07:09am EDT 28-Apr-99 Morgan Stanley\DW (Meeker, Mary (212)761-8042) AOL
AMERICA ONLINE: GROWING STRONG AND BREAKING RECORDS/P1
America Online(AOL): Growing Strong and Breaking Records
Mary Meeker (212) 761-8042/mmeeker@ms.com Date: April 28, 1999
Industry: Internet Type: Sales/Earnings Analysis
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Rating: Outperform Price: $153
52-wk Range: $176-17
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FY Ends ----EPS----
June Curr Prior P/E
98A $0.05 -- 3,060
99E $0.33 $0.28 464
00E $0.56 $0.55 273
01E $0.80 $0.78 191
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Qtrly ---- 1Q ---- ---- 2Q ---- ---- 3Q ---- ---- 4Q ----
EPS Curr Prior Curr Prior Curr Prior Curr Prior
98A $0.02 -- ($0.01) -- ($0.01) -- $0.05 --
99E $0.05 -- $0.08 -- $0.09A $0.07E $0.11 $0.08
00E $0.12 $0.11 $0.13 $0.12 $0.15 $0.14 $0.16 $0.16
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Shares Outst.: 1,186MM Mkt Cap.: $181B
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KEY POINTS
Last night, America Online (AOL, $153) reported CQ1:99 revenue on a
pro-forma-with-Netscape basis of $1.3B (up 66% Y/Y and 9% Q/Q) and
operating income of $159MM (up 23% Q/Q), with operating EPS of $0.09,
above our estimate of $0.07. The First Call mean estimate of $0.09
was for AOL stand-alone; excluding Netscape, AOL's operating EPS was
$0.11.
AOL subscriber growth was an impressive 42% Y/Y (excluding CompuServe
subscribers), with 1.8MM subscribers added in the quarter. AOL brand
subscribers grew to 16.9MM. Total CompuServe subscribers remain at
approximately 2MM, bringing AOL Inc.'s total subscriber base to 19MM.
AOL advertising and commerce revenues were also impressive at $210MM,
up 119% Y/Y.
This was a quarter of records - 1) AOL generated record operating cash
flow of $611MM; 2) AOL stand-alone (excluding Netscape) recorded its
first quarter with $1B in revenue; 3) AOL's net new subscriber
additions of 1.8MM came in at a record level; 4) the number of
simultaneous users at peak on AOL surpassed 1MM for the first time; 5)
AOL's backlog of advertising and commerce revenues reached a record
$1.3B; 6) AOL Websites for the first time achieved the highest reach
rating of any Web property in the at home, at work, and combined
home/work categories, according to Media Metrics' March results; and
7) ICQ, AOL's Web-based instant messaging service, exceeded 32MM
registered users, up 170% since June.
We are raising slightly/tweaking our F1999E EPS from $0.28 to $0.33,
our F2000E EPS from $0.55 to $0.56, and our F2001E EPS from $0.78 to
$0.80.
We reiterate our Outperform rating on AOL shares. AOL is a leading
multi-branded property on the Web and continues to support broad-based
momentum.
AOL Pro-Forma CQ1:99 -- At a Glance
CQ1:99A CQ1:99E CQ1:98
Revenue ($MM) $1,253 $1,211 $757
Y/Y Revenue Grth. 66% 60% --
Q/Q Revenue Grth. 9% 6% 5%
Gross Margin 45% 44% 36%
Oper. Income ($MM) 159 129 (24)
Operating Margin 13% 11% (3%)
Operating EPS $0.09 $0.07 $0.01
Shs. Out. (MM) 1,186 1,200 933
Pro-forma operating EPS of $0.09 came in above our estimate of $0.07 -
AOL reported pro-forma operating net income on a fully taxed basis of
$109MM (up 23% Q/Q) and EPS of $0.09. Pro-forma reported net income
of $420MM, or EPS of $0.33, included a $567 pre-tax gain on the sale
of Excite shares and $103MM in pre-tax charges related to the Netscape
merger and reorganization.
Total revenue up 66% Y/Y, with strong growth in both online service
and advertising/commerce revenue -- Total CQ1 revenue rose 66% Y/Y and
9% Q/Q to $1.3B. Of the total, online service revenue (69% of
revenues) rose 50% Y/Y and 11% Q/Q to $869MM, advertising, commerce
and other revenue rose 94% Y/Y and 13% Q/Q to $275MM (22% of
revenues), and enterprise solutions revenue (9% of revenue) rose 211%
Y/Y but fell 8% Q/Q. (Enterprise solutions consist principally of
software product licensing fees, technical support, consulting, and,
to a lessor extent, training services.)
On a stand-alone basis, AOL reported its first $1B revenue quarter,
with $1.1B in revenue. The pro-forma advertising, commerce, and other
segment breaks out: $210MM in advertising, $38MM in merchandise, and
$27MM in miscellaneous revenue. Want some comparison? CQ1:99
revenues for Yahoo! ($93MM), Excite ($54MM), and InfoSeek ($30MM)
totaled $177MM. AOL is clearly the big Internet dog. AOL also
reported that its backlog of advertising and commerce revenue rose to
$1.3B.
AOL CQ1:99 -- Revenue Breakdown
Change
CQ1:99 CQ4:98 Q/Q
Total Revenue ($MM) $1,253 $1,147 9%
Online Service ($MM) 869 786 11%
Advert./Commerce/Other ($MM) 275 243 13%
Enterprise Solutions($MM) 109 118 (8%)
AOL subscriber growth is a record 1.8MM - Total AOL brand subscribers
grew to 16.9MM, up 42% Y/Y and 12% Q/Q. AOL added 1.8MM subscribers
in CQ1, its highest add in any quarter. AOL's previous quarter add
record was 1.6MM in CQ4. (Both CQ4 and CQ1 are seasonally strong sub
growth quarters.) For reference, it took 9 years for AOL (beginning
in 1985) to gain 1.8MM total subscribers. Total CompuServe
subscribers remained at approximately 2MM, bringing AOL Inc.'s total
subscriber base to 18.9MM. More than 3MM of these subscribers are
based outside of the U.S.
AOL CQ1:99 -- Subscriber Model ('000)
% Change
CQ1:99 CQ4:98 Y/Y Q/Q
Sub. Base (excl. CompuServe) 16,865 15,086 42% 12%
New Subs., net 1,779 1,600 55% 11%
As % of Tot. Subs 11% 11% -- --
Est. Avg. Rev. Sub. Base 14,022 12,651 37% 11%
Rev./Sub./Month $19.40 $19.11 10% 2%
Pro-forma gross margin of 45% was up from 44% in CQ4. AOL management
attributed the increase in gross margin to network efficiencies and
noted that its average per hour network costs improved 10% over the
previous year. The ramp in high margin advertising and ecommerce
revenues likely also contributed to the gross margin increase.
Opex rose to $407MM, up 39% Y/Y and 7% Q/Q - Marketing expense rose
$6MM Q/Q to $207MM or 17% of revenue (down from 18% in CQ4). G&A
expense rose $17MM Q/Q to $110MM or 9% of revenue (up from 8% in CQ4).
And product development expenses rose $4MM Q/Q to $73MM or 6% of
revenue (flat with CQ4).
Operating margin reached 13% - Operating income was $159MM, up 23%
Q/Q.
Balance sheet fundamentals solid -- Cash and equivalents increased
$1.2B Q/Q to $2.8B. Another reference point - that $1.2B increase is
larger than the total cash and equivalents AOL had on hand at the end
of its last fiscal year, June 1998. A $567MM pre-tax gain on the sale
of Excite shares obviously played some role here. But so did a record
$611MM in operating cash flow. This cow is kicking off some serious
cash, no?
KEY CQ1:99 HIGHLIGHTS:
Welcome to AOL/MovieFone - On February 1st, AOL announced that it was
acquiring MovieFone, the leading movie listing and ticketing service,
for approximately $388MM in stock. For 1998, MovieFone recorded $25MM
in revenue (up 23% Y/Y). The addition of MovieFone's services and
content is a natural for AOL - providing users with useful and
relevant information and services. Tickets and movie info are a
natural for the Internet, and the upshot should be to continue to
build the stickiness of AOL's properties. AOL expects the deal to
close in May.
Major Advertising/Ecommerce Deals - On March 25th, AOL announced that
it had reached a $75MM, four-year marketing alliance with eBay. eBay
will pay AOL $75MM for a prominent presence across all AOL brands.
Under the terms of the deal, AOL will be entitled to all the
advertising revenues generated by the co-branded sites and may act as
the exclusive third-party ad sales force for eBay's main site, should
eBay commit to running adds on its key pages. The deal was a major
win for AOL, replacing the previous $12MM, three-year deal. It's
impressive to see AOL pile up large advertising commitments. And it's
especially impressive to see AOL re-up existing advertisers at higher
rates and for longer terms.
On February 3, 1999, AOL and First USA announced a 5-year marketing
deal, under which First USA will be the exclusive marketer of credit
cards on AOL properties. If successful, the companies expect the deal
to generate up to $500MM in revenue. As with the eBay deal, this was
a re-up and an expansion in terms of size and duration - a solid
accomplishment. Even more important, the deal marks the Internet's
largest advertising and marketing partnership to date.
DSL Deals with Bell Atlantic and SouthWestern Bell - On January 13th,
AOL and Bell Atlantic announced a strategic alliance to provide high-
speed DSL access to AOL customers. On March 11th, AOL and SBC
Communications announced a similar deal. As an access provider,
solving the broadband issue is a major challenge for AOL. Both of
these deals were positive steps towards solving the issue; they should
also lead to similar deals with other telcos.
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