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The Ails of AOL

It's hard to envy AOL. While other Internet heavyweights are growing by leaps and bounds, the unit of Time Warner (TWX) remains at the back of the pack. Compared with rivals Yahoo! (YHOO), Google (GOOG), and Microsoft's (MSFT) MSN, AOL's sites receive the fewest unique monthly visitors, and they have the slowest audience growth, according to Nielsen/NetRatings. In the business that provides subscriber-based services, AOL is losing customers at a quickening pace and sales are trailing off.

AOL executives are racing to stem the hemorrhage of dial-up customers and compensate for lost subscribers by boosting revenue collected from advertisers on its portal of Web sites and services like AOL Instant Messenger. So it needs to attract new users who've never before subscribed to AOL. To do that, AOL is building new features and adding content, like the recent debut of free television programming with its In2TV service, or the planned AIM Pages that will function like a social network (see BW, 1/30/06, "AOL: MySpace Invader").

TURNAROUND TIME? Steps in the right direction? Maybe. But financial results released May 3 indicate they have yet to have much of an impact. "They're doing some interesting things so far with their platform, and there's huge potential for AOL" going forward, says Rich Greenfield, analyst with Pali Capital. "I'd just like to see them moving a little faster versus the competition."

Gains in advertising are nowhere near offsetting subscriber weakness. Revenue from subscriptions, which makes up 77% of AOL's business, dropped 13% to $1.54 billion in the first quarter from a year earlier. Another 858,000 subscribers defected in the period. Advertising sales rose 26% to $392 million. Overall, AOL's revenue for the quarter ending Mar. 31 slipped 7% to $2.0 billion. Operating income fell 14% to $269 million.

Enter AOL's turnaround plan. One component of the strategy, unveiled last year, is to nudge customers who access accounts via slow dial-up telephone connections to sign up for services delivered at broadband speeds, which are provided in partnership with cable companies such as Time Warner Cable.

NO QUICK FIX. To win more broadband customers, AOL inked deals this year with telecom stalwarts AT&T (T), Verizon (VZ), BellSouth (BLS), and Qwest (Q). AOL is also betting on a boost from its partnership with Google, which invested $1 billion in AOL. The deal could mean additional traffic to the AOL site, as well as much needed revenue (see BW Online, 12/21/05, "AOL-Google: Who Gets What").

Meanwhile, AOL opened up its previously members-only features and services to all users on the Internet, in hopes of maximizing the revenue generated from the ads on the site. That has included services ranging from In2TV, which streams free, ad-supported versions of old Warner Bros. television programs like Perfect Strangers and Welcome Back, Kotter, to a new suite of financial blogs, which debuted on the AOL Money & Finance site on Apr. 27.

"They're launching a lot of new and different features to draw new users in," rather than trying to woo them away from services where they are well-entrenched, says Charlene Li, analyst with Forrester Research. "That's a smart move. The growth will happen slowly -- they are building a foundation and a base for the users, and that's not going to be one single silver bullet."

"IT'S STILL EARLY." So how long will it take? Time Warner CEO Richard Parsons told analysts on a May 3 conference call that it's still too early to say when the losses will end. "AOL's results have largely been in line with our expectations," says Parsons. "We are hopeful that later this year we will be able to predict when the subscriber base will essentially be stabilized."

Time Warner execs also said they expect AOL earnings to begin growing again in the second half of 2006, as the new broadband deals signed in the first quarter begin to bear fruit. Time Warner President and Chief Operating Officer Jeff Bewkes told analysts, "Page views from non-members on [] are small but they are growing ... [and] we are driving for these broadband subscriptions." He also noted, "It's still early."

Investors who have been waiting half a decade for a payoff from the merger that united AOL with Time Warner may beg to differ.

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