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AOL?s pricey deal for broadband
Cable deal may help ISP expand high-speed, but at hefty cost
By Julia Angwin
THE WALL STREET JOURNAL
Sept. 21 ? AOL Time Warner Inc. appears to have found the broadband deal Wall Street has been waiting for ? but it wasn?t cheap. After months of complex negotiations, AOL and Comcast Corp., the Philadelphia cable-services company, are finalizing an agreement giving AOL the right to sell a high-speed version of America Online to a portion of the 22 million cable TV customers Comcast will have once it completes its purchase of AT&T Corp.?s AT&T Broadband unit. The deal is part of a larger agreement between AOL and AT&T to dissolve a content-and-cable partnership called Time Warner Entertainment.
AMERICA ONLINE has agreed to pay the soon-to-be-combined AT&T Comcast $35 to $40 for each high-speed, or broadband, Internet subscriber it signs up, according to a person familiar with the arrangement. That rate is one of the highest in the industry. By comparison, EarthLink Inc., the nation?s No. 3 Internet provider, pays AOL?s own Time Warner Cable unit less than $30 for each such subscriber. In addition, America Online has agreed to give AT&T Comcast a cut of the advertising, e-commerce and other revenue it generates from these high-speed subscribers, according to people familiar with the terms.
All in all, it?s a pricey package that could translate into reduced profit margins for America Online. The world?s largest Internet service provider is already under pressure as subscriber growth slows and ad revenue plummets. For the slower-speed, dial-up service, America Online typically spends only about $8 a month on phone and computer-network costs for the average one-hour-a-day user, while charging consumers $23.90 a month, for a profit margin, before other expenses, of 67%. For the broadband service, America Online is likely to charge consumers a premium price of $54.95 a month ? higher than most competitors? ? yet end up with a profit margin before other overhead of only around 27%, because of the far higher fixed costs in the Comcast agreement.
Despite its financial pinch and depressed stock price, AOL has little choice but to spend freely. America Online?s best hope for re-energizing itself is to hitch its wagon to the growing demand for broadband Internet connections. America Online?s core dial-up business, while profitable, is maturing. And the rationale for AOL?s merger with Time Warner was that the two companies could use a broadband platform to distribute movies, music and other programming to customers nationwide. AOL hopes that getting America Online onto one outside cable system will help persuade others to sign on and further expand the service?s availability beyond AOL?s own Time Warner cable systems.
The deal also could help AOL?s chief rival, Microsoft Corp., which invested $1 billion in Comcast in 1997 and $5 billion in AT&T in 1999. (MSNBC is a Microsoft - NBC joint venture.)
When AT&T and Comcast agreed to merge last year, Microsoft obtained the right to an Internet agreement with AT&T Comcast on at least the same terms that it gives to anyone else. ?It gives us some level of protection,? says Bob Visse, marketing director for Microsoft?s MSN service, which says it has about 8.7 million subscribers, both dial-up and broadband, compared with America Online?s 35 million subscribers. Neither one breaks out high-speed subscribers.
CABLE CONNECTION ?CRITICAL?
Broadband is a rare bright spot in a struggling communications market. U.S. residents are buying broadband for their homes at a rapid pace. The number of high-speed Internet subscribers in the U.S. last year jumped 60% to 10.5 million from the year before, according to Forrester Research Inc. in Cambridge, Mass. The market?s fastest-growing segment is so-called cable modems, while digital-subscriber lines, or DSL, from phone companies have lagged behind.
?Cable-modem connections are outselling DSL two to one,? says Adi Kishore, an analyst at Yankee Group in Boston. ?From a long-term perspective, it?s critical that AOL get a cable connection.?
America Online has been available on DSL since 1999, but it has largely been shut out of cable.
While telephone companies have been required to offer rival Internet service providers wholesale access to their DSL lines, most cable companies face no such requirement and have been reluctant to offer a third-party Internet connection over their networks. Time Warner Cable began making America Online, EarthLink and other Internet services available to its 10.8 million customers last year.
Under the terms of the AOL deal, AT&T Comcast will make America Online available to a minimum of 30% of its subscribers by the end of the three-year contract, rolling it out in a staggered fashion after the cable merger closes, according to a person familiar with the deal. The deal provides for faster expansion if the parties agree. AT&T Comcast will bill customers for the America Online service ? something AOL had resisted in the past, hoping to build direct relationships with its high-speed Internet customers.
Investors are clearly hoping for a boost to America Online?s prospects. The deal could ?change the view of AOL, from a long-term-challenged business to a long-term-growth business with short-term issues,? says Henry Ellenbogen, investment analyst at T. Rowe Price, one of AOL?s largest shareholders.
Meanwhile, Microsoft and EarthLink are pursuing America Online?s slower-speed, high-profit customers. Microsoft will soon roll out an updated version of its online service, called MSN 8, that includes sophisticated parental controls ? a core feature of America Online. And EarthLink this week launched a feature that prevents all pop-up ads; AOL has recently begun limiting its own pop-up ads.
Even so, some investors expect AOL will ultimately prevail, just as it has in the past. ?They?ve been competing with Microsoft for a long time,? says Morris Mark, president of Mark Asset Management, an institutional shareholder in AOL. ?They have a huge potential head start.?
Copyright © 2002 Dow Jones & Company, Inc.
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