America Online – 12 August
Growth: Overweight (07-Mar-1995)
Income & Growth: Overweight (07-Mar-1995)
Capital Appreciation: In Line (28-Jan-1999)
Market Analysis; Technical Rating: Below Average (21-May-1999)
**The views expressed are those of the macro department and do not
necessarily coincide with those of the Fundamental analyst.
For full investment opinion definitions, see footnotes.
Investment Highlights:
· Over the past week we have discussed with AOL
management several of the challenges facing the
company, including pricing pressure in the
access business (from Microsoft, et al),
international subscriber growth, and the roll-out
of DSL and other broadband capabilities. We
continue to believe that these are real challenges-the
next 18 months won't be a walk in the park-but
we believe AOL will work its way through
them.
· We are maintaining our Buy/Buy rating. We
continue to believe that a confluence of catalysts
in the fall (q4 is a strong seasonal quarter for
traffic, advertising, and commerce) will bring a
change in investor sentiment toward AOL and
the rest of the leading Internet stocks, driving
them significantly higher by the end of the year.
· AOL's stock still has a vertiginous P/E: around
100X C2000E EPS (our official C2000 estimate
is $0.72; if the company's momentum continues,
we think it might be able to generate $0.90 or
so). The company's long-term earnings growth
rate is also high, however (50%-75%, in our
estimation), and the stock's P/E-to-Growth
multiple (around 1.5X) is actually among the
lowest of comparable industry leaders.
Bulletin
United States
Internet \ Electronic Commerce
12 August 1999
Henry Blodget
First Vice President America Online
AOL…Maintaining Top Rating BUY
Long Term
BUY Reason for Report: Update/Review of Thesis and Issues
Merrill Lynch & Co.
Global Securities Research & Economics Group
Global Fundamental Equity Research Department
RC#10122449
Stock Performance
0
20
40
60
80
100
120
140
160
0.00
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.10
0.11
0.12
1996 1997 1998 1999
America Online
Rel to S&P Composite Index (500) (Right Scale)
2
In the past few months, we have articulated concerns about
potential pressures on AOL's business, with the most
important being changes in the pricing of dial-up internet
access. Most of these concerns have always surrounded
AOL, but they have intensified of late with the advent of
bundled PC-and-access plans, free access in Europe and
U.S., and hints by Microsoft that-with regard to access
pricing-it has not yet begun to fight. We will continue to
be vigilant about these issues, as they remain potentially
serious ones for the stock price if not the company (AOL
must continue to exceed Street estimates for the stock to
appreciate significantly). With the seasonally strong
fourth quarter approaching, however, and AOL's business
momentum still strong, we are maintaining our top rating
on the stock.
Access Pricing. Our concern with regard to changes in the
access pricing model is not that AOL will be put out of
business-it is simply that the new pricing plans will
cannibalize some subscribers who would otherwise have
signed up for the premium-priced AOL service at $21.95
and, therefore, will reduce any upside to current Street
forecasts (in a serious scenario, obviously, successful price
competition would cause us to cut our estimates).
According to management, the new “free PC with rebate”
offers, in which the company is offering a $400 rebate on
the cost of the PC in exchange for a three-year subscription
to CompuServe, have been very successful thus far
(CompuServe will likely log the strongest growth this
quarter that it has had since AOL acquired it).
Importantly, however, management does not believe that
the new subscribers to CompuServe are subscribers that
would otherwise have signed up for AOL-or, at least, that
it is too early too tell. Management bases this opinion on
the fact that growth of the AOL service remains similar to
the growth at this point last year.
AOL continues to believe-and we mostly concur-that the
new “value-based” access plans, which are sold on price,
will appeal mainly to the 20%-25% of consumers who tend
to buy on price rather than brand. AOL continues to
believe that this segment is made up of those that would
choose the low-priced local ISP over AOL or, until now,
could not afford the combined cost of a PC and access.
Since the AOL premium service has approximately 50% of
the market, this leaves plenty of room for the company to
go after the value segment with its flanker brands without
threatening the growth or profitability of its flagship
service. Our only concern about this thesis is that there is
likely a certain difference in price that would cause even
the most ardent brand buyers to begin buying cheaper
brands-if, say, AOL remained at $21.95 and a
Microsoft/Yahoo!/AT&T/Excite@Home quality service
were suddenly offered entirely free (Qwest, for example,
just offered free dial-up internet access with the purchase
of 250 long-distance minutes for $25; although this access
is obviously not free, it is not inconceivable that ultimately
such plans will actually be offered free, especially for the
short term). As a result, we believe that investors should
remain wary of what Microsoft, et al, are up to and
continue checking with AOL management to make sure
that the growth of both the premium service and the
flanker brands remains strong.
Bottom line. We believe AOL remains by far the most
powerful company in the B2C internet industry. The
company is diversifying its revenue streams (when
Netscape's software business is included in the calculation,
access is now about 65% of revenue; excluding the
software business, it is about 75%), and even if subscriber
growth is flat this year over last year (which we expect it
to be), the company will still add more subscribers this
quarter than all of its competitors combined. In our
opinion, the catalysts of Q4-strong traffic, advertising, and
commerce-should bring renewed enthusiasm to the internet
sector when investors return from their vacations in the
fall, and we believe that the leading companies, including
AOL, will benefit disproportionately from this. We will
stay in close touch with the company about the access
issue and other issues over the next six months.
[AOL] MLPF&S was a manager of the most recent public offering of securities of this company within the last three years.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1999 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
regulated by SFA, and has been considered and issued in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law. The information herein was
obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available.
Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments").
MLPF&S and its affiliates may trade for their own accounts as odd-lot dealer, market maker, block positioner, specialist and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side
of public orders. MLPF&S, its affiliates, directors, officers, employees and employee benefit programs may have a long or short position in any securities of this issuer(s) or in related investments. MLPF&S or its affiliates may from
time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report.
This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific
person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that
statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive
back less than originally invested. Past performance is not necessarily a guide to future performance.
Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced
by the currency of the underlying security, effectively assume currency risk. |
