AOL Time Warner's Secret: Subscriptions


By David Shook With its combination of Internet and media businesses, you'd think AOL Time Warner (AOL) shares would have been decimated in the wake of September 11. After all, media and Internet stocks in general have been pummeled this year as the advertising market has all but dried up. Even AOL conceded on Sept. 24 that it couldn't adhere to earlier earnings guidance for 2001.

Surprisingly, however, AOL stock is holding its own. At $33 per share, it's trading at about where it began the year, while rivals' stocks are down 30% to 40%. AOL maintains this market premium over virtually every one of its peers in media and cable. For instance, Viacom (VIA), which grabs nearly 50% of its sales from advertising, has seen its stock plunge 23% since Jan. 1, closing on Oct. 9 at $33.60.

"BEST POSITIONED." Likewise, Walt Disney (DIS) -- with theme-park and ad revenues both sagging -- is down 37%, ending trading on Oct. 9 at $19.10. "Does AOL deserve a premium? Yes," says John Corcoran, Internet analyst for CIBC World Markets. Adds Spencer Wang of ABN Amro: "We still think it's the best positioned media company."

Indeed, many analysts believe strong subscription growth will continue to give AOL a big advantage over other diversified media companies -- especially in a down market. That makes it one stock that smart investors will want to keep an eye on. AOL's revenues are divided into subscriptions, advertising, and content. But subscriptions -- most importantly from Time Warner Cable and America Online -- account for about half of sales and are considered to be more recession-resistant than advertising, which accounts for only 24% of sales. Music, movies, books, and TV programming make up the rest of AOL's revenue.

Analysts believe AOL can continue to boost subscriptions even as the economy slows dramatically. When the company reports its third-quarter earnings on Oct. 17, "subscriptions are the number to watch," says analyst Youssef H. Squali, at First Albany. Squali figures total subscriptions should reach $4.45 billion, up from $3.7 billion in last year's third quarter. With a decent fourth quarter, total subscription sales should jump 15%, to $17 billion, for the full year, he estimates.

PROVING IMMUNE. The way Squali figures it: Driven by higher subscriptions, overall revenue growth from America Online and Time Warner Cable is expected to increase by 15% to 18% next year, vs. single-digit growth for the company's other units, which include the WB network and Warner Bros. Music. "For every new dollar in revenue and operating income that comes into AOL, 70 cents of it comes from America Online or Time Warner Cable," Squali says.

A big reason AOL is proving so immune to recession is new technology. Despite the slowing economy, the company has raised monthly charges for America Online, cable-modem service, and digital cable TV in recent months. It now brings in about $51 per month per broadband subscriber, vs. about $25 for a typical non-broadband subscriber.

Meanwhile, in the second quarter alone, the company added 373,000 new digital-cable subscribers and 226,000 new Time Warner cable-modem users, while also boosting American Online membership by more than 1 million, to 31 million total. In the past year, America Online has added 7 million new members, about equal to the entire subscriber base of rival Microsoft's MSN service.

CROSS-MARKETING PROWESS. How can Time Warner Cable and America Online maintain such robust growth? The two are finally integrating -- almost a year after AOL bought Time Warner -- and the potential for cross-marketing among the various businesses is huge. In cyberspace, the company is offering subscription discounts for Time, Sports Illustrated, and other magazines to AOL members, while marketing online membership via CNN and other Time properties.

And that may be only the beginning of the cross-selling. For instance, beginning this fall in four U.S. cities -- Raleigh, N.C.; Columbus, Ohio; Tampa; and Syracuse, N.Y. -- customers can buy a speedy, broadband version of AOL's monthly service over Time Warner cable pipes for the first time. The service will be rolled out in several other cities next year, a company spokesman says.

Meanwhile, AOL is putting major marketing clout behind AOL 7.0, the latest version of America Online's software. It offers few improvements over its most recent predecessor, but such campaigns tend to generate hundreds of thousands of new subscriber sign-ups, analysts say. Then there's overseas growth. AOL Europe and AOL Latin America now have more than 6.6 million members in all. The company spokesman says these divisions are likely to remain two of the company's fastest growing divisions.

CASH FROM OPERATIONS. Such continuing subscriber growth is the major reason investors are willing to overlook the vats of red ink the company continues to spill. In the third quarter, AOL is expected to lose $841 million, or 19 cents a share, on revenues of $9.25 billion, vs. a loss of $905 million on sales of $8.76 billion a year ago. The losses are due to goodwill write-offs of more than $1.6 billion each quarter related to the Time Warner merger.

Many investors, however, pay a lot more attention to the company's rapidly increasing operating earnings, which it projects will be up 12% to 15% next year, vs. this year's estimated $10 billion. Rivals such as Comcast (CMCSA), Disney, and Viacom can't come close to that figure, analysts say.

Of course, the recession could bite deeper than analysts expect if cash-strapped consumers start canceling their subscriptions to magazines and movie channels in order to conserve cash. In fact, a recent story on tips for saving money during a recession on America Online's personal finance channel suggested just that: Canceling subscriptions is one good way to conserve cash.

All in all, it may be the only big risk for AOL right now. Eventually, its Time Inc. unit is likely to see some declines in magazine sales as consumers begin to look for ways to economize. "That's inevitable in a recession," says Jordan Rohan, analyst for Soundview Technology Group. But the strength of AOL and cable probably will offset that. As long as subscribers don't get too jittery, AOL seems certain to continue outperforming its rivals. Shook covers the markets from New York


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