From the Business Week daily briefing:
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AOL: Just a Brief Slide for the Blue Chip of the Net?
Most analysts are pounding the table, saying this is a buying opportunity
America Online's share-price decline is starting to look worrisome. From
its Apr. 6 high of 175, AOL has fallen a punishing 40%. It closed on June
10 at 106 5/16, a 4% decline from the previous day brought on by a Merrill
Lynch research note that pointed to slower-than-expected subscriber growth
in the June quarter.
This comes on top of the chief concern of AOL investors for the past six
months or so -- the company's presumed vulnerability to competition from
high-speed cable Internet-access providers, such as Excite@Home (ATHM). As
the blue-chip of the Internet, AOL has stumbled along with its sector.
Fears over rising interest rates, a flood of new Net stocks for which there
may not be enough buyers, and a dearth of positive news in the lull between
quarterly earnings announcements have prompted investors to take profits in
high-flying Web shares.
Wall Street analysts, meanwhile, are pounding the table in an attempt to
persuade investors that the slide is a buying opportunity. "We continue to
believe that investors should not own another Internet stock until they
first own AOL," BT Alex. Brown analyst Shaun Andrikopoulos wrote on June 2.
He has a Strong Buy rating on the stock and has set a 12-month price target
of $200.
Morgan Stanley Dean Witter analyst Mary Meeker upgraded the stock to a
Strong Buy -- on May 11, when it was at $128. She argues that fears about
broadband are overplayed. She also admires AOL's powerful branded products
on the Web -- Aol.com, Netscape, and ICQ Instant Messaging. "The revenue
and profit generation from these assets is still in the early days," she
wrote.
"Obviously they have a hugely strong brand and a sticky customer base,"
says Bill Whyman, an analyst with Legg Mason's Precursor Group. With its 17
million subscribers, AOL has the kind of mass audience from which
E-commerce can ramp up. Nearly 20% of the revenues in its March quarter
came from marketing and advertising deals, and that percentage should grow,
analysts think.
"ALL THE MICHAEL JORDANS." For the first quarter of 1999, AOL reported net
income of $420 million, or 41 cents a share, on revenues of $1.25 billion.
That represents a burst from 1998, when revenues were $2.6 billion for the
full year -- and net income was $92 million, or 11 cents a share. Analysts
expect AOL's earnings to grow by 50% a year long term, and indeed the
company ranks first in the Business Week InfoTech 100. That ranking factors
in return on equity, revenue growth, total revenues, and total return to
shareholders.
Another strong positive for long-term investors: AOL's increasingly
high-powered and confident executive team. "We're quite aggressive in
recruiting the best minds in the world," says Stephen M. Case, chairman and
CEO of America Online. "We want all the Michael Jordans working for AOL."
As bullish as analysts are long term, they concede that they're keeping an
eye on several challenges facing AOL. AOL's slower overall subscriber
growth is due to anemic growth overseas, especially in the Britain, where
consumers can opt for free access (See "AOL Abroad: 'I Claim This
Land...Whoops!'" BW--June 14, 1999). AOL will have to come up with a
strategy to compete against free access. "It's not a tear-your-hair-out
concern, but something we have to watch," says Abhishek Gami, an analyst
with investment bank William Blair.
Pricing models for Internet access in the U.S., where some companies are
offering free PCs for customers who pay for Net service, could also be a
challenge, notes Merrill Lynch analyst Henry Blodget. "We believe it may
change or threaten the existing access business, where AOL is the leader,"
he wrote in a June 7 research note. Even so, he credits AOL with adapting
to new pricing models, such as when it switched to flat-rate pricing three
years ago. So he predicts that AOL will be able to react to the change and
maintains his Buy rating on AOL stock.
CABLE-ACCESS THREAT. While AOL's subscriber growth rate has slowed from
early this year, so has that of competitors, notes Gami, who points out
that Internet adoption typically slows when the weather gets better.
Year-over-year, subscriber growth is up from this time last year. He
expects AOL's financial results for the quarter ended in June to be strong,
since the company didn't spend as much on marketing during the quarter.
Still lurking is the threat that AOL will lose customers to high-speed
cable access. A positive for AOL was a June 4 Federal court ruling that
AT&T (T), which stood to restrict Internet service providers from using its
cable lines to offer high-speed access, will have to make them available.
But AT&T is sure to appeal. In the meantime, AOL has a plan to offer
high-speed access over phone lines. But investors are still waiting for its
cable strategy.
AOL also needs to prove it can make a success out of its Netscape
acquisition, which included a side deal with Sun Microsystems (SUNW). Part
of that entails selling complete E-commerce solutions to other businesses,
a departure from AOL's focus on consumers. "How they build out a
business-to-business E-commerce software side is still unclear to me," says
Whyman. AOL also has to implement its "AOL Anywhere" strategy for providing
access to its service via handheld and other devices that use Sun's Java
programming language.
At some point, the company's valuation will have to come in line with that
of other technology companies -- but not yet, says Gami. AOL's
price-earnings ratio figured on his estimates for 2000 earnings is still
above 200. "We always give a premium valuation to AOL," says Gami. "Like
Microsoft, AOL is never cheap." But it's too early to value the company
based on its earnings, says Gami who thinks long-term investors are better
served if AOL spends now to grow.
For now, AOL has a business model that works, and that is what long-term
investors should focus on, say analysts. AOL is facing challenges but has
proven it can be flexible and adapt to change. "We think it's a marathon,
not a sprint," says Case. In that light, the recent stock swoon may just be
AOL catching its breath.
With Cathy Yang in Washington
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