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AOL TW hedges bets on broadband future

Feb 4, 2002  •  Post A Comment

AOL Time Warner is betting on broadband growth in 2002 the way it bet on a robust advertising market and economy in 2001-and that could lead to the same compromised end.
The world’s largest media concern devoted much of its two-hour fourth-quarter earnings call with investors and analysts to explaining a long-term broadband growth strategy that sounds reasonable in theory but may not be very realistic in a year that is sliding sideways toward what may be a gradual 2003 recovery.
Incoming CEO Richard Parsons and Chief Operating Officer Bob Pittman said they are firmly shifting Wall Street’s focus away from the kinds of specific forecast and performance statistics for its core businesses that got the company into trouble last year. They are instead putting the emphasis on an overriding broadband strategy that requires the company to be viewed as an integrated whole with long-range opportunities to forge new revenue streams from digital information, entertainment and transactions.
Need for high speed
Multiple broadband services “is where the game is going to be played over the next couple of years in terms of growth opportunities in our space. We know what we have to do, and we’re confident we can get it done,” Mr. Parsons said.
However, AOL Time Warner’s new mantra is predicated on several assumptions that may not materialize as quickly as the company hopes this year-namely the eagerness with which consumers and competing cable operators embrace what it is selling.
Although no media conglomerate appears better positioned or better equipped than AOL Time Warner to capitalize on a digital world, the lingering economic slump is sure to get in the way. Like last year, when AOL Time Warner asserted its immunity to the adverse impact of a deteriorating economy and advertising market, the company is pinning its hopes on broadband this year, when new services and products will struggle for any kind of market share gains with cautious consumers.
Analysts generally expect 2002 cable operator earnings growth to match last year’s 12 percent to 14 percent despite weak advertising, although most of those gains will come late in the year and will be at risk if an economic recovery fails to materialize. For the first time since digital deployments began, the pace of digital rollouts in 2002 will be down 19 percent over last year, according to Merrill Lynch analyst Jessica Reif Cohen. After a bumpy ride, high-speed data rollouts should be back on track by year-end. However, AOL’s online customer base is growing more slowly and has seen the average revenue per subscriber decline for four consecutive quarters. Ms. Cohen calls “the continued multiple compression of the core AOL” business as the company’s biggest risk.
There is no denying that upgrading an expanding subscriber base to tiers of new revenue-generating services eventually will prove a gold mine in a better economy.
For instance, the 70 percent margins on data that have so far offset start-up losses will soon be pure profit. Time Warner Cable’s experience with multiple ISPs and add-on services don’t cannibalize the core business and do generate incremental revenues.
“The real goal for us to make money as a company is to get the [33 million] AOL members on to broadband so we can deliver and sell enhanced broadband services that will turn into big business: family plans, home networking, music, voice, games, entertainment and enhanced shopping,” Mr. Pittman said.
With the capacity to introduce HBO on demand and a seemingly endless array of other premium branded streaming video, data and voice services, the question is when, not if, the consumer will be willing to pay the price.
That’s why the immediate challenge is for AOL Time Warner to convert its overall 148 million online, cable and print subscriber base (that includes 3 million digital and 1 million high-speed data customers) to high-growth, multiple broadband services. The dominant Internet brand has 4 million broadband users on cable, DSL and satellite.
As the nation’s second-ranked cable provider, behind the combined Comcast-AT&T, and the dominant provider of direct broadband services to the home, “It’s just a matter of adding on to what they’ve got,” Mr. Pittman said. It is a built-in base of targeted users and purchasers of products and services.
Clear strategies
Still, Morgan Stanley Dean Witter analyst Richard Bilotti points out that AOL’s share of the U.S. broadband market remains low and “its ability to generate premium service revenue is unproven,” although opportunity is significant. The biggest issue is there are no near-term growth catalysts for AOL Time Warner or many other media concerns.
Mr. Pittman insists the company does have “clear and measurable strategies for AOL and Time Warner Cable,” although its only guidance so far is for modest cash flow growth of 8 percent to 12 percent on a 5 percent to 8 percent rise in revenues that assumes no improvement in advertising or the economy.
The company reported an 18 percent rise in earnings to $9.9 billion on a 6 percent rise in revenues to $38.2 billion, although it was in line with its own recently scaled-down estimates. Among the more enlightening financials disclosed: Half of the company’s highly touted $3 billion free cash flow covered severance and other one-time cost-cutting expenses in 2001. The company will invest the same $3.5 billion on content as last year. Although it will remain acquisitive, its $22 billion in debt is expected to jump to $32 billion when it buys back the 25 percent of its TWE partnership held by the combined Comcast-AT&T.
The modest and sparse financial projections set up AOL Time Warner for looking smart in the event of better-than-expected growth in its core businesses or an economic upturn. But the company is taking a risk in not giving Wall Street much to gauge or look forward to in the short-term-clearly reflected in its new stock low of $24 a share.
Billion-dollar behemoth
Even as economic indicators begin to improve, it will be a while before a company as large and complex as AOL Time Warner can begin building on the momentum. Even with more than $1 billion in advertising and marketing deals negotiated last year amid the worst ad recession ever, the company learned it can’t mandate a good idea in bad times.
Still, so much of AOL Time Warner’s new pitch is predicated on the notion that it can.
Mr. Pittman pointed to the encouraging early returns from the multiple ISP arrangement between AOL and Time Warner Cable’s 14 million customers that will be a template for critical ISP pacts with other cable operators.
The fact is, competing MSOs still are in no hurry to lock themselves into shared subscribers, revenues and resource arrangements until they fully understand their potential value and necessary safeguards. Some cable operators question whether the limited migration of existing non-AOL broadband subscribers to an AOL high-speed service is evidence they don’t need AOL to drive cable modem sales. Some question whether there ever will be multiple ISP pacts between AOL and other cable companies. Executives at competing cable companies say they are nowhere near a finalized pact with AOL.
Mr. Parsons’ priorities for the year are clear: growing and converting that subscriber base from narrowband to broadband; introducing new high-margin broadband services; better managing and shrinking the company’s $30 billion cost base; and building on $1 billion-plus in marketing deals even in a year when no advertising growth is expected. Mr. Parsons is forcing Wall Street to look down the road at what is arguably the brightest future in the troubled media space rather than looking down at its feet and the year ahead, which may be filled with pitfalls and surprises.
Tempering Wall Street’s penchant for short-term performance may turn out to be one of the company’s biggest feats.