The Plot Thickens for AOL
By Alec Appelbaum
THE MEAN SEASON
THAT QUEASY FEELING in the pit of investors' stomachs comes from the past two weeks' lessons in the law of gravity. If you've gotten used to investing in "stories," business plans that promise new ways of generating value, you have to accept that stories have middles when the hero is beset by lots of enemies. Even if you believe without any doubt that the hero will triumph, getting through the middle can be tough.
America Online (AOL) has been looking a lot like Errol Flynn in midmovie lately. Every time it pounces on a new business opportunity -- and it almost always guesses right -- a powerful foe comes along to neutralize the work that produced the advantage. A stock whose biggest enemies were once disdainful techies now does battle with the world's largest and most zealous corporations. And whether or not that battle affects how the company performs, it certainly seems to affect how the stock performs.
A case in point: AOL's three-week tussle over its proprietary Instant Messenger, a hugely popular chat program that lets a user send messages that appear instantly on the screens of selected recipients. First, Microsoft (MSFT) developed its own version, with software that let its Internet subscribers tap into AOL's database. AOL retaliated by adding new blocking software, then offered to negotiate with Microsoft; no dice. The stock dropped 10% in the week that included reports of the spurned offer. Inside of another week, AOL trotted out alliances with smaller Internet-service companies MindSpring Enterprises (MSPG), EarthLink Network (ELNK) and Juno Online Services (JWEB). The stock rose 1% the day of the first two announcements. This past Thursday morning, Novell (NOVL) agreed to load AOL's messaging software into its widely used directory software, giving 80 million office workers a way to pop messages to their own corporate "buddy lists."
Novell's expertise should make AOL's instant-messaging software more attractive to corporate types who worry about the security of their data. Through Novell's system controls, says International Data Corp. analyst Rick Villars, companies can restrict the ways that employees use the instant-messaging software. "It either limits messaging to certain sites or lets [a network administrator] predefine people to whom you can instant-message," explains Villars, so that someone can only talk to people in the same division, for instance, or can't talk to rivals.
So far, in addition to the smaller Internet-service companies, AOL has signed up IBM's (IBM) Lotus division and Apple Computer (AAPL) to license the instant-messaging software. The Novell connection may also provide AOL with some strategic security. "What I see is yet another vendor validating the AOL licensing approach, in contradiction to Microsoft," says International Data Corp. research director Mark Levitt. Brown Brothers Harriman analyst Dawn Simon, after speaking with the company, also stressed the deal's significance to future business arrangements. "What it implies to me is that [a rival] can't just have engineers [copy AOL's code and let its subscribers communicate with AOL's] without approaching AOL," she says. Of course, that's more or less what Microsoft did.
That's how AOL plays these days -- fiercely shielding its proprietary users and software with one hand, and welcoming all sorts of partners with the other. In the past two weeks, the Dulles, Va., dynamo announced pacts with kiddie vendor eToys (ETYS), educational darlings MaMaMedia, greeting-card powerhouse American Greetings (AM) and Knight-Ridder (KRI) newspapers. These companies pay for prominent placement on AOL's sites and for access to AOL's millions of subscribers. AOL, tellingly, calls them "tenants."
Once upon a time, AOL's ability to connect consumers to the Internet was enough to turbocharge its stock. AOL soared shortly after it sold most of its network real estate to MCI WorldCom (WCOM) in exchange for the CompuServe database in late 1997. Investors saw the deal as a way for the company to focus on its virtual real estate, the Web sites and user accounts that attracted advertisers and subscribers. A year later, AOL added to that virtual real estate when it bought Netscape and entered into cahoots with Sun Microsystems (SUNW) to plow the corporate market. But since then, physical real estate -- the wires that deliver Internet access -- has given competitors such as AT&T (T) ways to sell competing high-speed Internet access in conjunction with phone service or other incentives. AOL responded by forging partnerships with high-speed phone companies and a broad swath of content providers.
This alliance flurry is no short-term strategy. "[CEO Steve] Case is very smart; he is going to have problems [if] access is going to become a commodity," says an executive at another Internet-service company, who asked not to be identified. "He's going to be constantly forced to give away more stuff and sell access as other things." So AOL loads up exclusive content on its sites in the hope that almost every consumer will find something desirable there and nowhere else. Content, specifically e-commerce, is harder to duplicate than access, email or instant messaging. So expect to see AOL pursuing more deals with online merchants.
Trouble is, you can expect to see Yahoo! (YHOO) and Excite At Home (ATHM) and any other Internet company with enough bucks do the same thing. And all of AOL's other irritants -- AT&T locking it (for now) out of high-speed cable systems; Microsoft and others dangling free Internet access -- still dog the stock. That may explain the Street's muted response to the Novell pact; the shares only picked up 0.4%. Even Henry Blodget, Merrill Lynch's AOL bull, warned clients in a note that the next 18 months would "not be a walk in the park" for the company.
In those 18 months, Microsoft will unveil Windows 2000, a more Net-minded version of its widespread operating system. Jupiter Communications analyst Joe Laszlo, who says he's seen a sneak preview of the new Windows, reports that it incorporates functions like video and audio into the hard drive -- functions that a consumer might today seek from AOL. Depending on the outcome of the government's current antitrust proceedings against Microsoft, that could be a real threat to growth or just another irritant.
It's no wonder that AOL's 1998 online annual report begins with the phrase, "We're on a mission." Whatever investors may have expected, the company seems acutely aware that the happy ending lies at least several twists and turns away.
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