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AOL Might Have Puffed Up Sub Figures

America Online might have used a bulk sales initiative with retail partners to inflate its subscriber figures, according to reports.

A story in Friday's edition of The Wall Street Journal reports that AOL's higher-than-expected subscriber loss in the second quarter resulted from the end of a bulk sales agreement with three retailers to sell limited-use accounts for $1 to $3. The deal allowed Target, Sears & Roebuck, and J.C. Penney to offer the discounted accounts to their employees for $10 and keep the extra money.

In its second-quarter earnings report on Wednesday, AOL Time Warner said its online unit shed 846,000 subscribers, with 380,000 lost through AOl ending service to non-paying members. Deutsche Bank estimates another 370,000 of the decline was due to a drop of non-paying trail or retention subscribers.

The news raises further questions about how AOL has presented its business, coming as the company is under investigation for the accounting of advertising deals during the dot-com bubble, when complicated "round-trip" deals were used to inflate revenues.

With such bulk deals, AOL could have puffed up its subscriber numbers, accounting for all the accounts sold in bulk over the year. The Journal said that people inside AOL indicate that the bulk retailer accounts amounted to about 830,000 subscribers in 2001 and 2002, or 15 percent of subscriber growth, at a time when AOL trumpeted its massive consumer base as the key to its strength.

At the time of the bulk deals, AOL Time Warner was led by Jerry Levin, who stressed that the newly combined company's disparate parts were held together by a subscription strategy.

Merrill Lynch analyst Jessica Reif Cohen called the report of bulk deals a "nonevent," stressing that such a subscription strategy, like in the magazine industry, usually results in bulk discounts.

Since Levin's ouster, the company has refocused AOL on wringing higher revenue per subscriber, instead of building up a huge subscriber base through free trials and bulk sales.

Cohen said AOL's current subscriber base consisted of 17.9 million fully billed customers, 3.5 million on limited-use plans, and 4 million on trials.

Many Wall Street analysts turned decidedly optimistic on the online unit's prospects under Don Logan in the run-up to this week's second-quarter earning report.

While AOL Time Warner reported fatter profits, most of its positive results came from one-time events, like the release of "Matrix Reloaded" and its $750 million settlement with Microsoft, and cost-cutting measures.

AOL has lost 1.2 million subscribers in the past year, with most fleeing for high-speed connections or cut-rate dialup plans offered by competitors like NetZero.

Even with the subscriber losses, AOL maintains a huge audience of 25.3 million subscribers. Deutsche Bank forecasts AOL will end the year with 24.5 million subscribers. Maintaining a high audience is key for the online unit's efforts to turn around its advertising business. In the second quarter, AOL's ad revenues fell 48 percent to $179 million.

A shrinking subscriber base could also make it harder for AOL to tap into the lucrative paid search business. Cohen forecasts that search will account for 33 percent of AOL's ad revenues by 2007.

Some investment banks, such as Deutsche Bank, said the reaction to AOL's subscriber losses was "overblown." In a research report issued on Thursday, Deutsche Bank noted that most of the subscribers were not paying, noting that only about 96,000 paying subscribers left the service.

"This level of narrowband subscriber defections is not surprising, and is actually better than the [first quarter] pace," the investment bank stated.

Merrill Lynch said the subscriber losses, while surprising, would not hurt the company's financial position. Cohen said the losses were offset by cost cuts at the online division and an addition of 300,000 bring-your-own-access customers.