News: Analysis & Commentary: THE INTERNET
ANSWERED PRAYERS AT AMERICA ONLINE
After a series of setbacks, AOL's WorldCom deal charms investors
All of a sudden, the company that could do nothing right is once more the darling of Wall Street. On Sept. 8, shares of America Online Inc. jumped 9%, to close at 761/16--more than double the level the stock was trading at in January. The propellant: In one complex transaction, AOL managed to unload an expensive and hard-to-manage data network operation, boost its audience by nearly 30%, beef up its overseas operations--and still come out $250 million ahead. "The deal is a big positive for AOL," says Jonathan Cohen, a managing director at UBS Securities. "It represents a significant step" toward AOL's goal of recasting itself as a media company.
It's also a reprieve for Stephen M. Case, AOL's 39-year-old CEO, who had been catching a lot of flack on Wall Street and from customers for the shortcomings of the No.1 online service. "We've made a lot of progress by successfully reinventing and refocusing the company and rebuilding momentum," he says. With his Sept. 8 deal--in which AOL agreed to give WorldCom Inc. AOL's communications operation (ANS Communications) in exchange for the subscribers of CompuServe's service that WorldCom is buying from H&R Block--Case convinced investors and industry analysts that he can turn the struggling online giant around.
In the past year, AOL has suffered a series of setbacks and embarrassing gaffes. Last September, after years of assuring skeptical analysts that AOL's accounting methods were prudent, Case shocked Wall Street by announcing that the company would move to a more conservative way of accounting for marketing costs--a change that effectively wiped out previous profits. In January, a shortage of network modems left irate AOL subscribers unable to log on. AOL laid another egg in July when it announced plans to sell subscriber lists to mass mailers. A storm of protest forced the company to drop the plan.
SHIFTING CUSTOMERS. Customers may still be wary. Indeed, AOL is trying to assure technically savvy CompuServe users that their service won't be converted to the more entertainment-oriented AOL format. On Sept. 9, Case spent the day in Columbus, Ohio, huddling with CompuServe execs to discuss how to assimilate customers without angering them.
If Case can pull it off, his latest deal sets the stage for AOL to prove that its long-held vision of cyberspace as the next great mass medium is correct--and profitable. Instead of deriving revenue from the monthly fees of an ever growing pool of subscribers, the company will now derive growth from advertising and transaction fees, which were just 5.6% of sales in fiscal 1996 and 12.4% in 1997.
By shedding the ANS unit, which handled the mind-boggling task of linking some 9 million customers to AOL's hundreds of content areas, Case can now focus on building his mass-media model. "They were managing too many businesses with too many moving parts," says CNET CEO Halsey Minor. Under a five-year contract, AOL will buy network services from WorldCom, a long-distance company that runs the world's largest Internet-access network. The price, says WorldCom, is little more than what AOL is paying with ANS in-house. And the deal frees AOL from having to invest in network improvements. WorldCom also threw in $175 million.
The other key aspect of the deal is AOL's acquisition of CompuServe's 2.6-million customer base--a move that will put the AOL audience at 11.6 million. Suddenly, Case has the critical mass of subscribers and the corporate structure to pursue his mass-media strategy. After the WorldCom deal is concluded, AOL will command 54% of the U.S. online-service market, up from 45% today, according to International Data Corp. By contrast, second-place Microsoft Network has just 2.3 million subscribers. "AOL was already very, very far ahead of us in the Internet-access business, even without CompuServe," concedes Laura Jennings, vice-president of Microsoft Network.
HOOKING ADVERTISERS. But while AOL has left its longtime online rivals in the dust, new ones have shown up to challenge its mass-media plan. Yahoo!, Excite, and other Internet search-engine companies have begun offering gobs of content on everything from sports to local entertainment listings--much of it with advertising support. Even more threatening may be such rivals as Microsoft Corp.'s WebTV, which is trying to bring the Web to the masses via TV (page 96). On Sept. 22, Internet startup CNET will launch Snap! Online, a free Net service aimed directly at AOL.
To succeed, AOL has to line up the programming to keep 12 million customers glued to their PCs--and get advertisers to pay for access to those "eyeballs." Already, advertisers are warming to the prospects of such a massive online audience. "With fresh consumers going to online services and the Internet, AOL will be powerful, and it will probably be a smart place to target consumers," says Julie M. Bauer, an executive vice-president at ad agency Saatchi & Saatchi, which hadn't considered AOL a top venue before.
To keep advertisers coming, Case needs to invest in new programming. That's why the $250 million from the Sept. 8 deal is so welcome. AOL had less than $200 million in cash on hand before the deal, and to fund development, it had been trying to sell equity stakes in existing properties. AOL won't comment on its plans for those placements now.
AOL already has been spiffing up its content. This fall, the company will preview a software update code-named Casablanca that it says will be easier to use and that incorporates TV-like "video streaming." New programming will include a site for celebrity chats, news on films and TV shows, and behind-the-scenes looks at movies in the making. AOL also has in the works a site for women, called Electra, and it will offer a new service called Driveway, which lets users get custom news feeds.
One measure of AOL's success in content is how subscribers use the system, which has become one of the most popular gateways to the World Wide Web. The company says users still spend 35% of their time in AOL's proprietary content areas--places such as Love@AOL, a romance-oriented site, and Motley Fool, an investment-advice corner. (Business Week Online appears on AOL).
Still, to boost ad revenues, AOL must continue to improve programming to keep Net surfers in the ad space it controls. "What AOL is up against is billions of dollars thrown at development of services on the Net," says David Simons, managing director of Digital Video Investments, a research boutique.
INFLUX. The new deal will present AOL's managers with fresh challenges, too. It won't be a long-term coup, for instance, if AOL loses the CompuServe audience. Case maintains that he won't mess with CompuServe's formula and will keep the systems separate for now--except for when he's selling ads. "The combination of the two audiences together make it a more-than-attractive buy for some advertisers--the way cable companies sell packages of networks together."
AOL will also have to work hard to hold the CompuServe customers it inherits in Europe. The influx makes AOL the largest online company in the market, with 1.5 million subscribers. In Britain, AOL will have a stronghold with 48% of the market, says Nick Gibson, an Internet analyst at Durlacher Research in London. But in many other countries, AOL faces formidable competition from national phone companies in Internet service.
Back in the U.S., Case may face regulatory hurdles. The Justice Dept. has already said it will look into AOL's deal with WorldCom and WorldCom's buy of CompuServe. AOL insiders say Justice began asking questions when it learned that the company might bid for CompuServe earlier this year. Their likely concerns: that AOL's heft could enable it to control prices in the online market and that WorldCom's size would allow it to do the same for Internet access. Case predicts that his deal will close within six months with little interference from the trustbusters. "The Internet is an extraordinarily competitive marketplace with thousands of providers," he says. All with their eyes on him.By Catherine Yang in Washington, with Paul M. Eng in New York, Linda Himelstein in San Francisco, and bureau reportsReturn to top