d. Div.: - Yield: -Shares: 1.207 bln. 52-Wk.Range: 175 1/4 - 17 1/4
EPS FY Year P/E 1Q 2Q 3Q 4Q
Actual 6/98 $ 0.14
Actual 6/99 $ 0.35 234X $ 0.05 $ 0.08 $ 0.09E $ 0.13E
Current 6/00 $ 0.61E 134X $ 0.13E $ 0.14E $ 0.16E $ 0.18E
EPS CY Year P/E 1Q 2Q 3Q 4Q
Actual 12/98 $ 0.23
Current 12/99 $ 0.49E 167X $ 0.09A $ 0.13A $ 0.13E $ 0.14E
Current 12/00 $ 0.79E 108X $ 0.16E $ 0.18E $ 0.22E $ 0.23E
Today the battle for free' customers is more a war of words than competition in the
marketplace. Lacking the ability to effectively monetize the free' users
challenges any sponsoring organization in any number of ways. Accordingly, we
believe that the free-services will be used as a drawing card to bring prospective
members to the group. We would fully expect Microsoft and AOL to use these tools
to profile prospective subscribers for paid-services fulfilled, perhaps over
wireless or cable-based access venues. This technique is already used (very
successfully) by Excite@@Home in their efforts to increase yield for cable partners
to attract subscribers.
The Broadband Initiative Turning attention back to the broadband space for a moment
we believe it is important to note that the strategies employed by AOL and
Microsoft are very different with regard to providing users access to high-speed
connections to the Net. AOL formerly developed and deployed their own proprietary
networks and was challenged to build out systems including access points (where the
modems are) as well as the distribution and feeder networks. In conjunction with
the acquisition of CompuServe, AOL divested the most difficult (and expensive)
portion of these networks to MCI Worldcom and other vendors. Today, the company
enjoys a hybrid environment where AOL owns and controls the backbone networks (which
they would have to do anyway for security purposes) and have turned to partners to
provide access networks and distribution points. Beyond the obvious flexibility
offered and the ability for AOL to play one vendor against another AOL has been
able to off-load the financial burdens and risks of deploying, maintaining and
supporting new high-speed networks.
This approach is effectively similar to the relationship that ATHM has with cable
affiliates whereby ATHM provides the content and services over their own proprietary
backbone. Microsoft, however, has taken a different tack. While MSFT, like AOL
and others has turned to third-parties for the dial-up access portion, and could,
conceivably turn to any number of DSL re-sellers for access to high-speed
connectivity the company's direct investment in several cable properties including
RoadRunner (a unit of Time Warner TWX - $67 - rated Accumulate by Kathy
Styponias) and Comcast (CMCSK $35 7/8 not rated) may hinder their ability to tie
the networks and access together in as cohesive an environment.
We are not suggesting that MSFT lacks the knowledge, drive or ability to provide (or
facilitate) high-speed services rather we believe AOL and Excite@@Home will both
enjoy a wide margin of head-room' against MSFT in this marketplace further
calling into question the content and value proposition that MSFT will be able to
offer consumers the ultimate drivers of buying decision for access, and
homesteading' loyalty. This causes us to call into question MSFT's real agenda in
their current PR battle with AOL. Battling for free' customers alone makes no
sense to us for the longer term.
Content is King As noted above, consumers make choices due to content, convenience,
comfort and other influencing elements that together are the basis for habit based
activity. Often time brand presence and prestige, rather than product quality
and/or value, are primary drivers of buying activity and consumer actions. Once
these selection criteria are surpassed the consumer is considered to have
habituated' a practice making the vendor or product secondary to the action
itself. For example if a user had affiliated themselves to purchasing breakfast and
newspapers at a local convenience store getting them to change that behavior can
prove difficult even if the consumer can save money buy changing the vendor from
whom they are making the purchase. The "safe" and "comfort" space becomes more
important than price. This is furthered when the individual has created and
identity or other affiliation with the site or venue. Such is the case with many
users in AOL's core cadre of subscribers.
We note, however, that the identity alone (or habituation by itself) is not enough.
The user must be satisfied with additional services / resource provided on the
system. This is exactly the approach that AOL has followed, and continues to
develop in deepening their user's affiliations with the AOL flagship and supporting
products and brands. Like the access portion of the AOL operating model, the
company's licensing of content allows the content to remain fresh, interesting and
sticky' furthering the ties from user to the system. Microsoft will have to
replicate this across any number of content venues in order to attract and retain
the AOL subscriber base.
Tied closely to this structure is participation of sponsoring organizations in the
E-Commerce and advertising space(s). AOL's success with its business partners is
clearly tied to the company's ability to deliver a consistent, high quality audience
which they have continued to develop and nurture over the past several years
(following the onset of unlimited use pricing). In turn, name-brand merchants and
services, trading companies and other value-add organizations are turning to AOL for
near-instant access to 17 million subscribers in the flagship environments in
addition to the deals being cut for presence on the AOL.COM, Netscape and new
multimedia sites (including MovieFone, Spinner, etc.).
Beyond any free-based services where similar service and content packages can be
assembled, we expect that users will vie for the assembled packages' by and large.
Excite@@Home, AOL and many others, including Planet Direct (a unit of CMGI) have
demonstrated the need to provide the users with a complete package of content and
services. Hence, we have seen the growth of portals such as Lycos (LCOS $34 1/16
not rated), Yahoo (YHOO - $122 15/16 - not rated) and community environments such as
iVillage (IVIL - $33 1/2 not rated) and GotoNet (GNET -- $54 5/8 - not rated).
Without question Microsoft can replicate (or license in) one or more of these
content repositories but the costs will be significant and near-term returns
likely small. Hence, it calls into question how much loyalty / stickiness
Microsoft will be able to build and what kinds of threat(s), if any, this presents
to AOL.
Visiting Valuation Unlike other analysts who may use relative valuation methods to
value shares of AOL we have elected to focus on three primary vehicles that are
generally independent of any relative valuation elements. Our $212 price target is
based on a blending of an aggregated discounted cash-flow analysis, a segmented (by
business line) discounted cash-flow analysis and the use of a per-user discounted
valuation model (patterned on the value of a subscriber/member relative to the value
of a cable-based subscriber).
Our segmented DCF analysis yields a $184 price objective, our consolidated DCF
points to $211 and our per-user valuation model based on different lines of business
takes us to $242 for a 12-month price objective. Taking an average of these three
valuation methodologies equates to a $212 price objective for AOL shares. Our DCF
analysis is based on an average 17% discount rate and a beta of 1.57. We note that
the terminal multiple, currently in the 60 range, falls out of the discount rate and
beta data points. Further, we believe it important to note that AOL, unlike the
telephone-, cellular- or cable-providers, has the ability to capture material
revenue flows and transaction volumes for advertising and consumer-based purchases
that are nascent at current levels. Accordingly, we believe that the
higher-than-average terminal multiples are applicable at present and for the coming
several (5-7) years.
Our third basis of valuation uses the recent sale of cable assets, on a
per-subscriber basis, and applies this concept to the AOL membership base. AOL
currently enjoys six member segments including the AOL flagship service, AOL.COM,
CompuServe, ICQ, Netcenter (Netscape) and International members. Noting that
recent cable asset transfers have topped $5,000 per subscriber, we have elected to
use a starting value of $3000 per member, we apply discounts to the gross number of
members as well as to the value of each segment against the $3000 base rate.
Assigning discount rates of 25% to the flagship service, 35% to CompuServe, 50% to
the ICQ roles (noting a figure of 21 million registered users, not the most recent
38 million figure released), 60% discount against Netcenter, 50% discount to the
AOL.COM users, and a 60% discount to the International members, our calculations
yield a per share value target of $182.
Adjusting the base rate up in $500 increments, our calculations yield values of $212
per share at the $3,500 level, $242 at the $4,000 level, and $273 per user at the
$4,500 level. Accordingly, we remain highly confident in our $212 price target as a
conservative and supportable price objective for shares of AOL.
Prudential Securities Incorporated makes a primary over-the-counter market shares of
Excite@@Home, RCN Corp., and Microsoft.
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