Monday, June 9, 1997

America Online
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %>
Phone: 703-448-8700
Website: http://www.aol.com
Price (6/9/97): $57 3/8

HOW DID IT DOUBLE?

It's often darkest before the dawning of the Double. In the case of America Online, as system outages and busy signals tried the patience of patrons and shareholders, the stock continued to connect gains from its October lows. Investors who logged off early, convinced by the abundance of bearish analysts and more than 20 million shares sold short, were simply not online for the steady ascent.

As lucrative content and advertising alliances were struck, the stock price rose. As settlements were reached concerning access and pricing issues, the stock price continued to rise. And when the company surprised analysts with positive earnings for the most recent quarter when the consensus was for another loss, the stock price, yes, rose further still.

BUSINESS DESCRIPTION

America Online, headquartered in Virginia but doing potential business at phone jacks worldwide, is the world's largest online service. The company provides proprietary content and Internet access to more than 8 million customers. In December the company began to offer flat-rate pricing. By doing so, the company's business model shifted from a dependence on subscriber hourly fees to generating sales from advertising and services.

FINANCIAL FACTS

Income Statement

      12-month sales: $1550 million
      12-month income: ($5.9 million)
      12-month EPS: ($.06)
      Profit Margin: N/A
      Market Cap: $6529 million

      Balance Sheet
      Cash: $197.8 million
      Current Assets: $374.8 million
      Current Liabilities: $537.7 million
      Long-term Debt: $18.5 million

      Ratios
      Price-to-earnings: N/A
      Price-to-sales: 4.2

HOW COULD YOU HAVE FOUND THIS DOUBLE?

While the stock traded for as low as $24 back in November as investors began to digest the impact of the new pricing policy, the dial-up congestion was not a surprise. The busy signals of December and January did not slow down the ringing signals at brokerage houses, where shares of AOL were bid up well past $30 a share.

America Online did not become the only profitable online service by being anything less than responsive to the customer. So corrective steps like scaling back marketing expenses to recruit new users and a $350 million investment to increase network capacity were welcome but not unexpected news.

The media attention during the difficult logons and prolonged outages provided ample fodder for the bears, but it was actually a more telling case for the bulls. As angry users were interviewed by the press about their anxiety over not being able to check into their online world, the instant message was clear: America Online had become woven into the fabric of American culture and was clearly another brand name addiction for the masses.

WHERE TO FROM HERE?

The company has taken charges to rectify its arguably liberal accounting practices and that has depleted the balance sheet. The book value of $0.62 a share is barely enough to have bought a dozen minutes of online time in the hourly rate days, and critics often point to the company's market cap valuation of $800 per subscriber as being too high. However, this fails to consider the future growth and the untapped advantages of being a programming juggernaut, not unlike the major television networks.

Analysts believe the red ink is behind America Online and the revised earnings estimates now call for $0.85 a share next year. With a projected 50% earnings growth rate over the next five years the compounding can be encouraging, but the medium's future is uncertain. That is not necessarily a bad thing, as troubled competitors like Microsoft Network (MSN) and CompuServe are rumored to be near cashing out or closing shop.

Even the Internet service providers, which industry experts figured would bury America Online, are struggling to turn a profit. They simply cannot muster the proprietary content to land the major sponsorship deals needed to offset the losses incurred in keeping subscriber fees low. Can America Online be a few industry heartbreaks away from becoming a monopoly?

While the present lofty valuation makes another double in the short term unlikely, it is clear that America Online has set itself apart from the pack and will continue to reap the rewards of its dominance. For those who were unfortunate enough to have sold the company short over the past several months, America Online's logoff has a simple explanation for the money lost: Goodbye.

-Rick Aristotle Munarriz ([email protected])

WE DELIVER - Get The Daily Double delivered
straight to your e-mailbox every evening!