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Old Trumps New at AOL

By David Shook Everyone knew it would be the largest media conglomerate in the world, with movies, magazines, TV networks, cable systems, and access to the biggest Internet audience on the planet. But when America Online and Time Warner announced their $154 billion merger in January, 2000, the question loomed: Which culture would prevail? Would the open-collar new-media gang of AOL transform Time Warner's suit-and-tie brigade? Or would Time Warner bring high-flying AOL down to earth, turning the combo into a spendthrift giant with growth on the slow side?

The answer is becoming clear. With AOL Time Warner (AOL) shares trading at around $17.80, down 66% since the merger, and new CEO Richard Parsons -- a veteran groomed at Time Warner -- set to take over on May 16, AOL Time Warner is acting very much like an old media company. The upshot for investors is hardly what they might have expected a year ago: AOL Time Warner looks less and less like a growth stock, and more like a value play for the long term.

"DREAM IS OVER." Here's the real rub for the new-media crowd. With the stock trading in the same neighborhood as dot-com survivors Yahoo (YHOO) ($15.70 a share) and Amazon (AMZN) ($17), many analysts are wondering when investors will again take an avid interest in AOL. It's bound to snap back sometime soon as a function of demand and supply, once institutional investors stop dumping so many AOL shares.

Surging share-price growth, however, is probably a thing of the past, most believe. "I think the stock, and in some sense the whole merger, is fairly valued now," says Don Luskin, founder of financial research firm TrendMacrolytics. "The growth dream at AOL is over. It has proven itself to be just another big media company."

Institutional investors sure seem spooked. They've been unloading shares by the millions, and management hasn't done much lately to warrant a bounce-back in the stock. AOL Time Warner has reduced its financial forecasts three times since September 11. So far this year, it has shown no signs of a comeback in advertising and e-commerce sales.

SLOW RECOVERY. AOL declined to comment directly for this story, but a spokeswoman made reference to remarks by Parsons at a Bank of America luncheon in New York on May 2: "Not that long ago, it seemed like people couldn't say enough good things about our prospects," he said. "Now, fueled by negative speculation and, in many respects, exaggeration, the pendulum is in full swing in the opposite direction. In a few extreme cases, some people in the media have gone beyond being unable to see the forest for the trees. Now, it seems, they can't see the forest or the trees."

What most analysts see is a slow recovery in the shares once the institutional investors are finished ratcheting down their concentrated positions. But more fundamental to the stock's future is the change in perception. "It seems like an old media company now," says First Albany analyst Youssef Squali.

For Squali, that's a frustrating admission. He had a strong buy rating on AOL Time Warner as late as this April. At the time, he told clients they would be "buying Time Warner and getting AOL for free" if they bought shares at $21. Now, he says: "I can keep saying this thing is undervalued until I'm blue in the face, but if mutual-fund groups keep selling millions of shares every week, simply out of frustration, the financial analysis doesn't matter."

VALUE-HUNTER TIME? Squali and other analysts think AOL shares have been punished to the point where they can't fall much further, especially with some of AOL's old media divisions, including music and movies, expecting a strong year ahead. "You'd think that the stock will form a bottom here at some point," says Steve Eskenazi, a venture capitalist for WaldenVC in San Francisco. He thinks value investors are likely to step in to counter the brisk selling in the stock. But gone are the days of explosive growth and disaster-defying exploits that epitomized AOL's rise during the 1990s.

What a difference 17 months have made. Back in early 2000, it looked as if the future still belonged to the daredevils at America Online, the largest division in the AOL Time Warner stable. The smart money was betting that America Online Chairman Steve Case and his right-hand man, entertainment maestro Robert Pittman, would transform the staid Time Warner empire, reinvigorating its brands with a powerful dose of AOL's cross-promotional mastery.

Instead, it will be Parsons, a Time Warner exec hand-picked for the job by outgoing CEO Gerald Levin, who'll assume the helm. Parsons says the combined company now expects revenue growth of 5% to 8% this year, with cash flow growing at a pace of 5% to 9%. For nostalgic new media adventurers, that's very old media.

DEBT LOADED. Compounding that slowing growth is another problem typical of the old Time Warner ways: a heavy debt load. It spent the '90s burdened by heavy debt stemming from the mergers with Warner Communications in 1989 and Turner Broadcasting in 1996. Also, the cable systems required billions of dollars in investment to prepare for broadband and digital services.

Sixteen months after Time Warner's merger with AOL, debt suddenly looms as a big problem again. After being forced to spend $6.75 billion to buy back a 49.5% stake in AOL Europe from Bertelsmann this year, AOL has more than $28 billion in long-term debt, compared with $22.8 billion at the end of December.

None of Time Inc.'s major magazines -- including Time, Money, and People -- has been substantially affected, staffers say, and all continue to operate with a fair amount of independence. Take Sports Illustrated, one of the most profitable Time Inc. properties. When SI began feeling the pressure of growing competition from ESPN The Magazine, Time Inc. Editorial Director John Huey faced some hard decisions.

OLD FASHION NOTE. The problem was that ESPN The Magazine appeals to a younger generation of readers, while SI's audience continues to age. But Huey's replacement for Bill Colson, SI's respected veteran editor, was hardly from the new media mold that many at SI had expected: 57-year-old Terry McDonell, the former editor of Wenner Media's Us Weekly. SI staffers privately chuckle at McDonell's fondness for wearing a bow tie.

Likewise, the AOL movie studios in Hollywood -- Warner Bros. and New Line Cinema -- have carried on without a hitch since the merger, analysts say. They turned out two of this year's blockbusters, Harry Potter and Lord of the Rings.

What about technology? Are AOL's mavens introducing their magic at Time Warner? Nope. Consider the original plan to gradually switch the Time Warner outfits to AOL mail, the preferred e-mail platform and communication tool among the America Online staffers. Instead of a smooth transition, many of the Time Warner properties are still using their legacy e-mail systems and have scrapped the plans to migrate, deciding that such a move would be too cumbersome.

MORE LAYOFFS? Meanwhile, the execs who exuded techie panache at America Online's headquarters in Dulles, Va., are nowhere to be seen in New York. The man once thought to be the heir apparent to Levin's throne, Pittman, now spends half his time in Dulles trying to reignite the sputtering online unit, where employees are jittery about the possibility of another big round of layoffs, managers say.

Other America Online execs have already been cast aside. Barry Schuler, who ran the AOL division, now heads a newly created unit with a vague mandate of developing "digital services for AOL Time Warner platforms." With Pittman assuming Schuler's duties, Michael Kelly, once a top AOL exec and chief financial officer of the combined company, is now the chief operating officer of the AOL unit.

And what of the great synergies promised when the companies merged? In the first quarter of 2002, the AOL service's growth was essentially flat. Sales were up 8%, to $2.3 billion, but operating cash flow fell 15%, to $433 million. Compare that to the next biggest division of the company, Time Warner Cable. Its sales were up 19%, to $2 billion, while operating cash flow climbed 10%, to $841 million.

SLOWING SIGNUPS. Investors aren't just concerned about the AOL unit's e-commerce and online advertising revenues. Growth in subscriptions for the AOL services has been decelerating lately. The company is now giving away two months of free service to any new member who signs up for AOL's monthly Internet access, plus as much as a year free through rebate programs with computer retailers.

This generous offer follows a drop in first-quarter signups to 1.4 million subscribers, from 1.9 million in the previous quarter. And AOL has been unable to offer broadband Internet service in many large markets nationwide where it doesn't control the cable pipes or telephone lines. Nationwide broadband was considered to be the underlying technology necessary for much of the growth AOL and Time Warner envisioned. Now, that strategy is being rethought.

Can AOL Time Warner still find its way to solid growth? Yes. After all, this is the largest media entity in the world, with more valuable entertainment and news properties and established brands than Disney, Viacom, Vivendi, or News Corp. Perhaps investors will quickly end the descent of AOL's stock, with a rise beginning as the economy starts to pick up.

However, for the foreseeable future, investors may see the stock perform a lot more like the shares of entertainment mainstays such as Disney or Viacom -- moving slowly, with no sharp swings. Lose those open collars. Ties, anyone? Shook is a reporter for BusinessWeek Online in New York

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