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Analyst Sounds Alarm on AOL Subscriptions

Merrill Lynch media analyst Jessica Reif Cohen is raising concerns again about subscriber growth at AOL Time Warner's flagship ISP. In the process, her report is helping to fan more chatter about whether AOL will be cast out of the corporate fold.

With AOL's drop in advertising revenues over the past two years well documented, including its revised outlook for 5 percent less in full-year advertising and subscription revenues, Cohen is now asking whether subscriptions will be the next to fall at the ISP.

"Our concern is that as AOL advertising hits bottom and begins to recover, AOL's subscription revenues may be hitting a peak of their own," Cohen wrote in her latest research report.

New advertising business generated at AOL is hardly replenishing the quickly depleting backlog, her report said. Meanwhile, her estimate for AOL's 2003 advertising and commerce revenue is $1.2 billion, down 26 percent from the current year estimated ad revenues of $1.6 billion, 41 percent below from the year before.

In addition, her "worst case" scenario suggests that without incremental revenue from broadband applications, AOL's cash earnings from subscription fees could decline to an estimated $850 million in 2003 from a peak of $2.3 billion in 2001.

AOL has already said it expects 2002 advertising and commerce revenues of about $1.7 billion, about 5 percent lower than it expected. However, the larger media company expects to end up with revenue growth in the 5 percent to 8 percent range.

In addition to the lowered expectations on AOL's ad revenues, Cohen said her review of subscription growth in the AOL segment was rooted in her analysis of the economics of AOL's broadband offering. The service, she wrote, is not as attractive as the dial-up service for cash earnings, ("$9.66 per sub. per month vs. $13.04, respectively").

She also questioned the economics of AOL's broadband strategy in relation to "the steep and potentially growing access fees AOL is required to pay" to cable companies as part of its broadband service.

"Accordingly, the notion that AOL broadband will be a profitability savior for the AOL business may be a flawed concept, unless it is successful in driving substantially higher revenue per household through premium services."

Cohen's latest research report, in which she maintains a neutral rating on AOL Time Warner, can only crank up the stakes for the beleaguered AOL, just as it readies its Oct. 15th release AOL version 8.0.

The report comes as the Dulles, Virginia-based ISP nears the end of internal and regulatory probes of its accounting procedures while reorganizing management and business lines in the wake of major shake-up at the top that culminated with a new chief executive, Jonathan Miller, taking AOL's reins.

Cohen's report, meanwhile, describes an AOL division that is an increasing drag on the larger company's fortunes. The media giant's Warner Brothers movie studio, publishing, cable networks, cable and music divisions are performing at "either record levels or at the top end of relative industry growth," she wrote.

While allowing that "some of the strength may, in part, be attributed to affiliation with, and access to, sister-company AOL's unique promotional prowess," Cohen also wrote that the other division's strengths are "masked by AOL's near-term operating weakness and long-term strategic uncertainty."

Her report, and comments about AOL's outlook compared to the other Time Warner divisions, are bound to keep aloft the oft-raised question about whether the marriage of Time Warner and AOL can survive.

"Time Warner assets are gangbusters but AOL remains a concern. Where would Time Warner's stock price be if it had not merged with AOL? Perhaps an even more interesting question is where would AOL's stock price be if it had not merged with Time Warner?"

Shares of AOL Time Warner were up by 17 cents, just over 1 percent to $10.84 in midday trading on Wednesday, the day the report was released.