America Online: Subscriber Growth Intact
06:55am EDT 14-Jun-99 PaineWebber (Preissler, James R. 212-713-2060) AOL YHOO
Internet PaineWebber
James Preissler RESEARCH NOTE
212-713-2060/preissj@painewebber.com
Thomas Bock, Associate Analyst (212-713-3186) June 14, 1999
Richard Choe, Associate Analyst (212-713-2415)
America Online Rating: Buy
(AOL-$99.69)
America Online: Subscriber Growth Intact
KEY POINTS
* After speaking with management, we believe that AOL's subscriber growth is on
track to fall within the range of 750,000-850,000 net adds AOL originally had
forecast for the current quarter. We are still estimating approximately
800,000 net new adds for the current quarter. This would place AOL at 17.67
million subs at quarter's end, up 41% year-over-year, and up 4.8% from 16.86
in the previous quarter, very strong growth for what is typically a
seasonally weaker quarter.
* This translates to a rate of approximately 8,900/subs/day during the current
quarter, approximately 20% ahead of last year's June quarter rate of
7,400/subs/day. This was down from the March quarter rate of 19,800/subs/day
(which benefits from the seasonally strong new PC purchase holiday cycle),
which was up 21% from the March quarter a year ago of 16,300/subs/day.
* Domestically, we believe, AOL is tracking ahead of expectations with about
650,000-700,000 net adds, which we believe is a very strong sign, because it
shows that AOL is still adding subscribers at an above average rate. AOL
International appears to be the drag on the current quarter's subscriber
growth.
* In Europe, we believe, AOL's growth rate has been slower than expected, in
large part because of a continued environment which promotes metered local
calling. Essentially ISPs have been able to give away free Internet
connections, because in many countries local calls get billed by duration,
unlike the U.S. where local calls get billed at a flat rate. As the Internet
promotes more frequent as well as longer local calls, the local telephone
provider is therefore incentivized to help subsidize the free ISP model.
* However, as long as the metered local calling model remains, we believe this
could limit the development, penetration, and increasing usage of the
Internet that the U.S. has witnessed since it moved to flat-rate pricing.
* AOL, as in the U.S., is building its model to capture the mass market
consumer, which in the U.S., has demanded flat-rate pricing. Until then,
AOL's European subscriber growth rate could be under pressure, unless AOL or
one its subsidiaries offers a similar free access option. We think the
straight ISP competition will be fierce and very few free ISP companies will
be able to survive. We believe AOL Europe is a premium service, which users
are willing to pay for its content, community, IM technology, customer
service, e-commerce opportunities, and AOL software/technology.
* As the American customer has demonstrated, the mass market prefers the flat
monthly fee model offered by AOL. Ultimately, the switch to this plan in
December 1996 drove a spike in subscribers for AOL (AOL had 5 million subs
prior to the new plan), as well as an increase in average usage time per
subscriber per month. The average domestic AOL subscriber spends an average
of 55+ minutes online per day, increasing AOL's ability to show more
advertisements, as well as its potential to engage the subscriber in more e-
commerce transactions.
* We believe the winners in the space will be the companies that could get the
user's attention for longer periods of time for two reasons: 1) to monetize
the usage time, as well as 2) to become such a major part of the person's
life that the service becomes a necessity, increasing loyalty. However, such
heavy usage could get quite pricey if one has to pay the phone company by the
minute.
* According to management, CompuServe, with 2 million subscribers, could show
another quarter of modest increase in subs as well.
* Operationally we continue to believe AOL is on track to meet our expectations
for the quarter. We currently estimate total revenues of $1.34 billion ($930
million subscription, $293 million ad/commerce/other, $114 million Netscape
software), up 6.6% from the March quarter. Our EPS estimate of $0.11
represents a sequential increase of 16.7%.
* We maintain our Buy rating on AOL, with a 12-month price target of $215. AOL
is our Analyst's Best Call.
Key Data Quarterly Earnings Per Share (fiscal year ends June)
52-Wk Range $168-20 1998A 1999E Prev 2000E Prev
Eq.Mkt.Cap.(MM) $108,363 1Q $0.02 $0.05A $0.12
Sh.Out.(MM) 1,087 2Q (0.01) 0.08A 0.13
Float 63% 3Q (0.01) 0.09A 0.14
Inst.Hldgs. 55.3% 4Q 0.05 0.11E 0.16
Av.Dly.Vol.(K) 21,990 Year $0.06 $0.32 $0.55
Curr. Div./Yield None/NA FC Cons.: $0.33 $0.56
Sec.Grwth.Rate Revs.(MM): $3,089 $4,735 $6,172
12-mo. Tgt Price $215.00 P/E: 1661.5x 311.5x 181.3x
12-mo. Ret. Pot'l 115.7%
Convertible? No
-----------------Fiscal Year -----------------Fiscal Year
1998A----------------- 1999E-----------------
Q1A Q2A Q3A Q4A Q1A Q2A Q3A Q4E
Sep Dec Mar Jun Sep Dec Mar Jun
End of 9.40 10.40 11.87 12.54 13.49 15.09 16.86 17.67
period
subs (in
millions)
y/y Growth 43.5% 45.1% 42.1% 40.9%
q/q Growth 10.6% 14.1% 5.6% 7.6% 11.9% 11.8% 4.7%
Period 1.00 1.47 0.67 0.95 1.60 1.78 0.80
increase
(in
millions)
y/y Growth 60.0% 21.0% 20.5%
q/q Growth 47.0% -54.8% 43.0% 68.2% 11.1% -54.9%
Rate per 11,111 16,333 7,389 10,567 17,778 19,756 8,900
day (in
thousands)
y/y Growth 60.0% 21.0% 20.5%
q/q Growth 47.0% -54.8% 43.0% 68.2% 11.1% -54.9%
VALUATION
We believe AOL's 18 million subscribers could turn into over 35 million once
online usage hits maturity with AOL maintaining a 50%+ penetration rate, which
would value its subscribers using cable company comparisons at a conservative
$200 billion, or about $187 per share. Furthermore, AOL's web properties
(including Netcenter, ICQ, etc.) has the largest reach on the Internet and
strong usage metrics, according to Media Metrix. Accounting for synergies from
the AOL network, especially on the cost side, we believe that we could make a
strong case for these Web properties to be worth as much as Yahoo's properties.
Though Yahoo (YHOO-$135.25) had a market cap of $34.3 billion on 3/29/99, we
had a price target of $110 on YHOO before the Broadcast.com acquisition, so we
will use a $22 billion valuation for the Web properties, or an additional $21
per share. In addition, we think AOL's Digital City and Moviefone businesses
could be worth $4 billion in market cap, or $4 per share. Netscape's
enterprise software business, we believe, should sell at conservative 3x
estimated 2000 revenues of $640 million, or roughly $2 billion of incremental
market capitalization, adding another $2 per share.
Totaling the sum of the parts of the AOL network of properties, we arrive at a
potential worth of $215 per share, or $230 billion of market cap. Still, we do
not think we are aggressive in valuing AOL's worth and upside remains. For a
more detailed analysis of our valuation please see our note dated 3/30/99.
RISKS
AOL competes in a highly competitive as well as rapidly changing marketplace.
Any failure in execution could dramatically impact its revenues. The company
could potentially compete with a number of larger competitors such as
Microsoft, IBM, and others, who all have significantly larger resources, sales
organizations, and customer bases. Potentially, an interactive service based
upon high-speed access technologies could present a competitive threat if AOL
were slow to respond. Any deterioration in subscriber pricing or a significant
loss of subscribers could dramatically impact future revenue. In addition,
advertising and transactions on the Internet are an emerging business, with
little forward visibility.
Additional information available upon request.
The information contained herein is based on sources we believe to be reliable,
but its accuracy is not guaranteed. PaineWebber Incorporated and/or Mitchell
Hutchins Asset Management Inc., affiliated companies and/or their officers,
directors, employees or stockholders may at times have a position, including an
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or buy them to or from customers. These companies may from time to time act as
a consultant to a company being reported upon. Copyright (c) 1999 by
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