someone posted on ragingbull board:
Henry Blodgett Bulletin: 12/17/99
Analyzing Access Pricing: Why People Pay More For AOL
BUY
Long Term
BUY
Investment Highlights:
There is much concern in the market about the impact or potential impact of pricing
pressure in the internet access business, especially as it pertains to the owner of the
highest priced service in the business: AOL.
We continue to believe that internet access will be
both a multi-technology and a multi-price business:
consumers will access the internet through dial-up,
DSL, cable, wireless, and/or satellite, and they will
pay by the month, by the minute, with their eyeballs, and/or with their purchasing loyalty.
We think multiple business models will work? including, possibly, free. We also think
that, through multiple brands, AOL will ultimately offer most of the models that work (at
better economics than most competitors).
We think that ?premium priced? services such as the AOL flagship service will be able to
maintain their premium prices. If the costs of providing these services drop significantly,
the premium prices may drop, too?but the impact on the bottom line (gross profit per
customer) will likely be neutral.
This note explores the reasons we believe consumers are willing to pay more for
premium access services such as AOL?and why we believe they will continue to do so.
It does not argue that AOL is issue-free (it isn?t).
Why People Pay More For AOL
This note deals with a single question?why we believe
people pay more for AOL now and why we think they will
continue to in the future. It does not deal with the most
important long-term question for AOL investors, which, in
our opinion, is whether AOL can offset an inevitable
slowdown in the acquisition of new US premium
subscribers (the market is more than 50% penetrated, in our
opinion) with increased international and advertising and
commerce revenue. (We think the answer is yes, but the
analysis is complicated). We summarize this question at the
end of the note and will go into it in more detail soon.
In our opinion, the reasons people pay more for AOL stem
from the following points. We will discuss each in detail
below:
ú Even with essentially undifferentiated products and
services, people pay more for leading brands.
ú Internet access is a differentiated service.
ú People pay more for additional features (i.e., ?basic?
vs. ?premium?)
ú There are multiple ways to ?charge? for the same
product or service.
ú ?Value? is a function of more than price?and the
perception of it differs from consumer to consumer.
ú Price-shoppers are the least profitable?and, therefore,
least valuable?customers around; many great
companies are happy to leave them to the competition.
ú The volume leader usually has the lowest unit cost.
AOL: What Matters
We believe that the US market for internet access and
services is more than 50% penetrated (i.e., that more than
50% of the total households that will go online?75% of
the country, in our opinion?are already online). In our
opinion, this means 1) that the growth of new subscribers
to AOL will begin to slow within a year or two, and 2) that
the next 25 million households that go online in the United
States will be worth significantly less to ISPs, advertisers, and merchants than the last 25
million (simply because they have less disposable income)?and they will cost more to
attract as customers. On balance, therefore, the per-customer ROI for each incremental
online customer from here on in will decline from current levels, which will lead to a lower
DCF value per customer. This will likely lead to a law of decreasing returns on customer
acquisition cost.
The key challenge for AOL investors is to determine how
much this matters, if at all. Stock multiples tend to expand in times of value-driver
acceleration, and compress in times of flattening or deceleration. For investors who
believe, as we do, that the key value driver for AOL is no longer subscriber growth but
profit growth, the key issue to focus on, in our opinion, is not so much what happens to
access pricing (although this is clearly important for short-term stock performance), but
how much advertising and
commerce revenue per month the company will ultimately
be able to generate from its subscribers. Right now, AOL
generates approximately $5 of advertising and commerce
revenue per month per subscriber. If this number only goes
to $7 a month over the next five years, AOL is overvalued.
If it goes to $20, on the other hand, AOL is undervalued?
whether or not the average monthly subscription fee drops
significantly ($20 a month for 40 million users is nearly
$10 billion in annual advertising and commerce revenue?
or $5 billion in net profit). When you consider that
television generates approximately $40 per month from the
average television household, and that newspapers generate
approximately $70 per month from the average newspaper
household, it seems conceivable that AOL could ultimately
generate $20 per month. |
