AOL...Andreessen to sell nearly 1 million shares...
Today, I hope to get the call to pick up my new car, partial courtesy of AOL...However, can I rely on AOL to help with my next purchase???? According to this author, not a chance...(not a Prowler, Hotrod...er Jeff)
dailynews.yahoo.com
Why Wall Street Is Dead Wrong About AOL
By Steve Sherman
8/20/99 1:49 PM ET
URL: thestreet.com
With this column, we introduce Steve Sherman, an equity research analyst with Duff &
Phelps Investment Management. Steve is a generalist with a specialty in the technology
sector and is an avid follower of Internet stocks.
As always, let us know what you think.
Merrill Lynch's Henry Blodget reiterated his buy rating on America Online
(AOL:NYSE) with a price target of 150
Wednesday, based on the premise that AOL will benefit from a great e-Christmas. It's
hard to argue against Blodget's great track record, but this time he's not going to be
right: Though a big e-Christmas will boost a lot of the net stocks, AOL will not be
among them.
Why? In a story line that would make the Grinch jealous, competition from Microsoft
(MSFT:Nasdaq) (which we are long in some of our accounts) is going to spoil AOL's
Christmas, and show that it may be the most overvalued stock in the world.
This message will not be greeted with a chorus of cheers: Everyone on the street likes
AOL, and the stock has been a big winner for a lot of people. But unlike the Net stocks
-- a lot of which I think are great businesses with very attractive valuations -- AOL will
lose you money, because owning AOL is a bet against Microsoft's greed.
We all know AOL is a great company. It has dominant market share in a fast-growing
business, and it has sticky content that has kept the customer base growing through
many competitive challenges. The difference this time is that Microsoft is about to make
Internet access free. FREE.
That's a whole different ball game, one AOL isn't prepared to play. In the past, others
have tried to compete with AOL
primarily on quality and services, not price. In that environment, customers clearly chose
AOL. There is no question people prefer AOL at a similar price: When the services
cost about the same, MSN attracted 2 million users; AOL netted 18 million.
Now if you think Bill Gates is happy playing second fiddle to Steve Case and AOL, you
don't know much about Microsoft.
To be sure, Gates wants Microsoft's large share of any future net profits; but more
importantly, Microsoft wants to protect its dominant PC operating system from potential
Internet-based competition.
In the meantime, AOL is trying to push Microsoft around on the instant messenger
business, creating an environment where Bill Gates and Microsoft President Steve
Ballmer would get no small satisfaction from showing Steve Case who the big dog really
is.
So Microsoft has the motive to make access free. With over $17 billion in cash, it
clearly has the means to do so. The only missing ingredient is opportunity. It wouldn't be
prudent to launch such a massive competitive strike with the Justice Department trial
under way. As the trial wraps up in the next few months, that window of opportunity is
about to open wide.
Some will argue that just because Microsoft can offer free access doesn't mean they
will. And yet the $400 rebate program that Microsoft initiated with eMachines in June
was a warning shot that should have sounded more alarms than it did. For those who
didn't see the rebates as a precursor to free access, an Aug. 5 article in The Wall Street
Journal quoted Brad Chase, Microsoft's point man on the new Internet strategy. "We
intend to be aggressive with access," Chase said. "AOL might think about it as a profit
center. That's not how we think about it."
To me, at least, the message is clear. Microsoft wants to own this market now and
worry later about how to make money on it. It's one of the few companies in the world
that can afford to do that.
Nor will AOL be likely to benefit from the two-tiered ricing model that will follow, in
which 56k access will be free, and high-speed access will be charged at a premium.
Some argue that you can get free Internet access today, and it hasn't hurt AOL one bit.
Why will this round be different? Because this is Microsoft, not Joe's Free ISP. When
Microsoft makes home access at 56 kilobits-per-second free, it will be in your face
every minute. It will be on TV, in the newspaper, the e-paper and on billboards. The
ads will ask but a simple question: Why pay for AOL when you can get MSN for free?
For those of you who are AOL customers, or know folks who are AOL customers, do
your own survey. Would you continue to pay $21.95 a month if you knew you could
get simple, reliable, free access from Microsoft? Most people will switch.
Don't expect AOL to take this lying down. It'll either slash prices or give out huge
rebates to keep market share. Either way, AOL will not be making any profits on
Internet access for long.
Nor will AOL be likely to benefit from the two-tiered pricing model that will follow, in
which 56k access will be free, and high-speed access will be charged at a premium.
That's because AOL's customer base will be the slowest to trade up to high-speed
access because they are generally the least tech-savvy of the access customers. That's
precisely why many of them chose AOL in the first place. By the time AOL customers
are ready to trade up in a significant manner, DSL and cable may be very competitive,
or even free, so it's hard to see how AOL could earn enough from high-speed access
fees to support a free 56k-access market.
The question for investors is how to value AOL in this type of environment. Say for the
sake of argument that AOL can still charge a minimal price for access, enough to cover
its costs, and that it is also able to maintain its huge market share. Both of these
assumptions are generous, but not egregiously so.
AOL has a lot of specialized content and e-commerce deals, so even if it isn't making
money on access it will still be a multibillion-dollar company. But without the cash flow
from subscriber fees, a more appropriate benchmark for valuing AOL becomes Yahoo!
(YHOO:Nasdaq). But there's a difference: Since AOL is a closed system, a large
percentage of net users won't have access to the AOL content. I can get to Yahoo!
from anywhere, but I can't get to AOL from work, and I can't get to AOL if I have
access at home with someone else.
As a result, AOL has to trade at a discount to Yahoo!, a thought that will horrify any
owner of AOL today. But if AOL can't make a profit on access, it's hard to argue for a
higher valuation than the dominant e-content site. Since most people in the market don't
think that Yahoo! is grossly undervalued, then you've got to address the $95 billion in
market cap between Yahoo!'s $30 billion and AOL's $125 billion. The net result is
simple: Owning AOL is a losing bet against the deep pockets and greed of Microsoft.
Instead of making that bet, why not just light your wallet on fire. Chances are you'll lose
less.
Steve Sherman is an equity research analyst with Duff & Phelps Investment
Management, a Chicago-based money management firm with about $15 billion of assets
under management for institutions and taxable individuals. At time of publication, Duff &
Phelps was long Microsoft, although holdings can change at any time. Under no
circumstances does the information in this column represent a recommendation to buy or
sell stocks. Steve appreciates your feedback at commentarymail@thestreet.com.
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