Surprises Leave Investors Fuming
By GERALDINE FABRIKANT
INVESTOR confidence in AOL Time Warner has been badly damaged by its optimistic promises that haven't been met and its periodic failure to disclose negative news in a timely way. With the company set to report first-quarter earnings on Wednesday, shareholders are remembering its filings of last month, which held ugly surprises about potential restructuring costs.
"When it comes to disclosure practices, they pass," said Glenn L. Reynolds, the chief executive of the research firm Creditsights.com. "But they only get a gentleman's C."
For example, it was only during a call with analysts in January, before announcing year-end figures, that investors were told that an important component of the AOL unit's cash flow would not recur. The company had already failed to deliver on its vow to produce 30 percent growth in a key measure of cash flow in 2001, instead reporting an 18 percent increase, to $9.9 billion. Then, Wayne H. Pace, AOL Time Warner's chief financial officer, said a joint venture with Sun Microsystems to sell software to companies for their Web sites was ending. That venture, iPlanet, generated $400 million in revenue last year and $320 million in cash flow — or 11 percent of the AOL division's cash flow of $2.94 billion.
A spokesman said the company had referred to this in a news release about layoffs at iPlanet. But "the fact that there could be something that big that people didn't know about was a real shocker," said Dennis H. Leibowitz, of Act II, a hedge fund that invests in media companies. After the disclosure, some investors grew worried about other contracts. "No one knows if there is another blowup waiting," said one investor who insisted on anonymity.
And while investors knew that Bertelsmann had a deal requiring AOL Time Warner to buy the half of AOL Europe it did not own for $6.7 billion in cash, AOL Time Warner gave no hint that the unit had $255 million in debt or that its losses would be more than double the several hundred million dollars investors expected — $629 million, as it turned out.
"They should have disclosed the debt and the size of the losses in October, when they confirmed the purchase," Mr. Reynolds of Creditsights said.
Bruce Greenwald, a finance professor at the Columbia University Business School, added, "The way they hide the disclosure is that they complicate things."
Investors also took issue with a news release on fourth-quarter earnings, which boldly announced that AOL Time Warner had $3 billion in "free cash flow" — cash available after capital expenditures — a 238 percent increase over the previous year. But in another section, the release reported that free cash flow was only $1.6 billion.
In a conference call with analysts, Mr. Pace said the figure was depressed by one-time merger-related costs, including severance payments and legal bills. "But you don't know about the quality of the earnings because nobody has audited the $3 billion," said an analyst at an independent equity research firm. "They want to give you the impression that the company is a cash cow. But it is not generating that kind of cash."
The company suggested that analysts use the $9.9 billion in cash flow from last year for comparisons against 2000, but in the future they should use a lower figure, $9.3 billion, which counts the AOL Europe losses. Using the lower number would make 2002 comparisons look better.
Another bone of contention was in the details, first reported in the company's 2001 10-K filing to the Securities and Exchange Commission, of an AOL Time Warner joint venture with Advance/Newhouse Communications.
Previous documents stated that either side could initiate a restructuring of the partnership but not that either side could pull the trigger only after March 31 of this year. "We didn't know it could affect this year's financials," said Christopher Dixon, a media analyst at UBS Warburg.
Mr. Pace said the details of the agreement were in a "big, thick legal document," which he acknowledged that "most people would never read."
The new filing also said that a restructuring could force AOL Time Warner to consolidate the losses from Road Runner, which provides high-speed Internet access over cable. Last year, those losses were a hefty $230 million. Although AOL Time Warner owns more than 60 percent of Road Runner, it has not been consolidating those losses on its earnings statement because Advance/Newhouse, though it owns only a small stake, has blocking rights on management issues, so AOL Time Warner does not effectively control the venture.
"It is never good when investors learn so many new things in a 10-K," said Jessica Reif Cohen, a media analyst at Merrill Lynch.
Mr. Pace said he was hearing from investors that AOL Time Warner had done a "world-class job in terms of disclosure."
SOME investors say most of the bad news at AOL Time Warner is already out. Douglas A. Kass, whose investment fund, Seabreeze Partners, bet against AOL Time Warner by selling its shares short in 2000, before its stock slumped, is now more upbeat. "Analysts had been wearing rose-colored glasses, and now they are putting on accounting visors," Mr. Kass said.
He also views the pending departure of Gerald M. Levin, the chief executive, as a positive for the stock because, he says, Mr. Levin has lost credibility with shareholders. Indeed, an investor who bought Time Warner stock in December 1992, when Mr. Levin took over, has earned a compound annual return of just 9.6 percent, compared with 12.4 percent for the Standard & Poor's 500-stock index. Mr. Levin declined to comment.
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