AOL Goes From Dog To Diamond

Its new lease on life gives Dick Parsons a chance to boost Time Warner stock, excite shareholders, and quiet Carl Icahn

It's no secret that Time Warner CEO Richard D. Parsons loves a party, especially one thrown in his honor. So there he was on Sept. 20 schmoozing in a sea of tuxedos and sequined gowns at Manhattan's Pierre Hotel. The A-list had gathered for a dinner given by the Jewish Theological Seminary to honor the business and philanthropic efforts of Parsons and his wife, Laura, a child psychologist. Clearly, the 57-year-old executive, shaking hands and giving hugs, was soaking up the recognition.

And why not? Since taking the top job in May, 2002, Parsons has faced plenty of critics. Many shareholders, bitter over the ill-fated AOL-Time Warner merger, excoriated the CEO, demanding he jettison America Online and free the media empire of its biggest burden. But Parsons put his head down and methodically cleaned up a series of messes. He sold off businesses, reduced debt, resolved federal accounting investigations, and moved to settle shareholder lawsuits. And while the stock is trading at 18, where it was when he took over, today shareholders have eased up on AOL and taken a wait-and-see approach.

Indeed, AOL is emerging as a key weapon in Parsons' fight to keep shareholders in his camp -- and from joining forces with Carl Icahn. The infamous corporate raider has snatched up 3% of Time Warner's stock and has threatened to launch a proxy fight to get the stock moving again. While Parsons has announced plans to spin off 16% of Time Warner's cable unit and buy back $5 billion in stock, Icahn wants to force Parsons to spin off all of cable and spend $20 billion on Time Warner shares.

Instead, Parsons is counting on a revival at AOL, newly reborn as a portal, to get investors excited about Time Warner's stock again. Not only is AOL benefiting from a surge in online advertising but Time Warner has held talks -- now on hold -- with former arch-foe Microsoft Corp. (MSFT ) about linking up with the MSN Internet service, the No. 2 portal. Combine the interest from Microsoft and AOL's ascendancy as an advertising play, and the Internet unit suddenly looks a whole lot more valuable. Analysts say AOL could be worth $15 billion to $20 billion -- up to twice its valuation just two years ago. Says Mitchell Rubin, lead manager for Baron Fifth Avenue Growth Fund (BBFTHX ), a Time Warner shareholder: "I still see the potential for the AOL business as huge."

That prospect would go a long way toward helping lift the beleaguered stock -- and for now, it's helping Parsons keep Icahn at bay. Investors told BusinessWeek that, while having Icahn riding herd on Parsons isn't a bad thing, they would rather give Parsons a chance to make the portal strategy work before doing something drastic like spinning off cable. "Shareholders at this point are investing in management," says Henry Ellenbogen, an analyst at T. Rowe Price Group Inc. (TROW ), a Time Warner shareholder. Adds media investor Mario J. Gabelli, whose firm owned 16 million shares of Time Warner as of June: "If Parsons can get AOL right, it could boost that business' valuation from about $20 billion to $50 billion someday. I say stay the course."


The question for Parsons is whether to stick with Plan A -- going it alone with the AOL portal strategy -- or to tie up with MSN or even Google Inc. (GOOG ). Merrill Lynch & Co. (MER ) analyst Lauren Rich Fine speculated on Sept. 16 that Google might consider a deal. Google, which already provides search technology and shares ad revenues with AOL, declined comment. For now, Parsons vows to accelerate the AOL portal strategy. On Sept. 21 he told a Goldman, Sachs & Co. (GS ) investor conference: "The biggest growth opportunity for us is in AOL." Still, Parsons is considering all options, including selling off a minority stake in AOL. It's all good as far as investors are concerned. "AOL is the final remaining issue for Parsons," says Jerome W. Walther, executive vice-president of Church Capital Management, which owns 350,000 Time Warner shares. "I'm happy to see he's being proactive and seeking alternatives."

It's easy to see why many are giving AOL another look. After several years of watching revenues slide as dial-up subscribers deserted the service in droves, the online unit over the past nine months has focused more on the fast-growing Internet ad market. On July 21, the free Web site relaunched as a hub to help generate traffic among AOL's properties -- including AOL Instant Messenger, AOL Music, and MapQuest. About 112 million monthly unique visitors go to those sites, helping to generate $1 billion in ad revenues for AOL last year. Now, with the effort to gain an ever-bigger audience from its Web sites, AOL is likely to rack up $1.35 billion in ad revenues this year, says Fulcrum Global Partners.

Even if AOL's revenues continue to decline with its subscribers -- 900,000 fled during the second quarter alone -- the company hopes for growth in ad profits. After all, about 50 cents of every dollar of ad revenues falls to the bottom line, vs. just 20 cents of every subscription dollar, says AOL CEO Jonathan F. Miller. All the while, AOL continues to launch services to gain new users. On Sept. 20 it announced the rollout of a voice-over-Internet-protocol phone service, following similar moves by eBay (EBAY ) and various cable companies. AOL is introducing original programs to its flagship Web site, too. They include The Biz, a reality show where the contestants vie to start a record label at Warner Music Group Corp. (WMG ).

Given investors' enthusiasm for the AOL strategy, would Parsons risk a tieup with MSN? There are pros and cons. On the plus side, a combined AOL and MSN, which itself boasts 100 million unique visitors a month, would easily top rival Yahoo! Inc. (YHOO ), which has 122 million monthly unique visitors, according to comScore Media Metrix. That would make the duo much more attractive to advertisers. "A combination of AOL and MSN would turn the industry on its ear and make us reassess our assumptions of the power players," says Jeff Lanctot, vice-president for media at Avenue A/Razorfish, a unit of Seattle online ad agency aQuantive Inc. (AQNT ).

On the other hand, a deal with MSN would almost certainly mean ending AOL's lucrative partnership with Google. One third of AOL's second-quarter $320 million in ad revenues came from its search deal with Google: In exchange for directing AOL users to Google for searches, AOL receives 80% of paid search revenues generated. If, in switching to MSN Search as part of the deal, AOL were unable to command the same interest as Google from advertisers and users, it would lose a substantial and growing revenue stream. "It's risky for AOL, unless they get a big payoff [from Microsoft]," says David Card, an Internet analyst at JupiterResearch.


Many shareholders feel much the same way. While intrigued by a partnership for AOL, they want more details. "It seems like a waste if you give too much away, especially since it's the one sector of media growing by leaps and bounds," says Baron Fifth Avenue's Rubin.

And as Parsons woos shareholders, he must keep an eye on Icahn, who thinks Parsons' priorities are upside down. "While we think AOL is undervalued and we would study and maybe embrace alternatives," Icahn told BusinessWeek, "we still think the greatest value enhancer, the jewel here, is splitting off cable and buying back $20 billion of stock."

For now, Parsons appears to have the edge over the notoriously dogged raider. If his strategy works and Time Warner shares get out of neutral, who knows? It might even be Icahn who throws Parsons his next party.

By Tom Lowry and Catherine Yang, with Ben Elgin in San Mateo, Calif.

— With assistance by Ben Elgin

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