AOL Time Warner Still Fixing Holes



The AOL Problem

AOL Time Warner Chief Executive Richard Parsons says the company has made some progress in digging itself out of the financial sinkhole it fell into after the merger of AOL and Time Warner. He also said there's "a lot of hard work in front of us" before all the company's moving parts are in sync, back on track and operating at maximum efficiency.

With major problems at America Online, questions about its cable strategy, and two major government investigations looking into its accounting practices, analysts and investors could not agree more.

Investors tagged AOL TW's stock with a nearly 7% decrease the day it issued its second-quarter earnings results last Wednesday, as America Online continued to be a drag on its revenue and profits. The stock was down another 3% in midday trading the following day (to $15.19).

The company said that both the Securities and Exchange Commission and the Department of Justice continue to investigate "a range of transactions principally involving" AOL. Recently, the Office of the Chief Accountant at the SEC affirmed an earlier SEC staff conclusion that AOL incorrectly allocated $400 million paid to it by Bertelsmann as advertising; the company said it disagreed with that conclusion.

Even so, the company said it may have to restate past earnings results, pending the final outcome of the investigations.

During a conference call, company officials said they continue to consider a possible spinoff of Time Warner Cable, although an initial public offering wouldn't occur before the SEC investigation is resolved. The agency won't allow the IPO to go forward before then, the company said.

Of some concern within the cable unit was a second quarter slowdown in the number of new high-speed–modem hookups, which averaged about 13,100 a week for the period, down 14% from second quarter 2002.

One factor there, analysts said, was aggressive rate cutting by the phone companies for their own high-speed services. "Given the increasingly competitive nature of the market, this is a trend that will be watched closely," said Jessica Reif Cohen, Merrill Lynch's top entertainment-company analyst.

AOL TW is "not fully out of the woods yet," she continued. On the other hand, investors probably overreacted, at least somewhat. "We believe the operating and restructuring story at AOL Time Warner is just under way."

There are some positive signs, she noted, including reduced debt and "continued impressive results" from the company's filmed entertainment, cable networks and cable divisions. Companywide revenues were up 6% to $10.8 billion, led by gains at those three units.

It's America Online that is the problem. AOL revenues were down 6% to $2.1 billion.

Corporate operating income was down 15% to $1.3 billion, with AOL, networks and publishing posting declines. Filmed entertainment was the big gainer, up 24% to $407 million, while cable was up 11% to $752 million.

Network advertising was up 17%, including a 16% increase at the Turner networks and a 23% gain at The WB.

The company reported second-quarter write-downs of $364 million ($945 million for the first half) on investments (AOL Japan and NTV-Germany among them) showing "other-than-temporary" declines.