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Wall St. shows AOL TW no mercy

Jul 29, 2002  •  Post A Comment

Wall Street has put AOL Time Warner on notice: Its actions speak louder than its words.
A flood of debilitating downgrades and removal from recommended lists at top investment banking firms, which apparently stunned company officials, have collectively made the point. The challenges confronting AOL Time Warner-led by a regulatory investigation and worse-than-expected America Online performance-are more formidable than management has conceded, and it will require more than heavy-handed damage control to get the company and its stock back on track.
The company’s recent second-quarter earnings call failed to diffuse heightened skepticism by investors, analysts and other key constituents that its problems run deeper than recent questions raised about accounting for $270 million in America Online revenues, a top executive shakeup and daily revelations about internal turmoil.
The Securities and Exchange Commission’s “fact-finding inquiry,” which AOL Time Warner CEO Richard Parsons revealed during the July 24 call, is a bombshell that could explode at any time. No one knows where such a probe will lead, nor how deep it will go. It will either definitively prove the veracity of what the company insists are its “appropriate and proper” accounting practices and reported numbers or blow through the recent questions raised about America Online revenues to more serious issues.
Lowered expectations
A full-blown SEC probe could derail early efforts by the company’s new management team to refocus and advance the beleaguered media giant.
Anticipating a broader SEC investigation into the entire company, Sanford Bernstein analyst Tom Wolzien downgraded and removed the stock from the firm’s recommended list. He lowered his financial estimates, citing worsening America Online fundamentals including slower subscriber growth and the “shockingly tiny $70 million” in second-quarter online ad revenues from third parties, according to more extensive disclosures.
“The present climate makes the cloud of a securities investigation much darker and will keep the company in current low-double-digit trading range,” Mr. Wolzien said. “It is time to give management a chance to help regulators, to clean up what dirt there may be and to rebuild this finest set of media assets. When the issues are resolved, we’ll be back.”
Salomon Smith Barney analyst Jill Krutick said that even with Time Warner businesses exceeding expectations, the SEC inquiry will “cause shivers.” Goldman Sachs analyst Richard Greenfield downgraded AOL Time Warner to “market perform” and removed it as a recommended stock, citing “too many issues to recommend [it] solely on valuation.” Merrill Lynch cable analyst Jessica Reif Cohen downgraded the company to “neutral,” saying the more detailed data provided by the company about America Online is “helpful … but troubling” and certifies the AOL free fall that is dragging down the entire company. “It is not clear even from conversations with management what the timing and the length of the fact-finding investigation will be,” Ms. Cohen said.
The recent rash of analyst downgrades and lower earnings estimates signal Wall Street’s uneasiness. “You just don’t know where the bottom is,” one analyst confided.
Such overriding concerns pushed AOL Time Warner stock July 25 to a new low of $8.05 per share, off more than 80 percent this year and reflecting one-fifth of its $200 billion-plus merger market value.
But veteran analyst Chris Dixon at UBS Warburg said all the hand-wringing is overblown. “Back out the AOL business and the company’s other businesses-Time Inc. Magazines, Time Warner Cable, Turner cable networks, HBO-are outperforming their peers by double-digit multiples. The SEC [probe] is a nonissue. The AOL Time Warner glass is half-full, not half-empty,” he said.
Still, significant factors guarantee more near-term uncertainty, change and struggle:
* It’s looking as though AOL Time Warner could miss its own more tempered financial targets for a second consecutive year. Despite the company’s attempts to reassure that it can meet the low end of its full-year earnings growth forecast (about 5 percent), there is growing skepticism that AOL Time Warner will get lucky and break even despite a stronger balance sheet.
Although its filmed entertainment and cable businesses are growing at double digits, America Online advertising and commerce revenues (down 42 percent last quarter) will continue to be flat or in decline in an unstable ad market, throwing off the company’s overall numbers. The third quarter is expected to be weaker than the second quarter, making it vulnerable to more economic downturn. Although analysts continue to lower their 2002 and 2003 revenues, earnings and other estimates, there is a danger of lowering the bar just enough for the company to clear. At what point does real growth become artificial?
* Even an SEC investigation that turns up no wrongdoing paralyzes a company that needs more than anything to just do its business. That Mr. Parsons, Chief Financial Officer Wayne Pace and accountants Ernst & Young have signed off on the company’s past and present financials is encouraging. But the SEC and others may take issue with the way in which they were arrived at, stated or used. That’s a critical issue unique to new-old media hybrids, and leading to the eventual creation of new financial standards.
* AOL Time Warner must simplify already. The company finally may be close to taking a first step toward simplifying its structure by unwinding its troubled Time Warner Entertainment partnership with AT&T and its new owner, Comcast, which will eventually lead to a pure cable spinoff. The bad news is that cannot occur any time soon in this depressed and volatile stock market, in which cable stocks are hopelessly trading at irrational and historic lows. (The new AT&T-Comcast would lose more than $1.2 billion in value if they opted, instead, to take their 27 percent TWE stake public, as threatened, according to CIBC analyst Mike Gallant.)
* Mr. Parsons and his team need to deliver concrete synergies and integration, demonstrating just how the now decentralized company’s diverse businesses can “compete collectively” while “excelling individually,” as he said. Advertising and marketing cross-media selling will continue, driven by market momentum, because it makes economic and strategic sense. But simply saying that the Warner Bros. film and TV production unit should work more closely with the Turner cable networks, HBO and The WB TV network is well intentioned, but doesn’t fly. Investors, analysts, press and the company’s own employees need to see how.
* The company has to stop making broadband promises it can’t deliver, even as Time Warner Cable and America Online fuse their interests. The company last week said that America Online is the ISP of choice for about half the new high-speed Internet access subscribers on Time Warner Cable systems. The company needs to successfully complete long-awaited potentially lucrative ISP pacts being negotiated with AT&T-Comcast and Cox Cable to win back investor support.
* Let investors and other constituents see what newly appointed managers are made of. Jeff Bewkes (entertainment and network group chairman) and Don Logan (subscription-based new media and communications group chairman) each succeeded in transforming what were deemed no-growth businesses-HBO and Time Inc. Magazines, respectively-into key profit generators. But there are no guarantees they can emerge victorious for the larger, more unwieldy chunks of the company to which they are assigned. While analysts consider them top industry managers, they flinch at hearing Mr. Parsons extol their virtues in much the same way he did recently resigned Chief Operating Officer Bob Pittman not too long ago.
* Mr. Parsons and his team must constructively address prospective challengers, inside and out. Any suggestions of a potential rift between Mr. Bewkes and Mr. Logan and other key executives, such as Turner Broadcasting System Chairman and CEO Jamie Kellner, should be imm
ediately and firmly checked. Analysts call it classic internal Time Warner unrest. But AOL Time Warner is a big, unwieldy concern that needs all the expert help it can get, and it is fortunate to have skilled, well-connected executives among its own rank-and-file and investors. Major shareholders such as Liberty Media Corp. Chairman John Malone and AOL Time Warner Vice Chairman Ted Turner have discussed joining forces to try to “cease or assist” the new regime, sources close to the men said. Should the turmoil continue, sources said Mr. Malone, Mr. Turner and others may seek to press for more upside in more places, in the belief that adversity brings opportunity. Clearly not everyone sees it that way.