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To: Impristine who wrote (46960)	3/23/1999 2:34:00 PM
From: Glenn D. Rudolph	Respond to of 164684

2 [Note to readers: Back issues of The Internet Capitalist can be viewed on SG Cowen's Web site at www.sgcowen.com/rs/rs5.html.] The Week Online Alchemists: Turning Consumers Into Cash We visited AOL management last Friday in their Dulles, VA headquarters and had the opportunity to get an update on the business, see how their broadband strategy is unfolding, and query them on an emerging thesis we have for the likely source of their next large revenue stream. Herewith, the details. Subscriber Growth Remains Unusually Strong We suspect the March quarter could very well exceed the December quarter's record 1.6 million new subscriber additions, with continuing strength from International properties. This would be the first time in the company's history where they were able to add more subscribers in the March quarter than they added in the December period. Our estimate of 1.2 million new subscribers for the March quarter is way too low. Of course, it's helpful to remember that gross margins, S&M, and ad/commerce are all impacted by subscribers in some way, so let's go through them in turn. Gross Margins Seem Stable, Despite This Surprise Increase Doesn't sound like the addition of these new subs has caused any undue strain on the network (i.e. no major increases in COGS from the great subscriber growth): AOL has been doing 1mm+ simultaneous users on the network for the last 4 weeks and have been doing about 420 million hours on the network per month (54-55 minutes of usage per member per month). Importantly, they have been increasingly successful in pre-building the network to accommodate such increase in usage. In addition, AOL invented the market for spot modem capacity; with access to 1.5mm modems at a moments notice, they can meet (some) usage demand in real time without too much negative P&L impact. Our estimate for gross margin, at 38.2% (vs 38.5% last quarter) is likely a touch low. Sales & Marketing Expenses Too, Remain In Check Once again, we believe we'll find that AOL added these new subs without too much effort on the marketing front. Increasing returns = viral marketing = word of mouth buzz, an equation you've heard us repeat before. Though we never want to underestimate the power of viral marketing, AOL isn't simply spending money on acquiring subscribers but building out a portfolio of brands (AOL, Compuserve, Digital Cities, ICQ), so we're not going to get carried away with our optimism on how low S&M could go. Surely our 12% estimate ($130mm) for S&M could be too high, though we expect it to be in a range around that figure. Ad/Commerce Remains Strong; Retailing Activity Continues To Be Buck The Seasonality Trend We're not sure the Street needs more data points than the one from the deal AOL struck with First USA a few weeks back: $500mm over five years. That said, we can't help making the observation that “other revenue” lags the addition of subscribers; that is, great subscriber growth allows for even greater ad/commerce revenue down the line (by allowing AOL to “over-deliver” on their deals and get into the “upside” part of their ad/commerce deals. Management confirmed our belief that Internet retailing has continued to buck the seasonality trend by remaining strong during CY:Q1 (just as Amazon had intimated). Pittman stated that some 60% of AOL users had purchased something online by now; their goal