AOL investors,
Below is Part I of a two-part research report on AOL issued by Prudential Securities as of today (7/22). Table was deleted for ease of transcribing:
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RESEARCH
AMERICA ONLINE
JULY 22, 1999
AOL: E-COMMERCE ENGINE IS JUST WARMING UP; AOL STRATEGY FOCUSED ON TRACK-CURRENT PRICE IS A BUYING OPPORTUNITY-STRONG BUY, $212 TARGET REITERATED(Part 1 of 2)
STRONG BUY/SBI/SELECTAnalysts: Paul L. Merenbloom (212) 778-7328 Prior: Aydin O. Tuncer (212) 778-6764 Risk: HIGH Current 12-Month Price Target: $212
Key Points:
We believe that AOL E-Commerce efforts, and yields are only warming up.'; Results from 2Q demonstrate powerful leverage within the AOL operating model, suggesting that E-Commerce/Advertising revenues will grow disproportionately faster than subscriber revenues for the foreseeable future;
We believe that revenue per month per subscriber, now at $6.50 per share is tracking to reach the $9 run rate as early as December of this year; While subscriber growth, in absolute terms was below earlier forecasts, adding 755,000 net subs in the period demonstrate a powerful ability to retain, as well as capture significant audiences;
Subscriber revenues of $943 million v. our estimate of $951 million on 755K added subscribers v. our 900K earlier estimates suggests a lower churn rate and stronger subscriber acquisition during the first half of the quarter;
AOL's strategy is impeccably clear-aggregate content, commerce services, vendors, customers and bandwidth options; offer consumers the ultimate in choices-notably for content, services, bandwidth and features; keep the service(s) easy to use and well supported; and simultaneously drive user confidence, commitment, and online behaviors;
The company's multi-brand strategy, unique ability to adapt and incorporate new technologies, services, and features, and to rapidly (and flexibly) respond to dynamic market conditions will further the company's leadership position, subscriber roles, merchant partner relationship(s), and overall revenue/margin leverage;
We reiterate our price objective of $212 per share based on a blend of segmented DCF of $184, aggregated DCF of $211/share; and a line of business valuation of $242 per share;
We note that AOL is on track to reach a $10 Billion run rate within the next 4-6 quarters. Summary/Investment Thesis. Against a backdrop of competition from free-PC /Internet retail bundles, increasing contention over the open cable and broadband debate(s), and pre-released indications that subscriber growth would not reach previously expected levels of 900,000 for the period, America Online turned in their most powerful quarterly results to date. Noting the company's 755,000 net new subscribers-which reflect only the flagship AOL and CompuServe brands, total revenues topped $1.38 billion as subscriber revenues of $943 million were augmented by record setting E-Commerce/Advertising revenues of $306 million and Enterprise Software revenues of $128 million for the period. In the context of a quarter in which AOL completed the merger with Netscape, formed a strategic relationship with Sun Microsystems, furthered key relationships with the Cisneros group for AOL/Latin America, acquired MovieFone and two additional properties, and faced increasing pressure vis-à-vis Dixon's FreeServe in the U.K. the company's stellar results demonstrate the present, and potential power of the AOL operating model and strategy. Viewer online time per day is up 19% per year at 56 minutes per day. This growth rate, which has been consistent over the previous two years, and up dramatically from 14 minutes per day just three years ago, demonstrates AOL's success at making their product a part of the user's daily routine.
Accordingly, we expect that the E-Commerce/Advertising revenues presented thus far, which we note are up 11% sequentially and 145% annually, are only beginning their ramp. This suggests that AOL could harvest as much as 30%-40% of revenues as early as January, 2000. Further, we believe that operating margin leverage from E-Commerce/Advertising revenues will prove very substantial over the coming two years-stimulating profits and driving upward the value of AOL's shares. Addressing The Market's Needs With Multiple Brands And Services-Leveraging A Common Infrastructure. One of AOL's greatest strengths is the array of brands the company has developed and the high growth rates of several of these brands as measured by reach and markets addressed. Clearly the flagship AOL service continues to enjoy solid growth with an estimated 4.5 million subscriber (net) addition rate for the completed fiscal year and our expectations for similar growth rates for FY 2000. Compuserve, restarted in the last year, continues to grow from the 1.2 million subscribers six quarters ago to nearly 2.5 million subscribers today. ICQ-the company's Internet-based chat and messaging system-now boasts over 38 million registered users and over 1 million simultaneous users-matching only AOL for concurrent-access utilization. We believe investors should aggressively buy AOL shares for considerable returns over the coming 12-18 months. We reiterate our belief that AOL shares are substantially undervalued at current levels. Growth in the company's subscriber base will, we expect, continue to fuel AOL's reach into the marketplace-in turn stimulating and fortifying the AOL-Merchant and AOL-Consumer relationships.
In addition, we reiterate our belief E-Commerce revenues will generate a disproportionate contribution to operating revenues and earnings. Given the relatively early-stage of the Internet's E-Commerce efforts and the exceptional returns to companies using the Internet to dis-intermediate traditional distribution channels, increase brand awareness and loyalty, and to generate greater returns for a fewer number of vendors (recapturing margin) we believe that AOL's captured customer base, increasing reach and penetration, will lead to exceptional revenue and profit opportunities for AOL and its shareholders. We expect that the negative sentiment around Internet stocks and the lack of vision' into the future of AOL's operating model and potential, today, have created a unique buying opportunity for investors. We expect the back-to-school season to preview E-Commerce revenue opportunities and scale expected in the 1999 holiday season.
Finally, we wish to remind investors that E-Commerce seasonality seems to be abating with sequentially stronger results in each of the past several quarters. We Are Reiterating Our Strong Buy Rating On Shares Of AOL And Our $212 Price Target.
We believe that the leverage opportunities from the Netcenter business-portal and newly introduced Netscape Online (free) service rolling out in Europe (to counter Dixon's FreeServe services) will prove exceptionally powerful. Drawing eyeballs and E-Commerce revenues on a worldwide basis, AOL enjoys particular operating leverage deploying these services and AOL's International offerings on a common operating platform designed for AOL's proprietary system and on a network backbone and distribution network financially engineered to be funded primarily by AOL traffic alone. The Strategy Is Clear And Focused-Collect The Users, Change Their Behaviors, Capture The Brand And Harvest The Revenue Opportunities. Despite discussion and noise' about AOL's efforts in open cable access support, the free-PC/free-Internet access market and the myriad of joint-ventures and partnerships, we believe that AOL's core strategic focus remains singular and successful-collect eyeballs, increase online time per day, and begin to harvest additional high-margin revenues. To this end, the just reported revenues suggest powerful, untapped resources vis-à-vis E-Commerce/Advertising revenues. Noting over $1.5 billion in backlogged E-Commerce/Ad revenues AOL is well positioned to draw their subscribers and merchant vendors closer and closer.
We expect the company will focus future analysis on revenue per member per month contributions-growing from an estimated $6.40 per member per month in E-Commerce current revenues to a run rate of nearly $12 per member per quarter by the end of the current fiscal year. Noting the significant (positive) difference in gross margin contributions between subscriber monthly fees and E-Commerce fees we believe AOL will have the ability to demonstrated significant earnings leverage on subscriber growth rates of 5 million per year.
(To be continued)
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