AoL’s Sputtering Online Growth Engine

On January 7, AOL Time Warner CEO-designate Richard Parsons broke the bad

news: This year, his company will grow at about half the rate originally

promised when its $97 billion merger closed a year ago. Because of the ad

recession, he said, revenues will rise only 5% to 8%, while cash flow will be up

just 8% to 12%. The announcement hardly helped the company’s standing on Wall

Street. Since the merger closed in January 2001, AOL Time Warner stock has

fallen 33%, to $32 on January 9.

But the drop in ads for the magazine, TV, and online units is only part of

the problem. A deeper worry is the plight of AOL itself. Generating a quarter of

the company’s revenues and cash flow, the AOL online division is the company’s

engine for long-term growth. But now, the combination of slowing growth for

dial-up subscriptions and the pokey progress of AOL’s broadband business could

cause that engine to sputter.

After years of heady growth, some subscriber slowdown was inevitable. AOL

membership grew by only 24%, to 33 million, last year, compared with a 30% jump

in 2000. And growth will likely continue to shrink as the number of US dial-up

users plateaus at about 50 million households over the next five years,

according to online researcher Jupiter Media Metrix. That will mean a big dent

in cash flow: Along with a soft online ad market, the subscriber stall will cut

AOL’s cash-flow growth from 76% in 2000 to as low as 18% in 2002, says a

Goldman, Sachs analyst.

That’s why AOL is counting on broadband. By mid-2002, it plans to launch

premium-priced services, such as Web phone calls and HBO-on-demand delivered via

a connected set-top box to consumers’ TVs. COO Robert Pittman has said that

someday, AOL could charge subscribers $159 a month for broadband access,

multiple users per household, telephony, online music, games and films. "We’re

constantly inventing these services to ensure steady growth," he says.

But those plans may be tough to pull off. For starters, simply converting

dial-up users to broadband won’t dramatically boost cash flow. AOL’s sole

cable partner, Time Warner Cable, reaches only 20% of cable households. If it

wants to provide broadband services to its customers through other cable

companies, AOL will have to pay about $30 a month per user, according to Lehman

Brothers. So, even if AOL persuades other cable operators to deliver its

service, it will pay them a hefty cut.

It’s also far from clear that consumers will bite. AOL’s broadband

service may already be pricey for many. What’s more, AOL will face stiffer

competition in broadband from Microsoft. Its MSN unit also plans to leverage the

giant’s software strength by offering services such as online banking, games,

and music.

Indeed, if AOL wants to claim its supposed broadband birthright, it had

better get serious. Otherwise, it may get an even colder shoulder from Wall

Street–and subscribers.

By Catherine Yang with Tom Lowry in New York and Jay Greene in

Seattle in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc