Part 3: Whither AOL?
By Jim Seymour
Special to TheStreet.com
9/9/99 10:39 AM ET
For the past couple of days I've looked at the major challenges I see for America Online's (AOL:NYSE) future and at how I think it's going to respond.
But that kind of analysis is, by itself, not nearly enough, for it views AOL's future in terms of its past -- the old "more of the same" problem that so often blinds us to fundamental changes and opportunities.
I think the real future for America Online doesn't lie in steadily creeping up its subscriber numbers (currently running at about 1 million new subscribers every 100 days or so) and in selling a few more preferred-content-provider contracts. Rather, AOL will survive and, soon enough, prosper hugely by expanding its role far beyond the two-bit "You've Got Mail!" and watered-down content that fuels its profits today.
Problem is, much of what AOL is doing to reposition itself is either below the radar of the usual news sources or consciously hidden. Making a guess about the future of AOL requires digging deep. Consider:
AOL's smart digital-subscriber-line deals with phone companies are a good example. They not only gain volume and early position for America Online, but also mark these regional Bell operating companies' DSL installations as AOL's turf.
AOL is developing AOL Plus, its new auto-switching end-user software, which detects a fast connection and automatically adds richer bandwidth-sensitive content. (See yesterday's column for more on this.)
Two months ago, AOL announced that it had made a $1.5 billion investment in General Motors' (GM:NYSE) faltering Hughes Electronics (GMH:NYSE). The investment, to develop a two-way satellite service -- carrying AOL, of course -- shows AOL doesn't just want to capture urban cable and RBOC customers, but everyone who wants onto the Net, including those in rural areas. AOL and Hughes will also offer next year an interim, halfway-there package, combining satellite downlinks and plain old telephone-based uplinks -- also featuring AOL, of course.
AOL's continuing success in extracting hefty fees from other firms eager to become exclusive providers of something-or-the-other on AOL is growing. And it's expanding the deals it already has, such as the three-year deal announced two weeks ago with Gap (GPS:NYSE) to add Gap's Old Navy and Banana Republic businesses to Gap's own existing presence on AOL. And why not? AOL says its members spent $1.8 billion online through its site with these co-branded business partners in the first quarter alone.
AOL has been relentlessly aggressive about promoting its online "cybermall" stores' offerings: to wit, the recent Back to School promotion. We'll see these seasonal campaigns increase.
AOL has hired former Internet Shopping Network/Barneys/Neiman-Marcus executive Patrick Gates to shape up its Shop@AOL cybermall operation. Gates says he'll increase the number of Shop@AOL storefronts to at least 250 from today's 150 by the start of the "Christmas quarter," which is so important to e-commerce.
In one of Gates' first and smartest moves, he dumped the burdensome, proprietary Rainman technology required for AOL shops, replacing it with standard HTML pages that are far faster to build and modify and far more flexible than the old Rainman system.
AOL has been using its CompuServe subsidiary as its "fighting brand" to whomp other online services and tie up new customers. It's hard to find a name-brand or store-brand PC for sale these days in the big discounters such as Best Buy (BBY:NYSE) or CompUSA (CPU:NYSE) that doesn't come with a huge "$400 rebate" off its purchase price -- a rebate, the buyer discovers in the small print, that comes from CompuServe in return for a three-year prepaid CompuServe access account. That may sound high, but amortized over the term of the deal, it's not far off AOL's recent cost to acquire customers. And it's achieved, note, without diluting or discounting the America Online brand.
Behind the scenes, AOL has also been putting together an online bill-paying service it will soon offer to members. (Microsoft (MSFT:Nasdaq) rolled out its online bill-paying service first, but faces substantial lingering hostility in the banking business after Bill Gates' ill-considered remarks in 1997 about wanting to get into electronic banking. AOL looks like a much safer partner to many bankers -- and it brings as a dowry those 18 million-plus members/prospects.)
While AOL's progress in Europe appears at first to have been stymied by the explosion of free-ISP offers there, AOL has in fact been using deals with its European partners to stay ahead of the freebies. Two weeks ago, it whacked U.K. free-access pioneer Freeserve (FREE:Nasdaq ADR) with a free-access service of its own, Netscape Online, providing free CDs to set up the service, available through 800-plus Woolworth's stores throughout the U.K. Then last week, it announced a joint venture with its European partner Bertelsmann in Germany, one of the hottest battlegrounds in European Web competition.
It will offer AOL service for just $5.29 per month, plus telephone access charges. (In Europe, Web surfers pay a telephone-line-connect charge in addition to their ISP's charges. "Free" service can still be very profitable for big European ISPs. Beyond revenue from banner ads and other services, they have revenue-sharing arrangements with European PTTs, or national telephone services, which give them a cut of that phone-connect charge.)
America Online has been laying the groundwork to completely recast itself from the rinky-dink outfit most of us think of into the gateway of the ubiquitous Internet of tomorrow.
As I said, predicting the economic future of America Online in terms of more of the same -- that is, like yesterday's AOL but with more subscribers -- misses the point. AOL wants to be your essential link in that world of Internet addresses for everything, from your refrigerator to your car to your poodle's collar.
For a tiny inkling of what lies ahead, consider AOL's recent investment of $10 million in Radiant Systems (RADS:Nasdaq), a maker of point-of-sale terminals for service stations. AOL buying a stake in a gas-pump company? You bet.
Because in the universally connected world, AOL wants to ride others' pipes to organize our access to the data that travel over those pipes and to own significant chunks of that data itself. (Why should it function as an ISP anymore when we've all gone over to the fat pipes from the likes of cable outfits, RBOCs, competitive local exchange carriers and satellite companies?) And thus to get us to measure its growth not so much by counting only subscribers, but by counting income streams, franchises and revenue.
That appears to be the real play with AOL: the future. I don't see any other company that's ready to take on that role -- and this isn't a job for a start-up.
The worries with America Online seem to lie in the valley between Here and There. Today, AOL is profitable, growing, facing some problems and likely, I think, to endure a year or so of slow, or at least slowing, growth.
To refocus itself for leadership of tomorrow's Net, AOL needs to walk a fine line between continuing its present growth rate and remaining decently profitable, while investing in the tools and relationships it needs to prosper in the world of fast access.
The question is whether a perennially shortsighted market will allow AOL to do that, without punishing it for not running up into a split-time valuation again. (With six splits -- the real key to its wealth-creation record -- in as many years, AOL holders have come to expect a share price that rises with regularity to that magical "Time to split!" moment.)
I don't expect to see really big run-ups in AOL during this time of refocusing and transition. After falling a third from its all-time peak back in early April, AOL has wobbled around in more southern climes, most recently in the 80s and 90s. I think there's a good chance we'll see AOL stuck in a trading range below that April high over the next few months, with wider excursions only if and when we see overall market jumps.
This means AOL won't be very attractive for short-term traders.
But for longer-term investors, AOL has a fair chance to repeat its performance during the past decade, building new fortunes and emerging as the uber-brand in the truly connected world.
Yes, that depends on good to great management. But how do you think AOL has grown from a split-adjusted 25 cents a share in March of 1992 to today's just-under-100 price? It wasn't all luck and timing, as undeniably important as those were.
I suspect AOL's next decade is going to be a rich and rewarding one for shareholders. But you've gotta be ready for the dips and maybe for some dead money for the next year or so. If you can handle that, I think that from a decade out, the chance to have picked up AOL at under a hundred bucks a share is going to look pretty darn good. Even if your money just sat there for a while.
So, how long-term is your vision?
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