Tech Center
Facing Loss, America Online's Ally
Watches Its Expectations Dim
By THOMAS WEBER
Staff Reporter of THE WALL STREET JOURNAL
One of the Internet's best-known electronic-commerce deals has hit a pothole.
Tel-Save Inc., a tiny reseller of long-distance service, gained prominence
when it agreed to pay America Online Inc. $100 million to be its marketer.
But Monday, it reported a stunning third-quarter loss and replaced its
chairman.
The main culprit: a whopping extra $76.9 million that Tel-Save spent,
primarily for off-line marketing -- or good old-fashioned telemarketing and
direct mail -- aimed at AOL's members.
Tel-Save announced a net loss of $41.7 million in the third quarter. Excluding
a one-time gain, it had a loss of $92.3 million on $122.5 million in revenue.
Now Tel-Save, in a filing with the U.S. Securities and Exchange Commission,
says it wants to revise the terms of its AOL deal or possibly face "a material
adverse effect" on its financial condition.
Monday's developments contrast sharply with the hopes for Tel-Save's
high-profile alliance with AOL when the deal was struck early last year. AOL
agreed to market the discount long-distance service to its 14 million members
through such devices as the ads members see when they sign on.
The news calls into question the benefits of Tel-Save's arrangement with AOL,
which was hailed as a landmark in online marketing and commerce. Tel-Save's
willingness to bet so much on the AOL deal was considered proof that the
nascent medium had come of age. AOL says it has delivered what it promised.
"The program has been tremendously successful in its objective, which was to
sign up lots of subscribers," says Barry Schuler, president of AOL's
interactive services unit. People familiar with the Tel-Save marketing efforts
say AOL has so far signed up some two million Tel-Save customers -- more
than double the 750,000 originally projected.
No Profit
But with Tel-Save flailing amid losses and heavy spending on additional
marketing, it is far from clear that the return has been worth the investment.
Sales are up substantially -- Tel-Save posted a 53% jump in third-quarter
revenue as its subscriber base rose. But so far, the company has failed to
convert those revenue dollars into profit.
"They've definitely expanded their customer base," says Ted Levy, senior vice
president and equity strategist at McDonald & Co., Rochester, N.Y. "But at
what cost? The model of selling low cost via the Internet has not been met."
Tel-Save, of New Hope, Pa., has earned a reputation as one of Wall Street's
most controversial telecom stocks. Most recently, it has been known for a
series of confusing pronouncements by its chief executive, Daniel Borislow, in
which he indicated the company would be sold but later changed his mind. The
announcements have sent the company's stock reeling in both directions.
Monday Tel-Save also announced that Mr. Borislow would step aside and hand
the company's reins to Gabriel Battista, a veteran Internet executive who runs
Network Solutions Inc., the company that registers the "dot.com" addresses
used on the Internet. Despite the third-quarter loss, Tel-Save's shares rose
20% to finish $2.1875 higher at $12.9375 in Nasdaq Stock Market trading as
investors cheered the company's new CEO.
Back in February 1997, when the marketing deal was announced, it shook the
online industry. Tel-Save wouldn't just use the medium to recruit customers.
It also planned to move customer service online, sending bills electronically
over AOL and thus saving the cost of printing and postage.
With a little-known company willing to pay $100 million up front just to talk
to AOL's members, online marketing gained its biggest vote of confidence. In
short order, AOL also reached multimillion-dollar agreements with
Amazon.com Inc. and 1-800-Flowers Inc.
Warning Flag
Today, with $100 million marketing deals between merchants and Web
"portal" sites becoming routine, the experience of Tel-Save is a warning flag
for those who would stake their business model on e-commerce without
reconciling costs and revenue.
Mr. Borislow says Tel-Save simply overreached. The company poured on
extra marketing efforts with AOL as part of an effort to dress up Tel-Save for
a possible acquisition.
"We thought [having] more customers would give us a higher price," Mr.
Borislow says. "In retrospect, it was a foolish decision on my part." Mr.
Battista, who is slated to take over as chairman, chief executive and president
in the next several weeks, couldn't be reached for comment.
Mr. Borislow says the additional marketing efforts -- which involved sending
$50 checks to AOL members to get them to sign up for phone service -- were
effective in recruiting customers. "But it wasn't an efficient method," he adds,
because the cost was too high for Tel-Save.
One factor may be the composition of the online audience, suggests Abhi
Chaki, senior analyst at Jupiter Communications, a new-media research
concern in New York. Mr. Chaki says the decision to sign up as an AOL
member is often spurred by the younger members of a family, but the choice
of long-distance service remains squarely the province of Mom and Dad --
who may still be more susceptible to traditional marketing methods like phone
calls and direct mail.
Under that theory, it will still make sense for companies like Tel-Save to
devote a substantial portion of their marketing dollars off line, Mr. Chaki
says. "To reach the decision makers, they may have to take this hit." |
