January 9, 2002 4:00 AM PST
AOL Time Warner's identity crisis
Finalized nearly a year ago, the merger of America Online and Time Warner created the world's largest media company and what the deal's architects described as a catalyst for "supercharged" growth.
At the time, executives boasted of various "levers" they could pull to keep the combined company growing no matter what cards the economy dealt them. If AOL Time Warner were a football team, it would have been described as an offensive machine similar to the St. Louis Rams. The company was ready to run up the score.
But increasingly the merger between the two companies is looking defensive. Did AOL buy Time Warner because it couldn't keep up its rapid pace of growth?
That question may never be answered, but it's clear that AOL Time Warner is looking more like the old media Time Warner than the new media AOL. Although the company still talks about being supercharged, the mantra has been supplanted by incoming CEO Richard Parsons' call to under-promise and over-deliver--a common catch phrase used by companies who disappoint Wall Street.
"While AOL is still a solid operation, it's something of a one-trick pony compared to Time Warner," said David Lee Smith, an equity analyst at RBC Capital Markets. "AOL was born out of a phenomenon that took off like a bottle rocket and then quickly leveled off."
In other words, the company will become more Time Warner and less AOL.
AOL Time Warner admitted it had hit the wall Monday night when it reported 2001 financial earnings would under-perform and scaled back its 2002 expectations.
Company executives, most from the AOL side of the fence, had long adhered to the aggressive target of $40 billion in revenue and $11 billion in EBITDA (earnings before interest, taxes, depreciation and amortization) despite clear signs the advertising market was not recovering. Instead, company executives said revenue will come in at $38 billion with EBITDA hitting $10 billion.
Gartner analyst Eric Paulak says don't be deceived by the bad news coming out of AOL Time Warner lately. There's a lot of it, but the company still has a strong market position.
The company also revealed it will incur a $40 billion to $60 billion non-cash charge in the first quarter 2002 because of new accounting rules. The charges stemmed from AOL's falling stock value since announcing its intention to acquire Time Warner two years ago, but they do not reflect the financial health of the company.
Still, the charges highlight how much the mighty AOL has fallen since pulling off one of corporate America's greatest coups.
"Moving forward...we will be taking a conservative approach," CEO Gerald Levin said in a statement. "We will not, as we did last year, make assumptions about economic growth."
The AOL buzz-kill
It's been a tough year for AOL executives. Representing the Internet's triumph over old media, the luck of AOL's elite has gone south. Since the deal officially closed in January 2001, AOL executives were passed over for the CEO position, shuffled out of the chief financial officer role and faced with confronting the embarrassments of Monday night's financial reductions.
AOL was supposed to play the role of growth engine. But the Internet advertising collapse has begun to poke its head into AOL's financials, likely reducing the division's advertising and commerce revenue during the first half of 2002.
In a sense, AOL has gone from jewel to stone in AOL Time Warner's crown.
Meanwhile, some of the businesses inherited from AOL have caused short-term financial headaches. AOL Time Warner will acquire the remaining 49 percent stake in AOL Europe from German media conglomerate Bertelsmann for $6.75 billion in cash. The purchase will hurt the AOL division's earnings in 2002 because it will be EBITDA negative.
However, AOL Europe's rate of EBITDA growth actually helps AOL Time Warner as a whole in reaching double-digit EBITDA growth, according to Youssef Squali, an analyst at FAC/Equities. AOL Europe will lose $600 million in EBITDA in 2001, but it will reduce those losses to negative $300 million in 2002. Despite being in the red, the $300 million in net growth will help boost AOL Time Warner's percentage growth next year.
Confusing as it may be, it shows that AOL Time Warner's acquisition of AOL Europe may have saved its neck in perception. That could be a significant factor, given that Wall Street judges AOL Time Warner by EBITDA.
Still, AOL faces more exposure to considerable challenges in the European market with AOL Europe under its belt: namely, the dominance of national telecommunication monopolies and metered pricing schemes that make surfing the Web expensive.
To its credit, AOL remains the undisputed Internet leader. AOL has more than 33 million subscribers worldwide--leaps and bounds beyond any competitor--and its much-feared subscriber plateau appears exaggerated. It is also well positioned to push broadband into the home through aggressive marketing for people to upgrade their dial-up accounts.
If anything, the realities of the media business during a recession have taught the AOL guard a valuable lesson: Nothing is immune to a recession, despite the strength of the business.
"What these guys did was they made an arrogant bet that the economy would recover in time to meet their numbers," said David Simons, managing director of institutional research firm Digital Video Investments.
The "V" word
For Wall Street, it's back to basics in its evaluation of the company. No longer does the Internet hold much sway in its financial potential.
Revenue growth for 2002 will run at a paltry 5 percent to 8 percent, a conservative estimate that factors in a lackluster ad environment. Furthermore, stripping away AOL Europe from AOL Time Warner would show that the company would report 4 percent to 8 percent EBITDA growth--much less than the 8 percent to 12 percent with AOL Europe included, according to FAC/Equities' Squali.
Single-digit revenue growth and single-digit EBITDA growth has caused some to reconsider how they label on AOL Time Warner's stock. (Hint: it doesn't start with the letter "g").
"It's starting to fall into the value category," said Squali.
That's quite a turnaround, despite expectations of AOL's supercharging effect on the company's finances. The label only gives more proof that the pairing of AOL and Time Warner is being viewed from the tortoise's perspective and not the hare's.
"If you're only growing 5 to 8 percent revenue or 8 to 12 percent EBITDA, you're not a growth stock," said Paul Kim, an equity analyst at Kaufman Bros. "The old Time Warner barely grew on 8 percent growth for EBITDA and only 3 percent for revenue."