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Time To Offload America Online?


During the first week of April, Time Warner Inc. (TWX) CEO Richard D. Parsons will pack up his office in Manhattan's Rockefeller Center and move north to towering new headquarters near Central Park. But no matter what his locale, Parsons can't escape one persistent question: What should he do with America Online?

After two years at the helm, Parsons may finally be closing in on an answer. A pair of federal probes into AOL's accounting may be wrapped up later this year, according to a source close to the investigations. That would lift a cloud from the troubled online unit. So the timing couldn't be better for Parsons' recent meetings with investment bankers to explore his options: Seek a buyer, spin AOL off to shareholders, or continue making the best of a flawed enterprise.

The key question: What is AOL now worth? Remember, this is a company the market valued at a frothy $170 billion in January, 2000, just before it announced its merger with Time Warner. But in the depths of AOL's accounting scandal, some analysts assigned the unit a zero value -- or even figured it was a negative, pulling down Time Warner's overall market capitalization. AOL has watched helplessly while customers bolted: It lost 5 million worldwide subscribers in 2003, dropping the total to 30 million. Advertisers fled and revenues slid from $9 billion in 2002 to $8.6 billion last year.

But AOL is still making money on its two main lines of business: Internet subscriptions and Web ads. And it throws off $1 billion a year in cash, one-fifth of Time Warner's free cash flow. So analysts, investment bankers, and private equity investors figure AOL could be worth between $8 billion and $12 billion. BusinessWeek, using an estimate of AOL's 2004 earnings before interest, taxes, depreciation, and amortization (EBITDA), calculates an equity value of $10.6 billion for the unit. Given AOL's problems, a buyer would probably pay smaller multiples of EBITDA for AOL than for such competitors as EarthLink and Yahoo!. AOL's value is also reduced by the $2.3 billion in debt Time Warner assigns to the unit.

Cashing out that value isn't something Parsons can do right now. As long as the Securities & Exchange Commission and Justice Dept. are investigating, Time Warner is stuck with AOL. Even private equity firms aren't likely to touch the unit, analysts say, and the SEC probably wouldn't let Time Warner register a new class of stock to spin AOL off to shareholders. "The SEC investigation is a gating factor," says former Federal Communications Commission Chairman William E. Kennard, now a managing director at Carlyle Group, a private equity outfit.

BITTER INVESTORS. But once the investigations are resolved, Time Warner will have a green light to sell if it wants. Extracting AOL from Time Warner certainly would lift a burden from the company, especially among bitter investors who still blame AOL for one of the worst mergers ever. What's more, AOL's profit margins are smaller than average for Time Warner businesses. So losing AOL would give Time Warner's stock a nice bounce: Merrill Lynch & Co. (MER) analysts figure it might trade at 12.8 times EBITDA, lifting its multiple two points.

Company executives refuse to comment on AOL'S future. But insiders say analysts' valuations are too low and miss some promising signs of growth in ad revenues and broadband subscriptions. Merrill Lynch & Co. (MER) projects that advertising sales will grow 13% this year, to $886 million, helped by so-called sponsored searches. It also predicts that AOL will add 400,000 broadband customers in the first quarter, hitting 3.2 million. First-quarter results will be announced on Apr. 28.

In any case, Parsons can afford to wait. For the first time since he became CEO, Time Warner has a relatively healthy balance sheet. He has pared debt by about $10 billion from what was once a crushing $30 billion. "He doesn't have a gun to his head," says one investment banker, "so why sell now if he's in the midst of addressing operational issues?"

In an odd way, the SEC and Justice may be doing Parsons a favor by giving him time to make a decision. Whether AOL can show real strength in the coming quarters will go a long way toward determining whether it stays or goes. By Tom Lowry in New York and Catherine Yang, with Amy Borrus in Washington


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