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(Today's Barrons)
A few weeks ago, we offered, more or less in passing, some demurs on
the outlook for America Online. Comes now Doug Kass, chief cook and
bottle washer of a hedge fund called Seabreeze Partners, to weigh in with
some reservations of his own. Doug, we should note, has been short the
stock since it sold some 50 points higher than its current price of around 96.
We should also note that's one of the reasons his portfolio is up 60% or so
this year.
Among the negatives he cites are: the recent sale of four million shares by
insiders; the fact that PC manufacturers are offering sharply discounted
computers to buyers who sign up for Internet access; slowing in the rate of
the company's subscriber growth (in the quarter ended June 30, such
growth in the U.S. failed to exceed expectations for the first time in years,
and such growth abroad was decidedly nothing to write home about); and
increasing evidence of price competition.
This last -- gathering price pressures -- Doug views as especially significant.
For it was America Online's ability to boost prices back in April 1998 that
in no small measure provided the impetus for the stock's remarkable
sevenfold appreciation over the next 12 months.
Pure and simple, America Online has lost the power to control the price of
its product. The cost of Internet usage has begun to decline, and the trend
threatens (if you're America Online) or promises (if you're a consumer) to
accelerate.
Among the rivals likely to cut Internet charges are such formidable ones as
American Telephone. What's more, Doug conjectures, there's a very good
possibility of Microsoft offering free access. Rick Belluzo, its new online
chief, has already hinted at his willingness to lose money to gain market
share.
Doug also sees broadband access as putting fresh pressure on America
Online's pricing. High-speed Internet connection, he predicts, will become
inexorably more important to Web users, the way e-mail and chat rooms
became more important. That will pose a problem for the company because
it can't hope to get its customers to shell out $20-$25 more each month,
atop the $21.95 they're already paying.
The company, in his view, will have no alternative but to roll back the '98
price increase. And that will be especially bad news since it gets something
like 75% of its revenues and 20% of its profits from subscribers' access
fees.
In the fullness of time, Doug expects the price of America Online stock to
be cut in half.
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