Open access will help AOL Time Warner

Jun 4, 2001  •  Post A Comment

America Online gave new meaning to the term “owning the customer” with the announced 9 percent increase in its monthly subscriber fee-a move that has some interesting implications for cable systems’ open access to competing Internet service providers.
The move arguably isn’t much different than newspapers or magazines raising their per-issue prices or cable operators hiking their monthly subscription rates.
But AOL already has demonstrated that once it has a “customer” in its grip, it will relentlessly try to sell or cross-promote every service and product it can.
AOL can pursue unilateral price increases supported by a layer of new services without regulatory approval. What’s more, its online subscription service-especially on a broadband platform-will be a powerful springboard to other revenue-generating opportunities over which it exercises similar control.
Even Microsoft Corp., seeing the value of a subscription model, has said it is moving to a subscription-based fee for its popular products and services to ensure a steady stream of new revenues, especially from upgrades such as its new Office XP, announced last week.
Microsoft has lost no time pursuing AOL subscribers with a $50 million “switcher” ad campaign seeking converts (at a guaranteed $21.95 a month) to its MSN Internet service, which ranks second behind AOL with 5 million members. The Microsoft move offers a brief glimpse of the heated ISP competition ahead.
AOL Time Warner executives have maintained since their historic merger in January that they do not need to raise AOL’s online subscriber fee to meet the company’s lofty overall financial targets for the year.
But being able to generate $500 million more in revenues and earnings over the next year by raising its fee to $23.90 a month effective July 1, provides a nice cushion in a year when advertising spending and consumer spending are way off.
AOL Time Warner is the only one of its media peers that has had the flexibility and ability to respond to a weak marketplace with such a fast, assured way of accelerating one of its many core revenue streams.
That is possible largely because AOL “owns the customer”-a concept that has dominated the issue of cable open access, where it may now have even more profound implications. With multiple Internet service provider offerings set to move from trials to the broad marketplace later this year, some analysts are questioning whether this often overlooked and misunderstood negotiating point could turn out to be one of the more valuable long-term aspects of such alliances.
A plus for cable
Even with what generally could be a 15 percent to 25 percent revenue split to ISPs, open access is expected to be positive for cable operators, as it will accelerate data deployments and revenue growth-and lead to higher data margins.
Analysts are guessing that cable operators generally will maintain control of the customer when opening their two-way plant to multiple Internet service providers who, in turn, can bring broadband access to their customers. In that case, billing, customer service, capital expenditures and customer deployment remain the domain of the cable operator.
In exchange for access, there is expected to be some mix of service, e-commerce and advertising revenue sharing.
The notable exception will be AOL, where billing and customer care will reside with whichever entity-the cable operator or AOL-brings in the data customer.
Broadband access should give AOL higher margins, lower churn and increased usage, and AOL should use the broadband pipe to develop new value-added subscription services and revenue streams in a continuing effort to build out its AOL Anywhere platforms.
Those new high-margin broadband services, not viable on narrowband connections, could include streaming video, interactive games and music downloading.
Analysts point out that broadband will provide a more robust advertising platform that will support pricing premiums-not only with advertisers but also with subscribers. The rollout of any such extended services on its digital subscriber line, satellite or even the stand-alone AOL TV platforms would be slow or troublesome.
So it’s little wonder that AOL Time Warner, which resists giving up any ground for any reason any time, only flinched a bit when federal regulators deemed that AOL must hold Time Warner’s Road Runner (the second-largest broadband service with 1 million subscribers) separate from the AOL services, as well as avoid such joint activities as cross-promotion and marketing, in order to give competing ISPs a break. Under the terms of a consent decree, Time Warner Cable, among other things, must offer its subscribers EarthLink and one other competing ISP before it can begin offering AOL later this year.
Not surprisingly, the trials to date have been conducted by the largest cable operators-Time Warner, Cox Communications, Comcast Corp. and AT&T Corp.-which offer either Road Runner or Excite@Home to provide content, connectivity and backbone high-speed data services in exchange for a one-third service revenue split.
In any case, Merrill Lynch analyst Jessica Reif Cohen said open access will bolster broadband deployments by all cable operators and likely boost cable valuations by at least half a multiple point.
Ms. Cohen estimates total high-speed data service revenues will grow from $2.6 billion this year to $14.4 billion by 2010, spurred in part by linking more customers to broadband high-speed data through competing ISPs.
However, AOL Time Warner, which appeared to initially balk at the notion of giving competing ISPs equal access to its cable subscribers, likely will be the single biggest beneficiary of the mandated practice simply because of its unique position as the dominant Internet service provider and the nation’s second-largest cable operator.
Forfeits and tradeoffs
Late last year, Bear Stearns analyst Ray Katz predicted Time Warner Cable could forfeit as much as $1 billion in net present value as a result of open access provisions and deals such as the EarthLink pact. However, those losses might be largely offset by the increased distribution and subscriber base AOL gains through its open access agreements with other cable operators.
“The tradeoff may be best thought of as increased affiliate compensation for the next five years, or buying distribution at an average annual rate of $300 million,” Mr. Katz wrote in an open-access analysis to clients. “If the broadcast network analogy holds, and ubiquity is obtained for the online service, we would argue that it might be well worth it.”
Using the AOL Time Warner_/EarthLink deal as a model, Time Warner Cable is expected to receive $27 a month for each high-speed EarthLink wholesale subscriber while bearing connecting and customer service costs. Time Warner Cable will share in related advertising and e-commerce revenues only after such EarthLink revenues exceed a certain threshold, equal to four times EarthLink’s current advertising and e-commerce revenues.
It’s a no-brainer
Despite the variables that can occur on any of these fronts, Mr. Katz concludes that cable operators such as Time Warner need only increase their total data customer base by a mere 10 percent over the next five years to emerge “economically whole” or better from managed open access.
That’s a virtual no-brainer considering that analysts generally agree that multiple ISPs will boost by more than 10 percent cable modem deployment, cable operator data margins and data penetration, and high-speed data valuations.
Ms. Cohen estimates total high-speed data service revenues will increase from $2.6 billion this year to $14.4 billion in 2010, driven in large part by consumer choice of ISPs and by availability of broadband modems.
But not all ISPs are created equal.
Ms. Cohen estimates that the data services business utilizing AOL as an ISP, with no shared advertising, can be valued at about $40.4 billion in 2001, or $693 per basic subscriber and $452 per basic home passed. That compares with open access for non-AOL ISPs, w
hich valued the high-speed data business slightly higher at $48.4 billion in 2001, or $831 per basic subscriber and $542 per basic home passed, largely due to shared advertising and other revenues.
However, AOL already has a jump-start on the broadband market, as 22.7 million of its 29 million global members are U.S.-based subscribers, and 2.5 million of those already access the service via broadband connections. That technically means it should be able to grow its subscriber base and cable’s high-speed subscriber base faster.
Ms. Cohen figures that AOL should be able to command $10 per month per subscriber in service revenues in its open-access agreements with cable operators. The current industry average high-speed data pricing is about $30 a month (excluding modem leases), which equates to a 33 percent revenue split from cable operators to AOL, compared with a 25 percent revenue split or less for other non-AOL ISPs signing open-access agreements with cable operators, Ms. Cohen said.
Even a modest advertising revenue split of $2.50 per subscriber will be enough to make the AOL ISP model more compelling to cable operators than competing non-AOL ISPs when choosing open access partners.
AOL also has the ability to leverage off the power of its dominant service and online subscriber base in negotiating choice ISP deals with other cable operators. For instance, it has been long speculated that AOL Time Warner will attempt to unravel its troubled Time Warner Entertainment partnership with AT&T as part of a swap of assets and services that revolves around its AOL ISP service to AT&T Broadband customers.
On another front, AOL can successfully reposition itself as a utility. It can convince price-sensitive customers to pay $24 or so monthly for a service as integral to their lives as cable (with the average bill running about $40 a month) and telephone (where the average bill runs about $50 a month).
Ms. Cohen estimates that half of the industry’s new cable modem subscribers will utilize AOL as their ISP. Cable modem subscribers could account for 30 percent of total AOL subscribers by 2005, up from 12 percent this year.
In other words, AOL’s bonanza is the cable operator’s bonanza, and no single company will benefit more from the open access windfall.