TCS Daily

The Internet Company That Time) Almost Forgot

By Dominic Basulto - January 6, 2005 12:00 AM

In January 2000, when AOL announced plans to acquire Time Warner in a deal valued at $160 billion, nobody would have guessed that the much-ballyhooed transaction would eventually become known as one of the biggest blunders in U.S. corporate history. After tens of billions of dollars in lost shareholder value and tens of billions of dollars more in failed ambitions, AOL Time Warner suffered the ultimate indignity in 2003 when board members decided to lop off the AOL name entirely. It was a fitting move for a company that time apparently forgot. In the minds of many investors and analysts, AOL had become a has-been of the Internet era -- a rotting carcass ready to be picked over by corporate vultures. But Time© did not forget. Now, nearly five years ago to the day the ill-fated merger was announced, Time Warner's AOL unit could be on the verge of an epic comeback.

There are a number of reasons AOL could make a splash in 2005. Time Warner finally has in place a top-quality management team focused on cleaning up the mess at AOL and unlocking the value of the company's Internet properties. Gone are the dreamers and visionaries, replaced by managers focused on cost-cutting and bottom-line results. For the first time in a long time, the bleeding seems to have been stanched at the AOL unit. Most recently, Time Warner negotiated a $510 million twin settlement with the SEC and U.S. Justice Department to clean up the unit's accounting improprieties during the dot-com era. (It was a considerable penalty to pay, but Wall Street likes the move since it gives the company more flexibility to undertake new acquisitions in the cable industry.)

Moreover, the loss of dial-up subscribers at AOL has subsided, thanks to promotions like "bring your own broadband access." By some estimates, AOL was losing subscribers at a rate of 150,000 per month, as Internet users abandoned poky dial-up connections for super-fast broadband connections in droves. Even with those losses, though, AOL remained the #1 ISP in 2004 with 22.7 million subscribers. In the most recent quarter, the company made new progress: it added 470,000 broadband users, partially offsetting the loss of 640,000 dial-up subscribers.

AOL is also taking steps to compensate for the loss of subscription revenue by overhauling its business model to focus less on subscriptions and proprietary content, and more on online advertising. In 2004, online advertising revenues expanded at a 33% clip. In 2005, Time Warner CEO Dick Parsons predicts that online advertising could grow at a healthy 25% rate. With AOL's online advertising sales fast approaching the $1 billion mark annually, analysts and investors are taking note. The company's stock ended 2004 at nearly a 52-week high ($19.45) -- and there could be additional movement upward in 2005. Banc of America has put a $23 price target on the stock, while Merrill Lynch went one better, putting a $24 price target on the stock in mid-December.

Perhaps most importantly, AOL is waking up to a new understanding of how the Internet works. For subscribers, that means declaring a war on spam and devoting more efforts to creating a safe, secure Internet experience through parental controls and anti-virus tools. For non-subscribers, the company is finally tearing down its "walled gardens" and reinventing itself in the image of portals like Yahoo and MSN. AOL is making more content available on the Web (such as music and sports programming), devoting more efforts to developing Google-like innovations (e.g. a free Web-based mail for non-AOL subscribers similar to Gmail) and experimenting with new ways to leverage Internet assets such as Netscape, MapQuest and Moviefone. Behind the scenes, the company has also shifted to HTML encoding for its Web pages -- a move appreciated as much by technical geeks as by online advertisers.

With these changes in place, the company's valuation could soar. Analysts value Yahoo at close to $53 billion (19 times estimated 2005 revenues), Google at $47 billion (17 times 2005 estimated revenues), and Ask Jeeves at four times estimated 2005 sales. In contrast, analysts value Time Warner at $83 billion, a measly two times estimated sales in 2005. According to Wall Street investors, such a low multiple essentially assigns zero value to all of AOL. Yep, that's right. Zero value for a company with some of the Internet's top destinations.

In order to prove its skeptics wrong, AOL must hope that it can catch a lucky break, ride the wave in online advertising and reap the benefits of a revamped business model that leads to more Internet users embracing the company's new, more open Web presence. In 1998, when Wall Street Journal reporter Kara Swisher wrote the inside story of how Steve Case "made millions in the war for the Web," she called the company a "cyber-cockroach that refused to die." Nearly seven years later, little has changed. AOL simply refuses to die. In 2005, if all goes according to plan, AOL will reinvent itself once again and investors will reward Time Warner with a higher stock multiple that fairly values AOL as one of the most valuable and influential Internet players in the world.

The author write frequently about technology and venture capital.



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