"The AOL Puzzle"
"If AOL signed up every every one of the 272,128,532 men, women and children in the U.S.A. at its popular $20....."
of course, the market is discounting AOL signing up everyone in the world, and beyond. KO and G says that is not going to happen real soon.
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":As of the end of 1996, 9.8% of all large investors owned America Online, according to 13f filings with the SEC and as tabulated by the Carson Group. These filings track the holdings of all investors
owning more than $100 million in U.S. stocks. By the end of 1998, ownership of AOL had surged to 27.2%. The sponsorship of AOL
has undoubtedly grown since then. Last December, just a few days before Christmas, investors in AOL were visited by Santa Claus when Standard & Poors announced that the company was going to be placed into the S&P 500. The shares had traded as low
as $45-1/4 only a week before, but vaulted to as high as $79-7/8 within a week of the announcement. Nothing fundamental changed, of course. What was at work in the rocket like ascent of AOL was the realization that the Index funds now had to own AOL. Since the S&P 500 is a capitalization weighted index, as AOL went from a
$42.3 billion market cap to $74.6 billion in only two weeks, index funds were forced to buy still more shares to account for its larger representation in the overall index! Of course, the price action during this brief period was sufficient to send non-index investors on a
buying spree as well, pushing AOL's shares even higher. That was only a couple of months ago. The cycle has remained intact, with indexers and momentum players chasing each other's tails all the way
up to AOL's present peak market cap of $121.9 billion. Despite our tendency to view the internet in very favorable terms for its eventual impact upon society, we would hasten to point out that every growth story has its saturation point. True, AOL's growth has been phenomenal as their 16 million subscribers attest. What
would be the saturation point?
For the sake of our exercise, let's assume that at the point AOL achieves 100 million subscribers, they will be in virtually every
American home and a "mature" company. Mature companies are priced traditionally, say at under two times revenues, like Minnesota Mining & Mfg. (1.92x) or Eastman Kodak (1.57x). Our projected math is very revealing. By extrapolating enormous
future growth and using AOL's most popular monthly rate of $20 times 100 million subscribers affords a total of $24 billion in revenue. If we add on a generous helping of "other revenues," at a rate of growth suggested by the last four years of actual results, we can tack on another $3.2 billion, for a grand total of $27.2 billion. At last week's highs, the company is already priced at 4.48 times "maturity." In fact, if every one of the 272,128,532 men, women and children in
the U.S.A. were to subscribe to AOL's service at its popular $20 monthly rate, they would still only generate about $65.3 billion in revenues! As we see it, the rapid growth in the price of AOL's shares has nothing, but nothing to do with the company's potential. It is evident that the shares rise for only two reasons. One, momentum players and day traders believe in the power of kinetic energy and
climb aboard for a few more points. Two, indexers must maintain the proper representation of the constituents of the S&P index. Given
the extent of this mania, we would also hasten to point out that these "trends" can easily be reversed at a moment's notice. When this one reverses, if the downside movement is sufficient and AOL represents a considerably smaller share of the S&P 500, then indexers will then have to sell the stock, possibly taking it down even further.
What goes around, comes around."
3/29/99 issue of CROSSCURRENTS by
Alan M. Newman, Editor
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