My Life and Times

June 3, 2005
Free Internet Site: A Portal to AOL's Future?
By SAUL HANSELL and GERALDINE FABRIKANT

Last month, America Online convened a meeting broadcast on the Web to its 14,000 employees. The purpose was to show off the free Internet portal that it is about to introduce at AOL.com, the third attempt in three years to offset AOL's steady loss of subscribers.

Before the unveiling, Richard D. Parsons, the chief executive of Time Warner, AOL's parent, spoke. "AOL is not for sale," he said, according to two people who were in the audience.

"AOL is not for spinout," he added. "AOL is for keeps."

But a few days later, Mr. Parsons was quoted as saying that he was, in fact, open to spinning off some AOL shares to the public. Then Barry Diller, an established Internet bargain hunter, said publicly that he had been interested in adding AOL to his holdings last year, but had turned up his nose at hints that the price would be $20 billion.

Whether or not AOL is about to be cast off, its reversal of fortune is striking. Five years ago, when its merger with Time Warner was announced, America Online alone was valued at $164 billion. Now, as it sets out to reinvent itself, its place within Time Warner is in question.

The merger has long since become a symbol of the misbegotten assumptions and skewed calculations among old and new media at the height of the technology bubble. And as Mr. Parsons's varying statements indicate, what to do about AOL is a pesky puzzle.

The new portal will offer sections on news, sports and business, much as Yahoo does, along with some original programming, like music videos, and an emphasis on interests like women's fitness. The challenge is how to create a free Internet site compelling enough to attract traffic and advertising - with much of the content it previously reserved for paying customers - without hastening the demise of its subscription business.

AOL thinks its risks are low because few of its members join simply for the content, and some of its specialized content will still be reserved for subscribers. In any case, if the payoff is a bigger share of the resurgent Internet ad market, it calculates that a further loss in subscribers is a risk worth taking.

Almost from the time of the merger - in which AOL was, lest it be forgotten, the acquiring party - the online service has been in decline, dragging down Time Warner's share price. Some analysts say AOL is now worth just $8 billion, even as Internet companies like Google and Yahoo have surpassed it as hot properties.

Any day now, Google's market value, currently $80 billion, could pass Time Warner's $81 billion value. Google's annual sales last year came to $3.2 billion, against Time Warner's $42 billion, but investors see Google as the future, and Time Warner and AOL as the past.

AOL has also been a drag on Time Warner's reputation as the Internet unit went through three years of criminal and civil investigations of its accounting practices. Those cases were resolved in recent months through settlements that cost the company $510 million and forced it to restate past revenue. Related shareholder lawsuits remain outstanding.

All the while, AOL has kept shrinking - to 21.2 million subscribers in January from 26.5 million in 2002 - as the dial-up customers it brought online shift increasingly to high-speed access from their phone and cable companies.

Now, with the free portal, Mr. Parsons is about to embark on the most fundamental effort yet to revive AOL.

If AOL's latest attempt to tap into the booming online ad market works, it could provide a much-needed source of growth. If not, it may be tempting to simply jettison the online service - which many Time Warner executives blame for the evaporation of much of their retirement savings - before its value falls any further.

Mr. Parsons declined to comment for this article. But Donald Logan, the chairman of Time Warner's media and communications group, which includes AOL, said the company was committed to keeping the online unit.

"We have never put AOL up for sale," he said. "There is nothing going on and no thought of doing anything other than making AOL work."

When Mr. Parsons says AOL is for keeps, he may well be saying that he has no other choice. For now, there is probably no prospective buyer willing to pay Time Warner more for AOL than it is worth to keep. AOL still sends its parent nearly $1 billion in cash each year and, largely through cost-cutting, has remained highly profitable. Moreover, any sale would most likely bring large capital-gains taxes.

Mr. Parsons evidently harbors some hope that if AOL can find a path toward growth, it may again add some pizzazz to Time Warner's stock, which has lingered under $20 for three years. (The shares were above $46 when the merger closed in 2001, already in retreat from the $73.75 price when the deal was announced.)

But if AOL is to provide a boost, it will have to find a way to rival the investor appeal of companies like Yahoo and Google, said Richard Greenfield, a media analyst at Fulcrum Global Partners.

"The question remains, How does AOL fit into that new world?" he said. "Is there a place for AOL in the Internet? How long do you keep spending to reinvent AOL? Or do you just harvest the cash out of the dying Internet access business?"

All this puts no small amount of pressure on Jonathan Miller, the chief executive of the AOL unit, based in Dulles, Va., to make the latest turnaround strategy work. When he was hired in mid-2002, Mr. Miller talked of a future for AOL as a hub for online shopping and transactions, which he argued was a more reliable business than advertising.

But he quickly realized that his principal mission was to stem the rapid defection of AOL subscribers to faster Internet service offered by cable and telephone companies.

Mr. Miller spent several years and many hundreds of millions of dollars building a $15-a-month product called AOL for Broadband that included content like music videos and services like antivirus protection, but not the actual Internet access. It succeeded in retaining five million AOL members who might otherwise have canceled their service (and lost their AOL e-mail addresses). But it largely failed to draw new customers.

So AOL, which virtually invented Internet advertising, has spent more than a year playing catch-up with rivals like Yahoo and MSN. It has just finished replacing its own publishing system so it can take ads in the same standard Internet format as other sites. And Michael Kelly, a longtime Time Warner executive brought in to run ad sales, has started to repair AOL's reputation on Madison Avenue.

"Their sales force is now very focused and very competitive," said Greg Smith, executive vice president and director of media practice at Carat Interactive, an online buying agency. "They are much more willing to work with you."

Now those sales efforts are focused on the elaborate Internet portal planned at AOL.com, a site that has been largely used by its paying members to check their e-mail while at work, executives of AOL say. AOL.com will draw much of its content and its tone from the AOL service, with its flashy headlines, big photographs and instant polls.

But AOL will not give away those aspects of its paid service that its research shows are most appealing: special features for children with access controls for their parents, Spanish- language pages, protection against viruses and spam, and e-mail addresses at AOL.com. (The free service will offer e-mail at AIM.com.)

Of course, AOL's Internet service, which costs $23.90 a month, is facing ever more competition from low-price dial-up providers and even some broadband providers. This week, SBC Communications started offering high-speed Internet service to new customers at $14.95 a month.

AOL hopes to leapfrog its rivals by using the latest technology in its new portal, particularly with video. The site will begin public tests this month and should be generally available by the end of the summer. AOL will try to draw traffic to the portal from its assorted free properties, including Netscape, Mapquest, Moviefone and most important, the AOL Instant Messenger chat system. Collectively, those services are used by more than 50 million people a month who are not AOL members.

AOL also hopes that by moving its content outside its members-only service, its pages on many subjects, as diverse as musicians and diets, will be indexed by Google and other search engines.

"My biggest problem is the walled garden," said Mr. Kelly, who runs all of AOL's Web properties in addition to ad sales. "The world can't see the good stuff we do every day."

By sometime next year, if ad dollars are flowing in and investors start to bid up Time Warner shares, the bet will have paid off.

If AOL.com is doing well but Time Warner shares are still flat, Mr. Parsons may be interested in selling a partial stake in America Online to the public. This sort of spinout in theory would let investors put an independent value on AOL and allow the online unit to make acquisitions with its own stock.

The questions will be tougher if Mr. Miller's portal flounders as badly as AOL for Broadband has.

If Mr. Parsons is then inclined to sell, not many media or technology companies would have the combination of resources and need to spend $8 billion or more for a shrinking Internet service business. Microsoft is the most logical buyer because it could fold in its own Internet service, but pursuing a business with little growth potential is hardly Microsoft's style.

AOL's huge audience, and especially its instant-messaging franchise, would be of some appeal to Yahoo and Google, but such a deal would sharply curtail their earnings growth. Mr. Diller's company, InterActiveCorp, does not shy from complex deals, but Mr. Diller likes to buy things on the cheap and Mr. Parsons does not want to look as if he was taken advantage of.

In theory, a private equity firm might be the perfect buyer for a shrinking AOL. Michael Gallant, an analyst with CIBC World Markets, said that AOL's pretax operating profit could well double if a buyer simply wanted to cut marketing and product development costs and squeeze every last dollar out of its existing customers.

"The business is easily worth $15 billion in the slash-and-burn scenario," he said.

Roger McNamee, an experienced technology investor, said that "seems like an obvious deal-in-waiting, given the disastrous results today." Still, he said, the financing for an AOL buyout would be tricky.

In the end, he said, "AOL is worth more to Time Warner than it is to a private equity firm."

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