A Hard Corner for AOL to Turn


By Catherine Yang In the new year, Time Warner CEO Richard D. Parsons says he has resolved to reverse the fortunes of his beleaguered AOL division. When Parsons announces Time Warner's 2003 yearend results on Jan. 28, he'll likely vow that AOL will return to double-digit growth in earnings in 2004 -- aided by a revival of the online ad business.

Sounds like great news for investors betting on a turnaround of the world's leading Internet service provider. But those who might be considering diving back into Time Warner stock (TWX) still have a few hazards to contemplate.

True, Wall Street expects Time Warner, which dropped AOL from its corporate name last year, to score a 10% increase in earnings, to about $9.8 billion this year. After all, its cable, magazine, and online units are poised for takeoff with an advertising recovery. But AOL, which contributes about 20% of Time Warner's revenues and 15% of earnings (measured as OIBDA, operating income before depreciation and amortization), isn't out of the woods yet.

UNCERTAIN SUBS. For one thing, Time Warner stock, trading at around $18.50 as of Jan. 15, likely won't spring much higher until after the U.S. Securities & Exchange Commission completes its accounting investigation of the AOL unit. Time Warner says it's cooperating with the probe.

The stock has been trading above its lows of the past 12 months. But investors should be training a keen eye on AOL's uncertain susbcription business. The heart of AOL has always been online subscriptions, which made up 90% of revenues last year. Parsons' big chore is to stanch the larger-than-expected member defections plaguing AOL since 2003.

Chances are, he -- and investors -- won't know if the division's newly launched broadband and discount ISP services will do the trick for another 12 months. That's why some Wall Street analysts are projecting AOL's earnings growth at only about 6% this year, compared with Parson's headier goal of 10% for 2004.

ONE YEAR LATE. That's still a respectable improvement for AOL, after the unrelenting bad news of the past three years. And the future is looking less bleak than it has for some time. AOL's ad revenues dropped 67%, from $2.3 billion in 2001 to an expected $750 million last year, as the unit ran off its multiyear dotcom-era ad deals. Now, as the online ad business is expected to grow 20% this year, according to Jupiter Research, AOL is poised for a recovery.

Its 2004 ad revenues could grow 7%, to $810 million, says Richard Greenfield, Internet analyst at Fulchrum Global Partners. Leading AOL's upswing should be the cash it gets from partner Google for popular paid search advertising.

Still, competitors already have an edge on AOL in this department. Yahoo! (YHOO) more than doubled its 2003 profits of $238 million from the previous year, largely due to an 84% surge in ad revenues, to $1.2 billion (see BW Online, 1/15/04, "Yahoo: Still an Online Ad Play"). Fact is, with the cushion from its boom-era ad contracts, AOL slid into the online-ad trough about a year later than rivals -- and will climb out a year later, too.

AD CHIEF NO. 3. What's more, AOL has special challenges ahead in regaining the trust of advertisers after throwing its weight around during the Net heyday. "AOL is making strides toward being more advertiser-friendly," says Jim Warner, president of New York-based Avenue A, a large online media buyer. "But they're not all the way there."

On Jan. 14, AOL announced its third new ad chief in 12 months -- Time Inc. veteran Michael Kelly. He faces a mandate to put search, commerce, and ad sales under one umbrella and to sell across all of AOL's brands -- including the flagship AOL subscriptions, broadband, and services aimed at kids, teens, and Hispanics. AOL declined comment in advance of its earning announcement on Jan. 28.

On the subscription side of the business, prospects are problematic. AOL's Europe operations will swing into the black this year, aided by favorable exchange rates. But back on home turf, AOL is expected to announce that it lost about 2 million of its U.S. dial-up subscribers to broadband and low-cost dial-up competitors in the last half of 2003. Analyst Greenfield expects that trend to continue, with about 4 million dial-up defections this year, shrinking the U.S. service to 20 million members from a peak of 26.5 million in 2002.

HIGH-SPEED SPRINT. AOL's plan to fight back is yet unproven. Last spring, it launched a bring-your-own-access broadband service to retain subscribers leaving for high-speed providers. For $14.95 a month, members can get the AOL service on top of broadband access they purchase elsewhere. While AOL added a promising 340,000 new broadband accounts in last year's third quarter, the business is unlikely to grow fast enough to overtake dial-up defections this year.

Greenfield projects maybe 2 million new broadband signups in 2004. Meanwhile, AOL just debuted a $9.95-a-month Netscape dial-up ISP to compete against discounters such as United Online (UNTD).

Any light peeking out from the clouds is good news for AOL these days. In 2004, investors might see some reward when online ads take off again. But beyond that, they can expect partly cloudy skies for a while longer. Yang covers AOL from BusinessWeek's Washington bureau


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