Time Warner Expects Offering AOL Free Will Be Costly By MATTHEW KARNITSCHNIG Wall Street Journal
July 11, 2006; Page B1 http://online.wsj.com/article/SB115258401032003019.html?mod=home_whats_news_us Time Warner Inc. expects its AOL unit to sacrifice nearly $1 billion of operating profit through 2009 under a proposed plan to offer the online service free of charge to some customers, according to internal company forecasts. The company, however, is also forecasting that growth in Internet ad revenue will partially offset the expected decline in subscription revenue and ultimately leave the company more profitable. The new proposal would cut roughly in half profit from AOL's sale of Internet subscriptions in the U.S. in the next three years, the forecasts show, from $1.6 billion this year to about $800 million in 2009. According to the forecasts, AOL, which has 18.6 million U.S. subscribers now, would end up with just over six million by the end of 2009. Internet access accounts for the bulk of AOL's profitability. The size of the projected decline in subscriptions highlights the considerable risks inherent in the company's proposal and the pressure management feels to take action. Nevertheless, according to people familiar with the situation, the company believes it can continue to increase operating profit throughout the period, betting that its operating margins in the advertising business will jump from 17% in 2006 to 42% in 2009. In addition to gains, the company believes it can cut about $1 billion from its marketing budget, according to people familiar with the matter. The latest proposal comes at the urging of Jeff Bewkes, Time Warner's chief operating officer, who took over responsibility for the business at the beginning of the year. Mr. Bewkes is considered the leading candidate to succeed Chief Executive Richard Parsons, whose contract runs to 2008. If AOL fails to meet growth targets for ad sales, Time Warner could take a substantial hit to its bottom line. The online division accounts for about 20% of its operating profit. AOL's internal forecasts estimate revenue from sales of domestic Internet subscriptions to drop by a staggering $2.7 billion over the next three years, from about $4.2 billion this year to about $1.5 billion in 2009. Overall revenue, including advertising and Internet-access, is expected to decline from $6 billion in 2006 to $4.9 billion in 2008 before starting to increase again in 2009 when it is expected to reach $5.3 billion. The overall revenue figure excludes AOL's European Internet-access business, which is on the market. AOL is betting it can maintain operating profit growth in the mid-single-digit range from 2006 through 2009, according to people familiar with the situation. To succeed, however, it would have to increase its advertising revenue at an annual rate of 25%-30%, according to the forecasts. Since 2004, AOL's advertising business has grown at about 35% a year, including acquisitions. While analysts expect Internet advertising to grow within the range that underlies AOL's forecasts, a sudden slump could rob the company of its main source of income and potentially undermine the business. Of AOL's 18.6 million domestic subscribers, about six million get their Internet access from a high-speed provider such as a cable operator or a phone company. These people pay a discounted fee to continue as an AOL subscriber. Under the plan, AOL would let subscribers with a high-speed connection keep their AOL account free. The plan would give AOL's domestic dial-up subscribers an incentive to switch to a high-speed connection offered by another provider. Management's theory is that former subscribers will remain loyal to AOL if they can use their AOL email account and software free of charge. That, in turn, would boost the number of people viewing the ads on AOL's Web sites. The forecast doesn't explore what would happen if more subscribers than expected take up AOL's free offer. The company assumes that many AOL users will continue to pay for the dial-up service, either because they don't have access to a high-speed connection or because they don't want to switch. AOL will focus on boosting ad sales on its email service, the part of its Web site that draws the most traffic. It recently began adding ads to the page where members' emails are displayed -- including posting ads that appear as though they're part of the email -- and will likely take similar steps if the plan is approved. Critics say AOL needs to do more to draw new users to its other offerings, which include a variety of news and entertainment sites. "They have not defined what AOL means for the average consumer," says Richard Greenfield, an analyst at Pali Research. The plan, to be put to Time Warner's board at the end of the month, comes as Wall Street has been pushing Time Warner executives to take decisive action to fix AOL. The Internet division's woes have weighed on the company's stock price for several years. Time Warner stock has fallen 11% since February. In recent years Time Warner has undertaken various initiatives to turn around the business, including beefing up its free Web site with many of the features previously offered only to paying subscribers and a recent plan to offer AOL at a discount to users with high-speed Internet access. Those efforts, however, have largely failed. In the first quarter alone, AOL lost about 850,000 subscribers. Total U.S. subscribers were 18.6 million in the quarter, down from 26.5 million at the end of 2002. The plan has the enthusiastic support of AOL head Jonathan Miller but it is being resisted by some employees. Implementation of the proposal, which is expected to lead to thousands of layoffs, would prompt a broad restructuring of AOL's management ranks, the people say. ================================================= George Antunes Voice (713) 743-3923 Associate Professor Fax (713) 743-3927 Political Science Internet: antunes at uh dot edu University of Houston Houston, TX 77204-3011 Reply with a "Thank you" if you liked this post. _____________________________ MEDIANEWS mailing list [email protected] To unsubscribe send an email to: [EMAIL PROTECTED]
