America Online – 28 April 1999
2
Summary. AOL logged a great FQ3, easily exceeding
consensus EPS, subscriber, and advertising and commerce
growth targets. The other key metrics we look at—gross
margin, operating margin, marketing spending and
efficiency, network efficiency, and usage per month—
were also impressive. Netscape lost money and fell slightly
short of expectations, but this was expected and, in our
opinion, no big deal. Our only disappointment with the
quarter was that we were not able to raise estimates as
much as we had hoped. We would not be surprised to see
the stock trade off near-term—it usually does after the
company reports earnings—but we still think the
intermediate and long-term outlook is excellent and the
stock remains a core holding.
Outlook remains excellent—but keep an eye on Netscape
enterprise revenue and estimate trends. We are still in the
second inning of a nine inning game (development of the
interactive services industry), and AOL has an impressive
lead. We would keep close tabs on 1) the magnitude of
estimate increases over the next few quarters (at some
point, we may not raise estimates anymore), and 2) the
expected growth of the AOL/Sun/Netscape enterprise
solutions revenue. AOL is guaranteed to receive $330
million in revenue a year from Sun, but our estimates call
for nearly twice that in F2000. The market for commerce
software is highly competitive, and the alliance's
complicated structure, in our opinion, will make it difficult
for the company to gain share.
On a stand alone basis (excluding Netscape), AOL
reported a fully taxed EPS of $0.11 vs. $0.02 a year ago,
exceeding our estimate and consensus of $0.09. The
upside resulted from higher than expected advertising and
commerce revenue, gross margin, and operating leverage.
EPS would have been as high as $0.12 had the company
not spent a penny more than expected in G&A—a result of
high payroll tax associated with the exercise of a high
number of stock options (Unnerving? Yes. But given the
stock's 1000% run-up in the last year, not all that
surprising). Including Netscape, EPS were $0.09 vs. a loss
of $0.08 last year. During the quarter, AOL recognized a
pre-tax gain of $567 million due to the sale of shares in
Excite. Including this gain, EPS were $0.33 on a
consolidated basis.
Subscriber growth of 1.8 million surpassed our original
estimate of 1.15 million and even beat our revised
estimate of 1.7 million. Importantly, marketing efficiency
(marketing spending per net add) improved in the quarter:
the company spent only $127 million on marketing—less
than our estimate and less than last quarter. At the end of
the quarter, the total AOL member base was 16.9 million,
up 41% year-over-year (19 million including
CompuServe).
Advertising and commerce revenue also beat our estimate
and consensus, increasing 25% sequentially to $157
million (AOL stand-alone). This represented a major gain
in market-share versus the other industry leader, Yahoo!,
which was up only 13% sequentially (AOL has lost
advertising and commerce market-share to Yahoo! for the
last 6 quarters). On a conslidated basis, advertising and
commerce revenue increased 12% sequentially and 114%
year-over-year to $210 million—nearly 3X the level of the
company's closest competitor (Yahoo!) and more than the
total revenue of Yahoo!, Excite, Infoseek, and Lycos
combined. Consolidated backlog increased an astounding
62% sequentially, from $804 million to $1.3 billion. The
last major component of the “other revenue” line,
merchandise sales, increased 58% year-over-year, which
was surprising, given management's stated intention to
“wean” itself of this revenue stream over time.
Total revenue (consolidated) of $1.3 billion exceeded our
estimate of $1.2 billion, increasing 66% year-over-year.
Subscription revenue increased 51% year over year to
$869 million. Other revenue, made up primarily of
advertising, commerce, merchandise, and joint-venture
agreements, increased 94% year-over-year to $275 million,
well ahead of our estimate.
The gross margin (stand-alone) increased 250 basis
points to 41%, despite record growth in the subscriber
base. Management attributed the leverage to increased
network efficiency. The company's per-hour network
costs decreased more than 10% year-over-year—and this
was enough to offset an slight increase in average usage
from 48 to 55 minutes per day. Because of an increased
pace of network build-out to support the large addition to
the subscriber base, we expect the margin to drop a point
or two next quarter.
Marketing expenses (stand-alone) were only $127 million
versus our estimate of $132 million, despite the huge
increase in the subscriber base. The company's customer-acquisition
cost decreased from a year ago. We expect
subscriber growth to stay strong over the next year (we are
looking for the company to add another 4-5 million
subscribers in F2000, versus the exceptional 5.4 million
added this year).
Additional operating leverage boosted the pre-goodwill
operating margin another point--to 17%. The operating
leverage in the AOL stand-alone model continues to
surprise us. Most of the unexpected leverage this quarter
was the result of the improvement in the gross margin, but
operating leverage was also higher than expected.
Cash flow from operations increased to $611 million, up
an impressive $400 million sequentially, but was largely
the result of a $400 million increase in accrued expenses
and liabilities.
An already strong balance sheet got stronger. The
company currently has $2.3 billion in net cash. |
