America Online – 22 July 1999
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Summary. AOL logged a solid FQ4, easily exceeding
consensus EPS targets as a result of impressive operating
leverage. Advertising and commerce revenue met
expectations, and the other key metrics we look at—gross
margin, operating margin, marketing spending and
network efficiency—were better than expected. Overall
subscriber growth fell slightly short of our estimate, but
growth in the core U.S. business was solid (most of the
shortfall off of our original estimates resulted from the
situation in the U.K.). Growth of non-paying users (ICQ,
Netscape, AOL Instant Messenger, etc., was also solid).
We were encouraged that we were able to raise estimates.
We would not be surprised to see the stock trade off near-term—
it usually does after the company reports earnings—
but we still think the long-term outlook is excellent and the
stock remains a core holding.
Outlook remains excellent—but keep an eye on 1) the
“rebate” and bundling movement in the U.S. and 2)
Europe. We are still in the early innings of a nine inning
game (development of the interactive services industry),
and AOL has an impressive lead. We would keep close
tabs on 1) the impact of the recent wave of access/device
bundling deals in the U.S. on subscriber growth and
monthly revenue per subscriber, and 2) the success of the
new “free” service in the U.K., Netscape Online, as
international success will become increasingly important.
the expected growth of the AOL/Sun/Netscape enterprise
solutions revenue.
Fully taxed EPS of $0.13 vs. $0.05 a year ago, exceeding
our estimate of $0.10 and consensus of $0.11. The upside
resulted from great cost control, higher-than-expected
“other” revenue (but not advertising and commerce
revenue) and enterprise revenue, gross margin, and
operating leverage.
Subscriber growth of 755,000 fell approximately 100,000
short of our all-in estimate (including Compuserve, last
revised June 10th), but was solid enough when viewed in
light of the summer season and the situation in the U.K. As
a result of the success of Freeserve and other “free”
services in the U.K., AOL scaled back marketing spending
on its flagship service in the country while developing a
competitive response. Because of this, international
subscribers increased a relatively paltry 69 million, versus
our original estimate of 200,000. On July 12
th , AOL
launched Netscape Online in the U.K., its own free service,
with which it hopes to regain the dominant position in the
country. 755,000 net new adds represents 41% year-over-year
subscriber growth—in line with the growth rate of the
last few quarters. Growth of non-paid users of AOL
services also showed a solid increase. At the end of the
quarter, the total AOL member base was 17.6 million
(more than 19 million including CompuServe).
Advertising and commerce revenue was in line with our
estimate, increasing 11% sequentially and 83% year-over-
year to $233 million. The advertising and commerce
portion of the “other revenue” line is critical to the
company's future earnings growth, as it contributes the
bulk of the company's profits. Although AOL lost
advertising and commerce share relative to its major web-based
competitor, Yahoo! (11% vs 24%), we are still
comfortable with the performance (AOL's sequential
growth tends to be less seasonal than Yahoo!'s, and
Yahoo! benefited from a strong seasonal quarter). Backlog
increased 15% sequentially, from $1.3 billion to $1.5
billion. The last major component of the “other revenue”
line, merchandise sales, increased 13% sequentially.
Enterprise revenue of $128 million was stronger than
expected. AOL is guaranteed to receive $310 million in
revenue a year from Sun, or about $75 million per quarter.
Enterprise revenue showed nice growth above and beyond
this, however.
Marketing Spending / Efficiency. The company spent
only $214 million on sales and marketing, down slightly
from $218 million last quarter. Thanks to the strong AOL
brand, marketing is more a fixed than a variable cost--and
over the last several quarters, this has clearly been true.
Since the company's merger with Netscape, a straight
“marketing per new subscriber” analysis is much less
meaningful than it used to be, but for old-time's sake, we
did it anyway. The company's customer-acquisition cost
increased from about $123 last quarter to $283 this quarter
(assuming 755,000 net new members in the quarter). This
increase does not come as a surprise when viewed in light
of the summer season and the recently diversified services
due to the Netscape acquisition. We expect subscriber
growth to stay strong over the next year (we are looking
for the company to add another 4-5 million subscribers in
F2000, versus the exceptional 5.1 million added this year).
Total revenue of $1.4 billion exceeded our estimate of
$1.3 billion, increasing 46% year-over-year. Subscription
revenue increased 40% year over year to $943 million.
Other revenue, made up primarily of advertising, commerce,
merchandise, and joint-venture agreements, increased 89%
year-over-year to $306 million, ahead of our estimate.
The gross margin increased 130 basis points to 46.2%;
operating margin pre-goodwill increased an even more
impressive 5.5 points to 17.6%. Management attributed the
leverage to increased advertising and commerce revenue,
network efficiency and seasonally light subscriber growth.
EBITDA increased to $393 million, up 126% year-over-year,
and cash flow from operations increased to
$196 million, a 57% increase.
Cash declined from $2.8 billion to $887 million, the
majority a result of a $1.5 billion cash investment in
GM's Hughes Electronics. Deferred revenue decreased,
but is not a good measure of backlog, as it reflects cash
received, not net bookings. AOL received less cash up
front for deals signed in the quarter than it has in the past,
and prepaid annual subscriptions, which generally boost
deferred revenue, usually contribute the most in January
and March. Financially, we feel the Hughes investment
will be a win for AOL: the $1.5 billion investment in
convertible preferred securities carries a 6 1/4% coupon |
