AOL's Got Cash, and It Wants to Get Broadband
By George Mannes
Staff Reporter
6/21/99 7:15 PM ET
Now we know what America Online (AOL:NYSE) plans to do with its pile of money.
At the end of March, the nation's largest online service had $2.7 billion rattling around in the petty-cash drawer. Monday morning, AOL put a $1.5 billion dent in that stake by agreeing to invest in Hughes Electronics (GMH:NYSE), operator of the DirecTV home satellite TV system.
The deal, which AOL chairman Steve Case said was the largest cash investment the company has made, highlights how seriously AOL is taking the transition to broadband Internet access and non-personal computer Internet devices. But it doesn't solve all AOL's problems, since AOL's cash is buying it only partial entry into these markets, and satellite connections to the Internet haven't been particularly popular up to now.
The alliance between AOL and Hughes, a subsidiary of General Motors (GM:NYSE), will boost two separate efforts to extend AOL's services. One is AOL TV, a previously announced version of AOL viewable over the TV set, which includes features such as an AOL-flavored online channel guide and the ability to watch TV while chatting online with friends who are also connected to AOL. DirecTV, which has 7.3 million subscribers in the U.S., plans to start offering AOL TV next year.
The second venture is AOL-Plus, a version of the AOL online service designed for users with high-speed access to the Internet. AOL has already signed deals with two Baby Bells to offer high-speed access to consumers via digital subscriber lines over regular phone lines. And the company is fighting to get access on favorable terms via high-speed cable systems, particularly those owned by AT&T (T:NYSE), which also controls high-speed cable Internet firm Excite@Home (ATHM:Nasdaq).
Now, as different firms maneuver for position in a broadband environment, AOL is banking that satellite connections will be an important part of its "broadband tapestry," to use a phrase that Case trotted out several times during a conference call with reporters on Monday. (Despite the expected growth of cable modems and high-speed DSL lines for Internet connections, one-third of Americans will not be able to sign up for either of those technologies by 2003, Case said.)
For AOL, the deal "is significant if it works," says Gary Arlen, head of Arlen Communications, a Bethesda, Md., high-tech research firm that doesn't do any work for AOL or Hughes. "They are depending on Hughes to pull off satellite broadband delivery."
As part of the deal, Hughes will spend a bundle of cash it receives from AOL to market the two companies' products over three years. That includes spending $500 million to jumpstart AOL-Plus via DirecPC (Hughes's DirecPC, a service distinct from DirecTV, connects people to the Internet via satellite), $500 million to sell DirecTV and $400 million on the combined DirecTV/AOL TV services. About $200 million of the money it spends will go back in AOL's pockets in the form of advertising and e-commerce deals, according to Hughes Chairman Mike Smith.
So far, connecting to the Internet via a satellite dish has not held wide appeal. Hughes's DirecPC service, which allows for downloads of up to 400 kilobits per second -- about 14 times faster than a 28.8 kbps modem but slower than DSL or cable modem connections -- has attracted only 40,000 subscribers in the U.S. since its consumer launch in 1997. Excite@Home, by comparison, claims download speeds up to 12.5 times faster than DirecPC's, and has a subscriber base that's grown to 460,000 from 5,000 in early 1997. As Smith readily admits, Hughes just hasn't marketed its DirecPC service.
But the technical setup might be off-putting, too; consumers who use DirecPC to receive information quickly from the Internet still need a phone connection to send information in the other direction, whether it's email they want to send to Grandma or the address of a web site they want to visit. That situation won't be fixed until Hughes's planned consumer launch of a next-generation satellite system, dubbed Spaceway, in 2003.
On the bright side, DirecTV says it believes that between 18% and 20% of its subscribers are also AOL members, presumably making them ripe for signing up for AOL TV or AOL-Plus, both of which will require equipment upgrades for current DirecTV subscribers. Like @Home, which acquired the portal site Excite for its consumer content, Hughes is betting that well-branded content will lure people to its high-speed -- albeit unsexy -- technology. "We think the [AOL] brand name on front of it will help tremendously," Smith says.He says that he's hoping the agreement will bring DirecPC 1.5 million subscribers over three years.
But Mike Wallace, Internet analyst at Warburg Dillon Read, says what's more important to AOL isn't satellite-aided high-speed access, but the development of the interactive AOL TV initiative. "That's probably why most of the money is being spent," he says. (Wallace has a strong buy, his firm's highest rating, on AOL; his firm hasn't done underwriting for the company.) Broadband satellite access is probably more important overseas than it is in the U.S. "Here, cable is still the important thing," he says.
Cable access is certainly still an important part of Case's tapestry. In the press conference Monday, he insisted the newfound, nonexclusive access via satellite didn't undercut AOL's arguments that it needs access to cable TV systems for high-speed home connections. One person who is well aware of that is the former chairman of Hughes Electronics -- AT&T Chairman Michael Armstrong. AOL is still fighting its cable access battle on several fronts.
AOL's stock closed Monday at 115 3/8, up 3 3/8; GM Class H Common stock, which tracks Hughes's earnings, closed at 56 5/8, up 3 3/16.
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