But they insist they'll meet the expected 30% growth in so-called EBITDA, or earnings before interest, taxes, depreciation, and amortization, by which media companies measure performance. Meanwhile, AOL Time Warner is making a mad dash to meet its targets. "We're on a maniacal path," says Pittman.
SQUEEZING BLOOD. On Aug. 21, the AOL division announced 1,700 layoffs on top of 2,400 job cuts already announced by the parent. Reaching for new revenue, AOL Time Warner is also launching a unit to offer ad clients one-stop shopping across print, TV, and the Internet. And it's creating an interactive arm that aims to cash in on video-on-demand and interactive TV if and when that market takes off.
But "they cannot squeeze more blood out of this stone," says Charles Crane, co-investment officer at Victory SBSF Capital Management, which holds 1.5 million AOL shares. True, AOL Time Warner, which generates about 25% of revenues from advertising, 40% from subscriptions, and 35% from content, such as box-office and music sales, is more diversified than many other media outfits. But every segment is now under attack. U.S. ad revenues are expected to decline 4% this year, according to The Myers Report media newsletter. Music sales could slump 5%, says Kagan Worldwide Media. And media merchant bank Veronis Suhler & Associates figures U.S. film box office sales may inch up only 2%, vs. 7.2% in 1999. Even subscriptions, AOL Time Warner's stalwart earner, may slow as the rate of new U.S. online subscribers levels out.
All this may remind investors that before merging, AOL and Time Warner were both slowing down in growth. AOL knew its astronomical gains couldn't last forever. Indeed, new AOL subscribers will grow by only 18% next year, vs. 23% this year, says Merrill Lynch & Co. And it doesn't help that Microsoft Corp. will be pushing the rival MSN online service with the fall release of its XP operating system. AOL's hookup with Time Warner helps hide those trends. "AOL ducked out of danger at the most incredibly opportune time," says Jupiter Media Metrix Inc. analyst Mark Mooradian.
LESS LEEWAY. For its part, Time Warner needed to boost anemic growth with high-performing acquisitions. After it bought Turner Broadcasting Systems in 1996, a $191 million net loss turned into profits of $246 million a year later. But the Turner channels CNN, TBS, TNT, and others are maturing, so Time Warner is betting on AOL for a shot in the arm.
Because perception is reality on Wall Street, any erosion of AOL Time Warner's go-go expectations could do real damage. If investors see a partnership of two slowing businesses instead of an Internet-media juggernaut, they are more likely to question management at every turn. The company will have less leeway to do the tough work of making convergence a reality. AOL Time Warner shouldn't squander the excitement generated in the first year of the merger with missteps on the Street.
Technology Writer Yang and Media Editor Lowry cover AOL Time Warner
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