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More AOL Woes for Time Warner

Jan 5, 2004  •  Post A Comment

The entertainment conglomerate that began the year as AOL Time Warner ends it as simply Time Warner. But the hangover from the merger of Time Warner and America Online, which has been denounced as one of the worst business deals in history, is not over.
Instead, as Time Warner sheds nonstrategic assets such as Warner Music, the problems at AOL continue. The biggest issue is the continuing defection of dial-up and narrowband subscribers. In its most recent Securities and Exchange Commission quarterly filing, Time Warner said it lost about 600,000 subscribers between September 2002 and September 2003-a sizable drop.
Tom Wolzien, senior media analyst for Sanford C. Bernstein & Co., a Wall Street research and investment management firm, said AOL’s churn is very high. “They’re losing five out of eight [narrowband] subscribers,” he said.
The company said in a recent SEC filing that this degree of decline would “likely continue.”
AOL’s salvation does not appear to be in broadband either. AOL now claims more than 2 million broadband subscribers. But only a minority uses AOL as their broadband supplier. That number is dwarfed by Comcast Cable’s 4.8 million high-speed data customers.
Time Warner acknowledged in its most recent quarterly SEC filing that its broadband subscribers are less profitable than its dwindling narrowband base, a potential long-term problem. A large percentage of the broadband subscribers Time Warner counts are not receiving their high-speed connections from AOL. They pay only a minimal amount to get AOL for Broadband.
Porter Bibb of MediaTech Capital said that Jonathan Miller, AOL’s chief executive, had “failed to come in with a credible business model for the transition to broadband.”
The good news is that AOL has not fallen apart quite as quickly as some of its detractors expected. AOL continues to account for a sizable chunk of Time Warner’s $4.5 billion in free cash flow. And some analysts expect 2004 will be a good year for the service as it adds revenue from broadband subscribers and interactive advertisers.
The real question becomes whether or not AOL is for sale. For the record, the company denies AOL is on the block. However, many analysts remain skeptical. “Sure, they would sell at the right price. But I don’t believe the cash flow at the online unit is headed downward,” commented Jordan Rohan, an influential analyst at Soundview Technologies. “2004 could be a good year for them.”
What seems obvious is that the AOL service and many of its divisional components fit perfectly into the category of “nonstrategic assets,” which Time Warner says it wants to unload. But the complications may outweigh the benefits, and at least for the moment, the AOL unit is still throwing off significant cash flow.
There are persistent reports that interested parties have been circling AOL, especially Barry Diller and his InterActiveCorp. and Microsoft and its MSN Internet service provider. Mr. Diller’s IAC is said to be interested in the e-commerce applications, and MSN is eyeing AOL’s 25 million U.S. online subscribers.
In November the German newspaper Suddeutsche Zeitung reported that Time Warner Chairman Richard Parsons held talks with the T-Online division of Deutsche Telekom, an Internet service provider with 12.9 million subscribers in Europe, including 200,000 broadband subscribers. The discussions were reportedly about a possible merger or joint venture. The talks were brokered by former Bertelsmann CEO Thomas Middlehoff, a former AOL board member. AOL has about 6 million subscribers in Europe and 24 million in the United States.
T-Online spokesperson Mark Nierwetberg did not deny that his company had discussions with AOL, but said T-Online does “not comment on possible negotiations or talks.”
Sources close to Deutsche Telekom said officials there privately acknowledge that the company’s discussions with Mr. Parsons were more serious than has been publicly stated. “They had a deal in place,” the source said, but the discussions eventually fell apart over details such as leadership and evaluations.
Sale `Speculation’
Tricia Primrose, a spokesperson for Time Warner, described any possible asset sales this way, “Any speculation is just speculation, and AOL is not for sale. We’re working every day to return AOL to a growth track.”
Deborah Roth, VP of corporate communications at IAC, said her company doesn’t comment on “rumors and speculation.” Microsoft spokesperson Brian Peterson said, “MSN makes it a practice not to comment on rumors or speculation.”
In a Dec. 10 interview with Advertising Age, Don Logan, chairman of Time Warner’s Media and Communications Group, said the company would consider selling AOL “if the company and the people at AOL believe they don’t have a sustainable business model that allows us to grow in the future.” Any sale of AOL, he added, was “a long ways off.”
Still, one has to wonder about such a formulation-why alert bidders that you will sell AOL only if it does not have “sustainable growth?” What bidder would buy under those circumstances?
Mr. Logan did not address the possible sale of some AOL assets. AOL could sell off parts, such as the European or American ISP units. Mr. Diller’s IAC would doubtless covet AOL-owned services such as MapQuest and Moviefone, the latter an obvious adjunct to Mr. Diller’s Ticketmaster.
But several hurdles remain before Time Warner can see AOL in its rearview mirror. For one thing, the list of potential buyers is relatively short. Further, the ongoing SEC investigation into the AOL’s unit’s accounting practices has not receded, as some at Time Warner hoped. Instead it has spread, with subpoenas issued for key AOL executives, including former chairman Steve Case and former CEO Robert Pittman, and has an uncertain future in regard to possible penalties and other liability. Mr. Wolzien stressed that separating the AOL unit and its liabilities would be difficult, and what company wants to acquire an unknown quantity in terms of potential liabilities?
Even though Morgan Stanley analyst Richard Bilotti noted in a report issued Nov. 24, “It is not feasible to ascertain the potential size of the final settlements with shareholders and the SEC regarding the accounting at the AOL unit,” it is sure to be sizable.
As a division with more than $1 billion in cash flow, AOL in total could be expected to sell for up to $10 billion, but concern about possible liabilities related to the SEC investigation has led some would-be suitors to balk at that price. Time Warner has also been hit with at least 40 shareholder lawsuits related to the AOL merger.
Another problem is the incredible discrepancy between AOL’s valuation today and that in place at the time of the 1999 merger, at the height of the Internet bubble, when it was valued at an incredible $163 billion.
Selling AOL’s various units now would solve a number of problems for Mr. Parsons as he seeks to consolidate Time Warner’s debt load, which will stand at about $20 billion after the $2.6 billion sale of its music division. Time Warner has repeatedly stressed its desire to grow in the cable business, which includes twin goals of acquiring the more than 3 million New York-area subscribers of Cablevision Systems at a cost of at least $15 billion, and buying out Comcast Cable from the 21 percent it owns in the Time Warner Cable unit, valued at over $6 billion.
A possible Time Warner acquisition of Cablevision is considered likely even as the two companies traded barbs last week about subscriber fees from Cablevision’s Rainbow unit. Reports last week also had Time Warner considering merging with MGM, a move most consider unlikely due to the high asking price.
Meanwhile, morale at the AOL unit is said to be low. Internet pioneer Jeff Dearth, a senior partner with Washington investment banker DeSilva & Phillips, said he was startled by the lack of energy during recent visits to AOL’s Dulles, Va., headquarters.
“There is so little going on,” he said, contrasting today’s AOL with the white-hot company of the late 1990
s. “I went there in the last year to try to get a deal off the ground with the business development people, and Dulles was like a ghost town. In the old days, people were buzzing in and out; the energy level was incredible. I had to ask myself, `What’s going on here?”’