AOL Rides Its Credibility to
Blue-Chip Status
By Cory Johnson
West Coast Bureau Chief
4/5/99 5:28 PM ET
There once was a time when America Online (AOL:NYSE) was the
embodiment of all that a Net stock was -- in other words, a profitless
company, full of hype, with a ridiculously inflated stock price. Moreover,
the critics liked to carp that America Online had second-rate
management, third-rate technology and fourth-rate bookkeeping ... the
long of it was a short. And how: At one point, AOL was among the
most popular short targets on Wall Street.
These days, the shorts are lucky if they've kept their white-collared
shirts. Since the end of the fourth quarter of 1997 -- America Online's
last profitless quarter -- the stock is up 1,226%. Yes, $10,000 invested
in AOL 15 months ago would've netted you about $122,000, while a
$10,000 short would've netted you a job at McDonald's (MCD:NYSE).
But here's the rub. AOL's stock-market success story is not the tale of
a Net stock turning a profit and gaining Wall Street's favor. Rather, it's a
tale of a Net stock that is no longer considered a Net stock. To Wall
Street, AOL has become the Internet's lone blue-chip.
"This stock was absolutely vilified by the investment community two or
three years ago," says Ryan Jacob of the $340 million Internet fund.
(His own fund was among those that initially stayed away.) "But these
days, in my mind, portfolio managers now look at AOL in the same vein
as a Coca-Cola (KO:NYSE) or a Gillette (G:NYSE)."
In terms of size at least, America Online is a behemoth. No other Net
stock comes close to its 934 million shares, or its $154 billion market
capitalization. Need further proof that AOL doesn't really have a peer
group? Think of the biggest Internet stock you can. And then another.
And another. AOL is still bigger: Its market cap is more than 90% larger
than the combined value of eBay (EBAY:Nasdaq), Amazon.com
(AMZN:Nasdaq) and Yahoo! (YHOO:Nasdaq).
The triumph of AOL's business
model has been trotted out far and
wide. But AOL's success in
shedding the stench of its Internet
brethren has been just as
impressive. About three years ago,
the company began taking some
savvy steps to woo Wall Street.
AOL buried one consistent
complaint about its accounting by
taking a painful, but one-time hit to
earnings. The company was
roundly criticized for amortizing
marketing expenses -- like those
annoying discs it mailed to the
universe -- sometimes stretching
out those costs over two years.
This was an affront to
conservative financial types, the
kind of impending disaster that
draws short-sellers out of the woodwork. In October 1996, AOL finally
gave up defending the practice and took a one-time charge of $385
million to write off these deferred costs.
Hiring dazzling management hasn't hurt either. When AOL hired Bob
Pittman -- not only a former Time Warner (TWX:NYSE) and Century
21 muckety muck, but also a former disc jockey -- it found a guy who
talks the Wall Street talk. As the corporate pitchman, he had no peer
among garage-band Net companies. "Retail investors don't get a chance
to see this, but management of this company is just so impressive,"
says Brian Hayward, manager of Invesco's $407 million Worldwide
Communications fund. Hayward managed an impressive 41% return in
1998, with America Online, his largest holding, pacing the way. "By Wall
Street standards, Pittman might not be the best," Hayward says. "It's not
so much that he's as impressive as, say [AT&T (T:NYSE) CEO] Michael
Armstrong, but in the Internet space, no one comes close to AOL's
management."
America Online also took the unusual step on Sept. 1, 1996, of leaving
the Nasdaq for the venerable New York Stock Exchange. While
bigger tech players like Microsoft (MSFT:Nasdaq), Intel
(INTC:Nasdaq) and MCI WorldCom (WCOM:Nasdaq) were all content
with Nasdaq, AOL sought the prestige of being listed alongside the
Citibanks and Con Edisons of the world. Street credibility followed in
suit.
The coup de grace came with AOL's Dec. 22, 1998, addition to the S&P
500. S&P 500 index funds, like Vanguard's $78.1 billion behemoth, had
to pony up for AOL shares. More so, while mainstream funds could
choose to ignore the eye-popping gains of Net stocks, they couldn't
ignore the S&P 500. "At the end of the day, your benchmark is the S&P,"
says Jacob. "The fact is, now that AOL is in the S&P, active fund
managers have to deal with it."
Are any other Net stocks on their way to blue-chip status? There's no
consensus, though money managers cite Amazon.com and Yahoo! as
contenders. But for now AOL shares stand with no one. "For the last
two years, there's been only one stock that active fund managers felt
comfortable with," says Jacob. "And that's AOL."
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