For AOL, Netscape was Just the Beginning
December 4, 1998
Analyst: Alex Yakirevich
America Online's (NYSE: AOL) plan to acquire Netscape Communications (NASDAQ:
NSCP) for $4.2 billion in stock marks the first union of two Internet titans. The deal,
which is expected to close in the first half of 1999, significantly benefits both parties.
Netscape found a powerful ally and can breathe much easier competing against
Microsoft (NASDAQ: MSFT) and other software giants within the Internet browser and
electronic commerce markets.
With Netscape, AOL has several lucrative opportunities. The company can enhance its
content offering and to enlarge its online audience, which will ultimately translate into
higher advertising revenue by adding the Netcenter Web portal to its list of online
properties. According to Cyber Dialogue, a consulting company, the newly-formed
Internet giant will reach approximately 70% of all Internet users in the U.S. AOL's
predominantly consumer audience is highly complementary to Netscape's predominantly
business-oriented clientele.
More E-Commerce
A larger audience will also allow AOL to ramp up its electronic commerce revenue by
offering Netscape's suit of e-commerce applications to merchants who wish to conduct
their business on the Web. Another driver that should attract more business partners to
AOL is the distribution agreement with Sun Microsystems (NASDAQ: SUNW), which
was signed at the time of Netscape acquisition. Under the agreement, Sun will use its
formidable sales force to promote AOL's e-commerce services and Netscape's
e-commerce software. As part of the deal, Sun will provide hardware and software
operating systems and support businesses dealing with AOL.
Potential Pitfalls
The purchase of Netscape, however, is not going to be consummated without
difficulties. One of the most serious roadblocks is that AOL and Netscape are targeting
two different audiences. While, AOL caters to the residential market, 61% of Netscape
users surveyed by Cyber Dialogue said they use the service to be "more productive" at
work. This means that AOL is facing a challenge of developing content specific to
business users, which is new territory for AOL.
While the acquisition of Netscape considerably strengthen AOL's portal business, the
company's principal Internet service provider (ISP) business still needs reinforcement.
That's why we think that more deals involving AOL are coming up. This time it will
probably be in the cable networking arena.
AOL is still very much dependent on its online subscribers. In the first quarter of 1999,
the company generated 83% of its revenue from subscriptions to its dial up
connectivity services. However, in order to keep and expand its enormous subscriber
base, AOL should ready itself to provide a host of interactive services and other exciting
applications, which require high-speed Internet access -- a capability that AOL does not
have.
Partnering with a cable operator, such as TCI (NASDAQ: TCOMA), which is capable of
providing high-speed Net access, would be a logical solution for AOL, since both
address the residential market.
However, AOL's management stressed, as it has on many occasions, that it desires to
stay independent. This explains the fact that AOL challenged the proposed merger
between AT&T (NYSE: T) and TCI and demanded the unbundling of a cable network
operated by @Home (NASDAQ: ATHM), a cable ISP partly-owned by TCI.
Bottom Line:
Assuming current regulatory efforts fail to force @Home and the likes to open up their
infrastructure to other ISPs, AOL will be faced with two options: using its high-flying
stock to buy a cable network operator or lose its independence by pairing itself with
another company. Either way, shares of AOL should rise. |
