How AOL TW can dig itself out of a mess

Jul 22, 2002  •  Post A Comment

AOL Time Warner officials must come clean this week on America Online advertising revenues and accounting practices, a new top management team’s executable vision and how it will integrate its disparate operations if it is to salvage any of the value promised in its $106 billion merger 18 months ago.
The forced resignation of Chief Operating Officer Bob Pittman, who oversaw the America Online advertising revenues and accounting practices now under severe scrutiny, is not enough.
The company must throw a new organizational structure and vision behind a team of top executives who will accomplish more modest integration and revenue growth goals if it is to recover from its self-inflicted wounds. CEO Richard Parsons is wasting no time trying to accomplish that, despite formidable obstacles.
It may be an impossible task, despite those who say Mr. Pittman’s abrasive, aggressive style was the reason for the internal unrest and financial woes. While Mr. Pittman is a convenient scapegoat, AOL Time Warner’s deep problems are as much a product of the executives and systems that remain.
Jettisoning Mr. Pittman does nothing to immediately reverse the media giant’s fate-any more than what has been accomplished by Mr. Parson’s succeeding Gerald Levin.
While Jeff Bewkes (chairman of HBO), 50, and Don Logan (chairman of Time Inc.’s publishing unit), 58, are well-regarded veterans of Time Warner, the company’s modus operandi has been to house isolated fiefdoms that have clashed more than they have meshed. The successful subscription-based businesses they oversee are very different from America Online. Under the new regime, Mr. Bewkes (chairman of the entertainment and network group) and Mr. Logan (chairman of the subscription-driven new media and communications group, including AOL) will have to work with a newly appointed chief of America Online-all part of a new office of the chairman team patterned after General Electric’s proven rule-by-committee structure. But embracing Time Warner’s traditional ways could be just as bad.
“Any return to the old Time Warner should not be acceptable to any investor,” said Sanford Bernstein analyst Tom Wolzien, citing its history of “fractious divisions, internecine warfare and avidly practiced media’s worst trait-surrounding, dismembering and then killing the agents of change.” Before the merger with AOL, Time Warner was prone to its own “routine” inflation of financial results “by including sale of small cable operations and operating profits,” Mr. Wolzien said.
Much of the initial heavy lifting will be up to Mr. Parsons, who has been in constant damage-control mode and must now do the opposite of what he set out to do months ago: provide more detail on all parts of the company instead of limiting his scope to force analysts and investors to view the sprawling media company as a whole.
If Mr. Parsons can quickly get AOL Time Warner to operate as an integrated entity, the company will trade at traditional media multiples, many times higher than $13 a share, or 9 times estimated 2003 earnings before interest, taxes, depreciation and amortization that it traded at before the latest revelations. Mr. Wolzien said that should be $20 a share, using earnings without factoring in $28 billion debt.
Valued as the media conglomerate it has struggled to be, AOL Time Warner would be lucky to muster an $11 per share target, or about eight times 2003 estimated earnings.
On the critical accounting issues raised, AOL Time Warner is expected to use its scheduled July 24 second-quarter earnings report conference to detail and certify not just AOL online ad revenues but any division numbers that may not come under scrutiny.
Wall Street smells and wants blood.
It’s possible that no matter what tack company officials take in reporting its second-quarter earnings this week, Wall Street simply won’t believe some of the numbers, having been burned by AOL Time Warner’s overly optimistic earnings forecast last year, which led to Mr. Levin’s exit. The absence of corporate integrity and the intense lack of investor confidence are powerful adverse forces even the most faltering media merger has never had to face. Mr. Parsons is facing a stiff challenge from leading institutional investors that control a huge chunk of company stock, sources said.
The only way to get back on track is through performance, and yet even the strong and improving financial performance of AOL Time Warner’s core film, television, cable network and other businesses may not be able to override the negatives.
Investors said they fear that the questionable accounting moves-apparently made to save what was to be a mere $140 million loss against AOL Time Warner’s overall $5 billion in advertising and commerce revenues-could be indicative of other such practices.
Any prolonged probe of AOL’s financial reporting would arrest the company’s ability to do deals such as the acquisition of additional cable systems or companies, a cable spinoff or the restructuring of Time Warner Entertainment.
“While the company may not have done anything wrong, its dealing with an analyst community in the area of online advertising was anything but forthright,” said Mr. Wolzien, citing use of old backlog numbers and refusal to comment on changes and questions raised in filings. “Current management will need to go a long way to overcome the distrust that’s been created.”
There are several things AOL Time Warner must do:
* Re-establish integrity with advertisers. Advertisers and agencies doing business with America Online in the future may have new questions about what they are getting for their money and the real revenues generated by the much-ballyhooed cross-media ad deals.
* Reestablish financial reporting integrity. Because Internet-based companies historically have walked a slipperier financial slope, other AOL related elements will be questioned about subscriber and revenue numbers at every level.
The company must provide certifiable subscriber and financial data across the board and in answer to the onerous accounting questions raised. Among other things, The Washington Post claims AOL converted legal disputes into ad deals, shifted revenue from other divisions to boost its online business, booked the sale of eBay ads it sold as AOL revenue, counted Sun Microsystems stock rights as ad and commerce revenue and flipped long-term ad contracts it risked losing into short-term gains that boosted quarterly revenues.
These moves helped AOL Time Warner to beat rather than miss analyst ad revenue estimates at a time when its peers reported sharp declines that punished their stock. AOL Time Warner insists it followed accepted accountant standards to produce “accurate” and “appropriate” disclosures.
* Re-establish management integrity. The firm command of long-time Time Warner executives could result in recasting the hybrid new-old media concern in the old Time Warner structure. A new structure and set of accountable metrics must be devised over time, analysts said.
That will require the infusion of some new executives. Many of the executives who were involved in these questionable dealings remain in the loop: namely former AOL Chief Financial Officer Mike Kelly, now chief operating officer of the online division, and David Colburn, business affairs chief and a close confidant of AOL Time Warner Chairman Steve Case.
* Re-establish growth momentum. AOL Time Warner must find a way to mine its combined subscriber base and use Time Warner’s prize content as the basis for devising new, compelling forms of content that will drive broadband usage while maintaining and growing AOL’s analog online service. The only way to get back on track is through certifiable performance of its core operating businesses.