Part II of A Prudential Research Report (7/22/99):
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Further, it is important to note that AOL has yet to monetize their ICQ, AOL Instant Messenger, and/or Netscape user bases. While some advertising revenues are flowing through these channels, it is our expectation that over time, the 38 million ICQ members could generate as much as $8 per member per month in E-Commerce/Advertising revenues to AOL-against a cost basis of less than $1 per member per month. Clearly, the AOL earnings and revenue leverage are in early stages and offer strong upside potential. Bandwidth Is A Side-Bar-Although Important, We Believe That AOL's Strategy Is To Give Users What They Want, Where They Want It And At Prices That Are Easy To Digest. Despite attention to the need for speed, including AOL's announced deal with Ameritech complementing the high-speed access deals from Bell Atlantic and Southwestern Bell, we note that the footprint of broadband access is, today, too small to be meaningful other than as an indicator of events to come.
AOL's Plus' service, expected to roll out this fall tied to the release of AOL 5.0, will include features that enable AOL to automatically scale the user's experience (and access to advanced broadband resources) to the individual's connection channel and PC capabilities. Simplified, we believe that AOL is adopting every and all access approaches in order to offer their members choice. Choices in content, speed, pricing and access venues will, we expect, strengthen the bond between AOL and its various members-increasing brand loyalty and enhancing the potential for E-Commerce revenues. We do not believe that AOL is in material competition with Excite@@Home, or many other vendors for market share.
Despite the apparent positioning over Open Cable access and contention for E-Commerce deals vs. Excite, Yahoo!, Lycos and others, we remind investors that the market is, by and large, nascent and that AOL is a clear leader in their segment. Yes, we expect a small percentage of customers will leave the AOL service for the promise of DSL and/or cable access and a more self-directed experience-however it is important to note that AOL's customer core are people who wish to have turn-key access to services-narrow- or broadband based. AOL's marketing and E-Commerce efforts focus on the vast majority of the general user community-not the technophiles, early adopters, nor fringe.
While there is increasing choice to users to buy on price, and noting that the CompuServe brand value-product is placed in the middle of the consumer-PC focused products as co-bundled offerings in many retail channels, we have no reason to expect that AOL's core membership growth will be diluted. To the contrary, we expect that the growth of the lower-end segments (people shopping for free PCs and cheap access) represent a new and important market segment that AOL can share in and draw from as upgrade candidates. Revising FY Revenue And EPS.
In light of the company's subscriber growth experiences in F4Q, 1999 we are trimming our forward projections for 4QF00 subscriber growth modestly. We are still expecting new subscriber growth of 5.5 million for the coming year to tally 23 million by June, 2000. We expect revenue growth to $6.4 billion for FY2000, up from our $6.2 billion initial forecast.
Driving these changes are a reduction in our enterprise software (Netscape) to $517 million from $590 million offset by increases to our E-Commerce line to $1.5 billion from $1.2 billion. We continue to model subscriber revenues at $4.4 billion for the year. Our EPS forecast of $0.61, adjusted down from our $0.68 earlier estimate, reflects a more conservative set of expectations on marketing requirements-particularly for CompuServe, Netscape (enterprise software), MovieFone and ICQ. We also note that the introduction of AOL in Latin America and Hong Kong (Asia region) may require more aggressive marketing efforts and resources. While we still expect operating margins to show improvement from the 16% level from the June quarter, we note that the ramp from 16% to a 20% level may be back-end loaded as AOL continues heavy investments in developing and marketing total products and services across the five-plus brands during the coming year. We fully expect to be able to grow our revenue and earnings estimates during the coming year, but wish to remain conservative going into the F2000 year. The Quarter Was Solid. Online service revenues of $943 million were up 41% year-to-year and were $8 million below our estimate.
AOL added 755,000 new members in the 4Q, with 688,000 net new domestic adds and the balance coming from international markets. The international growth was below our expectations, reflecting increased competition in the UK market from free ISP' services.
We are slightly raising our subscriber growth estimate for FY 2000 to 4.8 million net new subscriber, up from our previous 4.7 million. Usage levels continues to remain strong at 52 minutes per user per day spent on the AOL service. ICQ had another tremendous growth quarter, reaching 38 million registered users, up from 33 million in the March quarter. AOL instant messenger also posted strong growth, adding 7 million registered user to reach 25 million users at the end of the 4Q. AOL had another impressive quarter for E-commerce/other revenues, posting $306 million in revenues versus our $240 million estimate and up 145% year-to-year. We believe that AOL is still in the early stages of monetizing its customer base through advertising and e-commerce revenue generation.
We are raising our E-commerce/other revenues estimates for FY2000 to $1.562, from our previous $1.22 billion, reflected our confidence in AOL's ability to generate 50% annualized growth in this area. The backlog for advertising revenue grew to $1.519 billion, from $1.321 billion in the March quarter and now exceeds the entire quarterly revenue run-rate for AOL, giving exceptional visibility to future quarters for this high-margin, highly leveragable revenue stream. Enterprise solutions revenues of $128 million were slightly below our $130 million estimate.
The Sun/Netscape Alliance, newly dubbed iPlanet, signed 30 multi-million dollar deals signed in quarter and added 40 first time customers to its existing base of 300 out of the Fortune 500 companies. We are lowering our Enterprise solutions revenue estimates for FY 2000 to $517 million from $590 to reflect a seasonally slow upcoming September quarter. The Operating Model Shows Continued Strength. Gross margins of 46.2% were substantially above our 43.7% estimate on improved network utilization and seasonally slower traffic patterns that led to the network not burning as hot as the past quarter. Operating expenses of $410 million were above our $388 million estimate, driven largely by higher than expected sales and marketing costs of $214 million (15.5%), versus our $188 million. G & A costs of $111 million were $1.5 million higher than our estimate. Other income was $12 million higher, leading to EPS of $0.13, ahead of our $0.12 estimate.
AOL's balance sheet remains exceptionally strong, with $1.4 billion in cash, below the March quarter and even with December quarter. AOL's debt levels remain extremely low, with only $348 million in long-term debt, giving the company flexibility and leverage going forward.
In addition, any increase in debt in the capital structure would lower AOL's weighted average cost of capital, significantly boosting our discounted cash flow valuations. DSOs of 22 days were down from 23 days in the March quarter and remain low on an absolute basis, pointing to AOL's effective collection efforts. We are lowering our EPS estimates for FY 2000 from $0.68 to $0.61, primarily to reflect higher operating costs going forward as AOL continues to invest in its land grab' to grow its subscriber base, particularly in new international markets such as Latin America. Consequently, we are raising our Marketing expense estimates in FY 2000 to $941 million from $832. In addition, our we are raising our general and administrative costs forecast to $492 million from $358 million for FY 2000. These changes revise our operating margin outlook to 18% for FY 2000 from 20% previously. Three Valuation Approaches Continue To Support Our $212 Price Target.
We have been valuing AOL shares using a segmented discounted cash flow analysis, a line of business breakout valuation, and a consolidated discounted cash flow approach. The segmented DCF yields $$184, the line of business valuation points to $242, and the consolidated DCF values the shares at $211. Taking a average of these three approaches yields our $212 price objective.
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Ibexx
PS: As usual, please read the above at your own risks. |
