January 21, 2003 4:00 AM PST

Yahoo and AOL: Reversal of fortunes

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The past two years have seen a dramatic reversal of fortunes for Internet bellwethers AOL Time Warner and Yahoo, highlighting both the pitfalls and the renewed promise of the Internet.

The shift has been underway for months. But it became palpable last week, when Yahoo reported surging revenue and profits amid ongoing turmoil at AOL Time Warner and its beleaguered America Online division.

The contrast couldn't have been sharper, compared with two years ago.

At that time, America Online had just finalized its merger with Time Warner, catapulting founder Steve Case to the top of the world's biggest media company as chairman. Yahoo, meanwhile, was preparing to announce the first of several steep downward financial revisions, based on a looming crash in the dot-com advertising market. The cuts would eventually slash the company's most optimistic revenue predictions for the year 2001 nearly in half.

"Two years ago, Yahoo's sheer focus on advertising revenue was perceived to be inferior to AOL's balance of subscriptions and advertising," said Mark May, an analyst at Kaufman Bros. "Today, the tables have turned, and Yahoo has a more balanced business."

It's too soon to tell whether Yahoo has put all of its troubles behind it, or whether the AOL division has what it takes to engineer its own rebound. For now, however, the two paths of the companies offer an instructive preliminary look at what's working and what isn't in the arena of dot-com turnarounds.

Ironically, Yahoo's playbook pulled many of its key pages from AOL, which is now looking to emulate its Web rival on some fronts.

That's not to say all of Yahoo's problems have been solved. Its advertising revenue has improved, but the health of online advertising spending in general remains questionable. Yahoo has also relied on its partnership with Overture Services to feed much of its profitability, which is not bad, but raises concerns about overreliance on this partnership.

Still, the series of bets made under the leadership of Yahoo CEO Terry Semel, who replaced Tim Koogle in May 2001, have done much to please investors and to quiet naysayers. Yahoo reported Wednesday its third-consecutive quarter of profitability, booking $46.2 million in net profit and a 51 percent jump in revenue to $285.8 million.

This is a far cry from Jan. 10, 2001, when Yahoo cut its yearly revenue projections to between $1.2 billion and $1.3 billion from $1.42 billion. The company ended 2001 with $717.4 million in revenue. The day after Yahoo reported those earnings, the Federal Communications Commission approved the merger between AOL and Time Warner after a bitter, yearlong review process that squeezed out concessions from the combined company.

Wall Street analysts Wednesday were impressed not only by Yahoo's strong numbers, but also by its growth in areas such as paid services--which Semel has deemed a benchmark of his tenure.

"Terry Semel's vision and plan was to build deeper and stronger relationships with users and then go out and build, buy and partner to make value," Dan Rosensweig, chief operating officer at Yahoo, said in an interview Wednesday. "Once you put that strategy in place, the focus is on how to best do that."

An AOL representative declined a request for executive comment.

Meanwhile, Yahoo's core business of selling advertising slots on its Web pages has also shown signs of improvement. Jeffrey Fieler, an equity analyst at Bear Stearns, estimated that Yahoo's online advertising revenue, which excludes Overture, jumped 11 percent from last year.

The company attributed much of this success to progress in its relationships with advertising agencies once snubbed and mishandled during the dot-com boom years.

Rethinking broadband
AOL Time Warner was briefly feared as a new media giant capable of commanding unprecedented power over emerging communications technology and distribution channels for news, music and movies. But the company quickly fell victim to a steep economic downturn and bitter corporate infighting.

AOL Time Warner Chairman Case said this week he would resign to become an outside director in May, citing internal pressure. CEO Richard Parsons was appointed as his replacement, scheduled to assume a new dual chairman and CEO position in May.

The company is scheduled to report earnings on Jan. 29.

Parsons' chief problems include managing some $26 billion in debt and righting the America Online division, which was once touted as a chief growth engine but that has since become a drag on overall profits.

Handed the challenge of fixing the matter, Jonathan Miller, a former USA Interactive executive, was appointed America Online's CEO last year.

Yahoo's transformation should give AOL hope. Not surprisingly, AOL's own ambitious turnaround plan, outlined in December, touches on many themes similar to those in Yahoo's plan from November 2001: Warm up to advertising agencies, launch premium services and partner with broadband providers.

However, the stakes in AOL's turnaround hinge on one important dilemma that its rival doesn't need to face: AOL's narrowband business, which has amassed 35 million subscribers, is in jeopardy.

One of the strongest arguments supporting AOL's claim of resilience two years ago was its foundation of subscribers. The media and Internet industries quaked when AOL and Time Warner merged, fearing the combined company's prospects in broadband.

The common belief was the company could convert AOL's narrowband subscriber base to joining the high-speed world of broadband, and then sell more interactive services to them. During a speech in December 2001, Robert Pittman, then AOL Time Warner's co-chief operating officer, predicted he could extract $159 a month per broadband household and up to $230 a month per household with services offered by Time Warner Cable.

But the AOL service's future potential could not mask the harsher realities of running a broadband service. AOL Time Warner executives soon realized that migrating highly profitable AOL dial-up subscribers to broadband would drastically slice profit margins per subscriber. That's because buying broadband pipes remains expensive, proportional to buying narrowband lines.

Facing this reality, AOL is backing away from its previous insistence on running its entire broadband service, from network maintenance to billing. Instead, the company plans to pursue partnerships with cable and telephone companies that would let it offer its flagship AOL service as a premium on top of an existing service. AOL also intends to heavily market "Bring Your Own Access," which charges people on other broadband services $14.95 a month to access AOL's proprietary environment.

This double shift underscores a turnaround from AOL's lofty predictions two years ago. Internet companies are getting edged out of the business of selling broadband.

"The access model is no longer, really, in the hands of the Internet portal," said May of Kaufman Bros. "In a broadband world, it's becoming the purview of the cable and (regional bell operating) companies."

Nickels and dimes
That threat, and Semel's example in selling premium services, has caused AOL to begin to follow in Yahoo's footsteps. In December, the company demonstrated its newest premium service, called AOL Call Alert, which allows members to manage incoming phone calls when online for $3.95 a month. AOL also plans to begin selling its digital music service MusicNet next month, a company representative said.

When Yahoo began selling premium services, the move was ridiculed by analysts and observers as a desperation move to diversify revenue. Many dismissed the idea of chiseling dollars from a user base accustomed to getting everything for free.

But again, Semel's bet has so far proven to be the right one. Yahoo's 2.2 million subscribers have contributed to the overall $89.4 million taken in by its fees and listings business--which includes an undisclosed amount from premium services--in the fourth quarter.

Whether these bets will prove right in the coming few years could all hinge on whether online advertising rebounds. Until then, history is rewriting itself.

"Semel should be given credit for focusing the organization, for improving efficiency and pursuing interesting long-term growth prospects," said Jordan Rohan, an equity analyst at SoundView Technology Group.

 

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