Since then, Case has made deals with AT&T and Microsoft, previously AOL’s blood enemies. And earlier this month, AOL announced strategic flip-flops and distressing numbers that have driven down its stock almost 25 percent since May 7, when it closed at an all-time high of $70. It’s far too early to write off Case, 37, who in a decade has built AOL into a colossus despite having to change strategies more often than most chief executives change underwear. But AOL is now facing its most major business is its closed system, which only AOL subscribers can reach. (Starting next month, AOL’s offerings will include Newsweek InterActive.) But the world is moving toward open systems, in which anyone can access anything. For instance, Motley Fool, a hip stock-market-oriented service, used to be available only to AOL customers. These days you can get it free on the Internet.
In an interview last month, Case claimed not to be worried. He said AOL will thrive by providing sophisticated services to the cyberskilled while charging the rest of us for guidance through the unstructured net. “Only 11 percent of U.S. households are online,” Case argues. “Why aren’t the other 89 percent? They think it’s too hard and too complicated, and they’re right.”
He dismissed questions about when, if ever, AOL would make real profits. AOL, you see, runs substantial cash losses, its reported profits notwithstanding. As we discussed in October, the company does this with accounting. Rather than charging its promotional expenses against profits as it spends money, AOL charges them off over 24 months. In October, I estimated its cash outflow at $75 million a year. But the company has ramped up its promotions. By my math, AOL ran through $185 million in the nine months that ended on March 31, despite reporting a $35 million pretax profit. How? Deferred expenses-money AOL has spent but not charged to profits-rose to $315 million from $96 million. Case said last month that AOL could improve its cash flow by cutting back on promotion, but had no plans to do so. “We’re going to turbocharge our growth,” he said. Oops. On May 8, the company said it was cutting promotion. I couldn’t reach Case last week to ask him what had changed. AOL’s Richard Hanlon said the cutback had nothing to do with saving money. Rather, he said, AOL wants time to cope with its growth problems, and with the rising turnover rate among its customers. In the March quarter, AOL added 2.2 million new customers, but lost 1.3 million old customers.
The turnover is spooking Wall Street. That’s troublesome, because AOL really needs the Street. For starters, AOL periodically sells new shares to raise money to cover its cash deficit. And AOL’s top honchos make most of their money on stock options rather than salary. Case, for example, is paid only $200,000 a year, but has made $19.7 million in the past five years by cashing in stock options. That’s my number, based on data from CDA/Investnet, which tracks insiders’ stock transactions. Case’s remaining options and stock are worth about $100 million.
Another problem bothering the Street is price-cutting. AOL charges $9.95 a month plus $2.95 for every hour over five. But some services, including AT&T, offer flat rates of about $20. So starting in July, AOL will offer a $19.95 rate that includes 20 free hours. This cuts a 20-hour user’s bill by almost 60 percent. AOL claims revenues won’t drop because some light users will switch to the $19.95 plan even though it will cost them more.
The bottom line: I think AOL’s stock-market value of $6.8 billion is way too high. Then again, I thought its $4 billion valuation seven months ago was too high, too, Even Steve Case’s best scrambling can’t prop AOL’s stock forever. Someday, he’s going to have to score by showing real profits or pull off a financial Hail Mary miracle play by selling AOL. Know a good, hungry phone company?
