What should happen to AOL?

Many options exist for Time Warner's Internet service provider as the unit starts to improve.

Los Angeles Times Staff, April 21, 2004 Wednesday From Lexis Nexis

America Online Inc. used its richly valued stock to swallow Time Warner Inc. only weeks before the Internet bubble burst. Three years later, Time Warner has indigestion, and it's trying to decide what to do about it.

Executives at the New York-based media conglomerate are considering selling AOL to a telecommunications firm or a private equity group, or spinning off the business to shareholders, according to a person familiar with Time Warner management's thinking. They might also merge it with an Internet player such as Yahoo Inc., which is run by former Warner Bros. co-Chairman Terry Semel, or InterActiveCorp, where Barry Diller, the former media mogul, is chairman.

Another alternative would be to sell AOL's aging dial-up access business and keep the growing broadband portion. Time Warner could even hold on to the entire AOL unit in hopes of profiting from the recovery in online advertising. America Online Chief Executive Jonathan Miller and other top AOL executives are scheduled to present their financial results and an updated long-term strategy to Time Warner's board of directors at its regular meeting Thursday. AOL's leaders also will talk strategy at a retreat next month with Time Warner management, according to a person close to Miller.

Some of the urgency to decide AOL's fate has dissipated in recent months, as the nation's largest Internet service provider has begun to show signs that it may be worth holding on to — at least for now.

A recovery in Internet advertising, better-than-expected sales of its broadband offerings and cost cutting at the dial-up business have all improved AOL's short-term prospects.

"Time Warner is committed to returning AOL to a growth track," said Edward Adler, a Time Warner spokesman. One high-level Time Warner executive said CEO Richard D. Parsons wasn't opposed to selling AOL but first wanted to see whether the unit could turn itself around to fetch a better asking price. Parsons has received "a number of calls" from interested parties, the source said.

Former AOL Chairman Steve Case, who orchestrated the merger, has let it be known that he would be interested if Time Warner ever decides to sell, though he has yet to put in a formal bid, the source said.

Time Warner may not have to make a decision about AOL for several years, analysts said. Even as millions of subscribers dump the dial-up service for faster broadband connections, AOL is expected to contribute about $1 billion a year in cash flow. Last year, the AOL division contributed nearly 22% of Time Warner's revenue of $39.6 billion and accounted for 12% of its $5.4 billion in operating income.

"AOL is not a liability," said Richard Greenfield, a managing director of Fulcrum Global Partners who preached patience. Yet the ability of AOL, which became a powerhouse selling dial-up Internet access, to make the transition to broadband is far from certain. The unit has begun reorganizing its internal financial structure to clearly distinguish its broadband business from dial-up, which would give it the option of one day spinning off the dial-up business, the person close to Miller said. It's a humbling turnabout for AOL, which snapped up the world's biggest media concern in one of the largest corporate mergers in history.

When the deal was unveiled in January 2000, proponents hailed it as the ultimate combination of old media and new, a convergence of content and the pipes needed to distribute it.

Few of the promises held true. The stock market crash, an advertising slump and fights between the AOL and Time Warner factions helped destroy $173 billion in shareholder value. Most of the top leaders from the AOL Time Warner days have departed, including Case and Gerald Levin, the former CEO.

The company's stock, which was worth $47.23 when the merger wrapped up in January 2001, closed Tuesday at $16.76, down 6 cents on the New York Stock Exchange.

The company's regret over the deal became clear in the fall, when it dropped AOL from its name and changed its ticker symbol back to TWX.

"They've not been able to fully leverage what AOL does into the Time Warner framework," said Jay Desai, chief executive of the Institute of Global Competitiveness in Raleigh, N.C.

Meanwhile, AOL's core business began to wane as consumers switched to faster broadband connections over DSL and cable lines. The total number of AOL subscribers worldwide — which peaked in 2002 at 34 million — fell to 32 million at the end of 2003. Making matters worse, the Securities and Exchange Commission began investigating the way AOL accounted for some of its big advertising deals.

But now the online ad market is recovering sharply, as evidenced last week by the doubling of Yahoo's first-quarter profit. Time Warner will report its results next week. J.P. Morgan analyst Spencer Wang predicted that AOL's ad revenue would grow 5% this year and 16% in 2005 after three years of declines.

Also, the growing popularity of broadband Internet connections hasn't hurt AOL as badly as some had feared. AOL has stemmed some of the financial pain by cutting costs and persuading more people who get their broadband elsewhere to pay an additional $14.95 a month for AOL content through its "bring your own access program." Altogether, Merrill Lynch analyst Jessica Reif Cohen predicts AOL will have 4.4 million broadband subscribers by the end of next year, up from 2.7 million last year.

There are even signs that the Time Warner and AOL factions are putting their paralyzing culture clash behind them. Last week, AOL announced that its instant messenger program would be integrated into the Matrix Online game produced by Warner Bros. Interactive Entertainment, and that AOL for Broadband would include exclusive features from "Smallville," which airs on the WB network. CED Broadband Direct

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